Gas Tax vs. Sales Tax: Which Wins?

In his statement today concerning public transit the Governor Blagojevich outlined his preferred plan to increase the level of transit funding:

The plan that I prefer would redirect – not increase – revenue from the existing sales tax on gas in Cook and the collar counties for the RTA. That’s money that is already collected from drivers who contribute to congested roads and air pollution in our region. It makes sense to dedicate that revenue to mass transit, and it also helps reduce congestion and air pollution.

The remaining hole in the state budget can then be filled with revenue from an expansion of gaming in Illinois – an expansion that every one of the legislative leaders has already agreed needs to get done to fund a statewide infrastructure plan.

There are some things to like about this approach, which appears to have the support of the Republican leaders and perhaps Senator Jones. The Governor recognizes that linking the gas tax (or more precisely the sales tax on gas) to transit makes good public policy. Drivers who create congestion, who benefit from the congestion relief benefits of public transit, and who contribute a large measure of air pollution, including greenhouse gases, properly are called upon to subsidize transit service. Those who drive the most tend to pay the most, which creates a bit of an economic incentive against sprawl.

While the Governor appears unwilling to increase the gas tax (or embrace congestion pricing for that matter) to reduce the congestion and pollution resulting from excessive private auto use relative to road capacity, linking transit funding to the gas tax is something that his successor can build on to start pricing auto travel in a way that promotes the most efficient use of the Chicago region's highway and transit systems.

The Governor's gas tax plan takes existing gas tax revenue from the six-county Northeastern Illinois region and applies ("diverts" in some eyes no doubt) that revenue to the region's public transit system. Filling the resulting hole in the State budget becomes someone else's problem while the RTA, the Chicago Transit Authority, Metra and Pace spend their new money. This is not a bad scenario if you are a transit supporter.

The Governor recommends that revenue from expanded gambling can fill the hole in the State budget created by the application of the gas tax monies to transit. There is something to like here as well, especially if you live in northeastern Illinois. A fair amount of that revenue will be generated from people from outside northeastern Illinois or even Illinois itself who gamble when visiting Chicago or other Illinois gambling facilities. The burden of transit funding thus is spread outside of the six-county region, another nice benefit for that region. The region gets the gas tax revenue for its public transit system but is not completely on the hook to fill the resulting hole in the State budget.

Using gambling revenue to replace the gas tax monies used for transit could put the City of Chicago is a difficult spot, however. On the one hand, the City presumably wants to find a source of funding for CTA and Metra service that serves the City. On the other hand, if that source of money requires the City to give up proceeds from a Chicago casino that would otherwise go to the City, then transit doomsday might not look so bad to the City.

In contrast, the sales tax built into SB 572 is not as directly tied to transit or driving. Charging a bit higher sales tax on a big screen TV, for example, is not likely to prompt anyone to change their driving habits. The sales tax has proved insufficient to keep up with transit agency costs, so it is a matter of time--likely only a few years--before the proposed sales tax increase in SB 572 proves inadequate for the transit agencies to maintain their current service levels. The increased reliance on the sales tax does not help the RTA diversify its funding base, even though such diversification is key to the long-term financial health of the public transit system.

When it comes to the predictability of revenue the sales tax wins. One virtue of the sales tax is that is does not vary that much from year to year. In contrast, a sales tax on gasoline sales is likely to bounce around with the changes gas prices.

On balance, however, taxing driving to pay for transit is at least as good an alternative as the sales tax to provide funding for transit. In many respects, a gas tax is superior.

Surely it is possible to amend SB 572 to swap out the sales tax increase in favor of the redirection of the sales tax revenue on gas, leaving in the CTA union concessions and the much ballyhooed RTA reforms. Hopefully, someone is work on that right now.

The RTA Sales Tax And Its Limits: Lack Of Diversification

The following comment to a recent post on the risks associated with fixing the current transit funding problem with more of the same--namely, a hike in the RTA's sales tax--struck me as right on:

Justin said...

An excellent argument for the inadequacy of the sales tax. Here's another argument against SB572: it puts all the RTA's eggs in one basket.

Practically, any good investor will distribute her capital across a number of stocks or bonds to spread her risk, and transit agencies are no exception. Theoretically, public transportation provides measurable benefits to a variety of beneficiaries, implying that a "rational" or tailored subsidy structure would include a similar variety of revenue sources. Most agencies, like the RTA boards, have some control over their fare revenues, yet depend on others for the rest. To spread the risk of one funding source going sour, transit agencies should seek to derive major revenues from at least two or three different sources, preferably even more.

