Identifying and Quantifying Rates of State Motor Fuel Tax Evasion (2008)

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TRANSPORTAT ION RESEARCH BOARD WASHINGTON, D.C. 2008 www.TRB.org N A T I O N A L C O O P E R A T I V E H I G H W A Y R E S E A R C H P R O G R A M NCHRP REPORT 623 Subject Areas Planning and Administration Identifying and Quantifying Rates of State Motor Fuel Tax Evasion Mark Weimar BATTELLE Richland, Washington Patrick Balducci Eihab Fathelrahman Susan Whitmore BATTELLE Portland, Oregon Anthony Rufolo PORTLAND STATE UNIVERSITY Portland, Oregon Research sponsored by the American Association of State Highway and Transportation Officials in cooperation with the Federal Highway Administration

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CRP STAFF FOR NCHRP REPORT 623 Christopher W. Jenks, Director, Cooperative Research Programs Crawford F. Jencks, Deputy Director, Cooperative Research Programs Andrew C. Lemer, Senior Program Officer Eileen P. Delaney, Director of Publications Margaret B. Hagood, Editor NCHRP PROJECT 19-06 PANEL Field of Administration—Area of Finance Debra A. Hillmer, South Dakota Department of Revenue, Pierre, SD (Chair) Robert A. Turner, Montana DOT, Helena, MT Cindy Anders-Robb, Federation of Tax Administrators, Cheyenne, WY Ron Hagquist, Texas DOT, Austin, TX J. Chris McAdams, North Carolina DOT, Raleigh, NC B. Starr McMullen, Oregon State University, Corvallis, OR Ashley Mixson, III, Frankfort, KY Joe O’Gorman, State of New Jersey, Trenton, NJ Robert Slaughter, National Petrochemical & Refiners Association, Washington, DC Anne Price Warhola, American Petroleum Institute, Washington, DC Martine A. Micozzi, TRB Liaison AUTHOR ACKNOWLEDGMENTS The research documented in this report was performed under NCHRP Project 19-06 by Battelle, with Portland State University acting as a subcontractor. Dr. Mark Weimar of Battelle managed the project and was the principal author of Chapter 5. Patrick Balducci of Battelle was the principal author of Chapters 3, 4, and 6 and a major contributor to Chapters 1, 2, and 5. Susan Whitmore of Battelle was the principal author of Chapter 1 and a major contributor to Chapters 2, 3, and 4. Dr. Anthony Rufolo of Portland State University was the principal author of Chapter 2, was responsible for conducting extensive interviews with tax administrators and industry representatives, and served in an advisory capacity in the development of the methodology presented in Chapter 5. Other contributors to the project included Eihab Fathelrahman of Battelle (Chapter 5), Katie Cort of Battelle (Chapter 5) and Chris Monsere of Portland State University (Chapter 2). The authors wish to thank the tax administrators and industry experts who were interviewed for this study. The authors also wish to thank the NCHRP 19-06 Topic Panel, chaired by Debra Hillmer, for the thoughtful guidance they provided in support of this project. C O O P E R A T I V E R E S E A R C H P R O G R A M S

This report presents the results of a study of state motor fuel tax evasion. The study was intended to provide states with a methodological approach to examine and reliably quan- tify state motor fuel tax evasion rates and support agency efforts to reduce differences between total fuel tax liability and actual tax collections. While state agencies’ unwillingness to make data available for the study limited the research team’s ability to achieve fully the project’s objectives, the report presents a comprehensive review of the literature on fuel tax evasion, assesses characteristics of state collection and enforcement practices, and identifies how these characteristics have traditionally correlated with certain types of evasion. The report also describes methods that could be used by states seeking to measure motor fuel tax evasion. The report will be useful to state government officials and others responsible for managing fuel tax collection and enforcement programs, researchers, and others con- cerned with fuel tax evasion and its curtailment. Revenues from motor fuel are used primarily to support the states' transportation sys- tems. In these times of large state budgetary deficits and shortfalls of revenues compared with needs for highway funds, it is particularly important that all motor fuel tax funds are collected, remitted, and credited to the respective state highway accounts. However, allega- tions of significant evasion of these taxes persist. The extent of loss of revenue from fuel tax evasion and the causes are not well understood. In the absence of reliable estimates for motor fuel tax evasion rates and evasion mechanisms, agencies cannot judge how to most effectively mobilize and deploy their enforcement resources. For states to maximize receipt of their motor fuel taxes, they must develop effective enforcement resources and use those resources efficiently. To do so, the states must be able to determine the origin and extent of fuel tax evasion and to evaluate the potential effective- ness of enforcement options. To assist agencies in meeting these challenges, the American Association of State High- way and Transportation Officials (AASHTO) requested the National Cooperative Highway Research Program (NCHRP) to undertake Project 19-06, Identifying and Quantifying Rates of State Motor Fuel Tax Evasion. This report is the final product of that study. The objective of this research project was to develop and demonstrate a methodology for identifying and quantifying state-level fuel tax evasion. The methodology, as envisioned, would account for different practices among states that may lead to different rates of eva- sion. The results from applying this methodology would allow individual states to develop and evaluate potential solutions and enforcement options. A research team led by Battelle – Pacific Northwest Division, Richland, Washington, con- ducted the research. The project entailed first reviewing the literature and other ongoing F O R E W O R D By Andrew C. Lemer Staff Officer Transportation Research Board

