Falling Fuel Prices Hit Variable Component of Kentucky Tax, Hurting Road Fund

AASHTO Journal, 21 November 2014

Kentucky Transportation Secretary Mike Hancock. Photo by Gov. Steve Beshear’s office. Some rights reserved.

The fall in motor fuel prices is poised to take a big bite out of Kentucky’s Road Fund come Jan. 1, which the Kentucky Transportation Cabinet said could require delays and even cancellation of some road and bridge projects.

The KTC said the variable component of the state tax on gasoline, diesel and ethanol will fall 4.3 cents a gallon for the quarter starting in January, triggered by an October Department of Revenue survey of average wholesale fuel prices.

If continued for an entire year, the KTC said, that tax decline would cut $129 million out of state road and bridge funds. However, even a quarterly slice could take away tens of millions of dollars in fuel tax revenue, depending on how much motor fuel is purchased in that period.

“The gas tax accounts for more than half of the revenue in the Kentucky Road Fund,” said Kentucky Transportation Secretary Mike Hancock. “A loss of revenue is always concerning, but a revenue impact of this magnitude is crippling. It means less money for building, improving, maintaining and repairing our roads, streets and bridges.”

A $129 million loss would be about 6 percent of Kentucky’s highway program, which was forecast to have $2.25 billion from all sources for the fiscal year ending June 30, including state and federal fuel taxes and a state usage tax on motor vehicles.

The formula adjustment will drop the state fuel tax on gasoline to 27.6 cents a gallon from 31.9 cents now, at a time when consumers are already pocketing big savings from the lower retail pump prices.

Like most states, Kentucky has fixed, per-gallon excise taxes. But the KTC explained that in the 1980s the Legislature included a variable, 9 percent wholesale tax under which receipts could rise or fall with fuel costs. The state makes quarterly adjustments in the gallon-equivalent tax rate based on a cost survey conducted in the prior quarter.

A number of other states have moved in recent years to adopt wholesale price-based taxes or use a blended system of fixed and variable taxes, in order to capture more revenue with rising inflation over time while the fixed fee allows predictability. Many have built in floor price mechanisms to guard against sudden price drops.

Kentucky enacted its variable tax component at a time when prices were rising rapidly, so the Legislature included a 10 percent per year cap on any increases to limit the impact on consumers. But it did not include a similar protection for the Kentucky Road Fund against sudden, sharp declines in fuel prices.

January’s tax decline will be the fourth out of the last five quarters, said the KTC. Just since the new fiscal year began July 1 the drop will have totaled 4.9 cents a gallon, which the agency said could result in a loss of $147 million in transportation revenue over a year.

Things could get worse for the transportation budget before they get better, if the next survey in January finds prices down even more and further cuts into fuel tax receipts. And if the state’s variable tax does not recover soon, that cap on increases could lock in lower taxes for entire next fiscal year beginning in July.

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