For instance, the MBTA gets revenues from roughly two sources: state sales taxes, and local assessments which are largely paid from property taxes. Many European transit agencies' funds originate from multiple levels of governmental jurisdictions, many of which share revenues and which are derived from a mix of Value-Added Tax, income tax, and business taxes. New York's operating subsidies come from a wide variety of taxes and jurisdictions ultimately based on the real estate market, businesses, petroleum use, and a sales tax in southern Connecticut, suburban New York State, the outer boroughs, and Manhattan itself. (There's an even an old post on this blog somewhere about the variety of MTA's subsidies, I think). [Old post here.]

By contrast, excessive reliance on a single source for operating subsidies is theoretically less than ideal, and risky and frustrating in practice. By continuing to rely solely on the sales tax, the RTA may soon regressing to doomsday.

Indeed, other robust transit agencies have been able to respond to cutbacks in subsidy from one source by substituting other sources. In Europe, these shifts often took place in the context of political decentralization, where the devolution of fiscal autonomy from central governments to regions appears to have caused an increased level of transit capital funding. U.S. transit agencies have responded to the cutback in federal operating subsidies with gradually higher state and local funds.

To echo Davey's comment, discretionary spending on consumer goods may decline quickly during an economic slowdown, yet cities rely on public transit to provide low-cost mobility even in hard times. In addition, sales taxes tend to be regressive, exacting a higher proportion of income from those least able to pay.

I agree with the Moderator that a long-term funding solution should look beyond the sales tax for theoretical and practical reasons. Taxes on real estate, parking, or (even better), road tolling are the way to go. Or the RTA comes hat in hand in a few years to a populace that won't want to hear it.

The Puzzling Persistence Of The Sales Tax Increase As The Preferred Funding Solution

Tuesday's apparently desultory hearing by the House Mass Transit Committee into alternatives to an increase in the RTA sales tax and the continued efforts to push for passage of SB 572 with that tax increase in place prompts the question--what is so great about relying on the sales tax as the primary source of transit funding in Northeastern Illinois?

As the CTA points out, its sales tax funding base has failed to keep pace with inflation over the past twenty years:

CTA has grappled with a steep decline in inflation-adjusted funding levels. CTA’s public funding for mainline bus and rail operations trailed inflation by approximately one percent every year. If funding since 1987 had kept even with inflation, the CTA would have received cumulatively $1.6 billion more to operate its buses and trains.

The situation has been deteriorating in recent years:

The CTA’s public funding is growing at a much slower rate than related expenses. Public funding levels only increased by four percent over the past five years and trailed inflation, which increased by 11.3 percent in the same time period. By comparison, CTA has also experienced substantial cost increases in fuel, materials (due to a lack of capital funds) and security.

If that is not enough, the RTA is reducing the CTA's public funding mark for 2008 by $14 million compared to this year's mark, surely a reflection of larger problems with the adequacy of the RTA sales tax as a funding source.

The CTA accounts for about 80 percent of the transit ridership in the region. Pace's financial condition is no better and it is on the path to a doomsday of its own. Even Metra, which for years was living high on the hog with more sales tax money than it could spend on operations, is making dark threats of a 20 percent fare increase and major service reductions. Clearly, the existing sales tax funding base is insufficient to serve the current needs of the transit system.

The inadequacy of the sales tax as the near-exclusive funding base for public transit in this region is illustrated by a simple fact. The RTA system relies on the same sales tax funding base that it did in 1985. Yet, even though that system now carries 20 percent fewer passengers than it did then, it is in a financial crisis. In other words, the same sales tax base cannot support a transit system that is 20 percent smaller than it was 20 years ago.

The inadequacy of the sales tax base is even more dramatic when considering the transit system's market share. Given the growing and sprawling population in the region, transit's market share declined even more sharply than its 20 percent decline in ridership. Clearly, the current sales tax funding base could not support transit's more robust 1987 market share if that market share magically reappeared since it cannot support even today's shrunken market share.

There is nothing wrong in the short term to increasing an already inadequate sales tax. Yet, the same factors that have made the growth in the existing sales tax inadequate will continue to work on the increased sales tax as well. The same cost factors--labor, fuel, pension, security--and possibly a few others that have outpaced the growth in sales tax revenue will almost certainly eat up the sales tax increase before too long. SB 572, if enacted, only postpones the day of reckoning resulting from the region's over reliance on the sales tax to fund public transit.

The real estate transfer tax built in SB 572 is a good starting point to diversifying the public transit funding base. Maybe that tax should be expanded throughout the six-county region under the rationale that travelers and property owners in all counties benefit from the congestion relief and other benefits associated with transit. A parking lot tax, increased auto registration fee, congestion pricing, a gas tax increase, and the like make up a menu of alternatives to a sales tax increase (or supplements to a smaller sales tax increase).

Let's for the moment assume, however, that SB 572 passes as is. How long will it be before the service boards and the RTA eat up the incremental sales tax revenue generated by the tax increase and start rolling out the next set of doomsday scenarios?

Predictions please.