research on fuel tax administration, enforcement, and evasion, and current state agency practices for fuel tax enforcement. An effort then was made to identify and collect state data on fuel tax collections and enforcement activities that could be used to analyze geographic, administrative, and other parameters that might be expected to explain the character and levels of evasion in states and variations among states’ experiences. In most states, the highway system is constructed and operated by the department of transportation, while fuel taxes are collected and tax regulations are enforced by a different agency. The ability of the research team to collect data was limited by the reluctance of most state revenue agencies to make data available for analysis. These agencies cited concerns for confidentiality of taxpayer information as the basis for their reluctance. Using data that were collected and knowledge from other work, the team developed a methodological approach to estimating state fuel tax evasion, presented the approach to selected professionals for review and discussion, and finally made refinements based on comments received. The results presented in this report describe a methodology for estimating the error, omission, and evasion (EOE) level for each of nine defined types of fuel tax evasion. The methodology relies generally on three approaches to estimating EOE: (1) audit and inspec- tion, (2) tracking to follow fuel from terminals to taxpayers, and (3) statistical analyses of sales for selected retail outlets. The report also describes data needed to undertake estima- tion of EOE levels.

C O N T E N T S 1 Summary 4 Chapter 1 Introduction and Background 4 1.1 Introduction 4 1.2 Background 5 1.3 Motor Fuel Tax Administration and Enforcement 5 1.3.1 Point of Taxation 6 1.3.2 Diesel Fuel Dyeing 7 1.3.3 Auditing Efforts 7 1.3.4 Uniformity and Coordination 8 1.3.5 Electronic Reporting 8 1.3.6 Fines and Punishments 8 1.4 Methods of Quantifying Motor Fuel Tax Evasion 9 1.5 Motor Fuel Excise Tax Revenue Forecasting 9 1.5.1 Federal Revenue Forecasting Models 11 1.6 Data Sources 11 1.7 Fuel Tracking 12 1.8 Other Relevant Studies 12 1.8.1 Highway Cost Allocation Studies 12 1.8.2 Highway Apportionment Models 13 1.8.3 Examinations of Alternatives to Motor Fuel Taxation 13 1.8.4 Montana Motor Fuel Tax Evasion Study 14 Chapter 2 Perspectives on State Fuel Tax Enforcement Practices 14 2.1 Introduction 14 2.2 Methods Used to Evade Motor Fuel Taxes 16 2.2.1 Use of Dyed Fuel On-Road 16 2.2.2 Abuse of IFTA Return Process 17 2.2.3 False Refunds or Credits 18 2.2.4 Bootlegging Across State Lines 18 2.2.5 False Claim of Export 19 2.2.6 Illegal Importation of Fuel from Foreign Refineries 20 2.2.7 Abuses Due to the Presence of Native American Reservations 22 2.2.8 False Product Labeling 22 2.2.9 Cocktailing 22 2.2.10 Tampering with Fuel Dye Equipment 23 2.2.11 Failure to Splash Dye 23 2.2.12 Illegal Removal of Dye from Exempt Fuel 24 2.2.13 Failure to Remit Tax Payments 24 2.2.14 Daisy Chains

25 2.3 Issues Related to the Point of Taxation and Refunds 25 2.3.1 Comparison with Other Excise Tax Systems 27 2.3.2 Moving the Point of Taxation as a Strategy for Decreasing Evasion 29 2.3.3 Refunds 30 2.4 Issues Arising from the Lack of Coordination and Uniformity in State Taxing Systems 30 2.4.1 Lack of Uniformity in Tax Systems 32 2.4.2 International Borders 32 2.4.3 Intra-Governmental and Inter-Governmental Coordination 33 2.4.4 Native American Fuel Sales 35 2.4.5 IFTA 35 2.5 Issues Related to Fuel Tracking, Bonding, and Licensing 36 2.5.1 Tracking Systems 37 2.5.2 Bonding and Licensing 38 2.6 Issues Related to State Enforcement of Motor Fuel Tax Collection 38 2.6.1 Education and Outreach 39 2.6.2 Information 39 2.6.3 Verification of Information 39 2.6.4 Audits 40 2.6.5 Fines and Punishment 45 2.7 Issues Related to Motor Carrier Enforcement 46 2.7.1 Motor Carrier Enforcement 50 2.7.2 Effectiveness of Motor Carrier Enforcement 51 Chapter 3 Strategies, Methods, and Tools to Measure and Evaluate State Fuel Tax Evasion 51 3.1 Introduction 51 3.2 Strategies, Methods, and Tools for Examining Evasion 51 3.3 Literature Review Method 52 3.4 Audit Review Method 52 3.5 Border Interdictions Method 53 3.6 Survey of Tax Administrators Method 53 3.7 Comparison of Fuel Supply with Taxed Volumes Method 54 3.8 Econometric Analysis 54 3.8.1 CSG and GPA 1996 Study of Motor Fuel Tax Evasion 54 3.8.2 Mingo et al. 1996 Study for Proposed Diesel Tax in Oregon 55 3.8.3 Eger and Hackbart 2001 Study of 50 States 56 3.8.4 Hackbart and Ramsey 2001 56 3.8.5 Addanki et al. 1987 Gasoline Tax Evasion in New York 57 3.8.6 Eger et al. 2003 Agricultural Consumption of Tax-Exempt Fuel in Midwestern States 57 3.9 Alternative Econometric Methods 57 3.9.1 Simultaneous Fuel Supply and Demand Model 58 3.9.2 Tobit Model 59 Chapter 4 Data Availability 59 4.1 Introduction 59 4.2 Overview of Data Categories

59 4.2.1 Transportation Data 60 4.2.2 Motor Fuel Data 61 4.2.3 Tax Administration, Enforcement, and Collections 62 4.2.4 Economic and Population Data 63 Chapter 5 Methodology for Identifying and Quantifying State-Level Fuel Tax Evasion and Required Data 63 5.1 Introduction 63 5.2 EOE Estimation Approaches 64 5.2.1 Tiered Approach to EOE Estimation 64 5.2.2 Approach #1: Audit and Inspections Analysis 66 5.2.3 Approach #2: Fuel Tracking Approach 67 5.2.4 Approach #3: Statistical Analysis of Sales 67 5.2.5 Remaining Issues and Caveats 67 5.3 Decision Tree for Individual State Analysis 67 5.3.1 Key Questions: 69 5.4 Evasion Techniques 69 5.4.1 False Refund or Credit 70 5.4.2 Evasion of Dyed Fuel Laws 74 5.4.3 Abuse of IFTA Return Process 75 5.4.4 Evasion Associated with Exporting/Importing Fuel Across State Lines 77 5.4.5 Illegal Importation Across International Borders 78 5.4.6 Failure to Remit 79 5.4.7 Cocktailing and False Labeling 80 5.4.8 Abuses Due to the Presence of Native American Reservations 82 5.4.9 Daisy Chains 82 5.5 Detailed Data Recommendations 82 5.5.1 Introduction 83 5.5.2 Quantity of Information 83 5.5.3 Temporal Element of Data Collected 83 5.5.4 How to Define EOE 83 5.5.5 The Need to Control for Double Counting 83 5.5.6 Data Recommendations 89 Chapter 6 Conclusions 89 6.1 Introduction 89 6.2 Motor Fuel Tax Evasion at the Federal and State Level 90 6.3 State Perspective on Motor Fuel Tax Evasion 90 6.4 Motor Fuel Tax EOE Estimation Methodology 91 6.5 Disseminating the Outcome of the Research Project 92 References 97 Appendix A Glossary 101 Appendix B Interview Protocol

105 Appendix C Interview Responses 105 C.1. Responses Related to the Point of Taxation and Refunds 111 C.2. Responses Related to Coordination Issues 121 C.3. Responses Related to Fuel Tracking Systems, Licensing, and Forms 124 C.4. Information and Documentation for Motor Fuel Excise Tax Forms 127 C.5. Responses Related to Enforcement Issues 132 C.6. Responses Related to Audits 139 C.7. Prosecution of Motor Fuel Cases 140 C.8. Responses Related to Motor Carrier Enforcement 146 Appendix D Annotated Bibliography 177 Appendix E Acronyms