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41.1 Introduction Revenues from motor fuel are used primarily to support the statesâ transportation systems. In this time of large state budgetary deficits, it is particularly important that all motor fuel tax funds are collected, remitted, and credited to the re- spective state highway accounts. Allegations of significant fuel tax evasion, however, persist, and the extent and causes for this loss of revenue are not fully understood. To effectively en- force tax codes, it is important to determine the origin and ex- tent of fuel tax evasion and to be able to evaluate the potential effectiveness of enforcement options. This report is completed as part of a NCHRP project to iden- tify and quantify rates of state motor fuel tax evasion in order to evaluate options for closing the gap between total tax liabil- ity and actual tax collections. The objective of this research project is to develop and demonstrate a methodology for iden- tifying and quantifying state-level fuel tax evasion. This report provides background material related to state fuel tax policies and techniques that have been used to evade these taxes in the past. The report analyzes methods that have been used in the past to estimate fuel tax evasion and characterizes the data available for such research. The report focuses on developing reliable estimates for motor fuel tax evasion rates to enable states to identify and measure state fuel tax evasion. The methodologies presented allow individual states to tailor approaches that suit the needs of their states and evaluate potential solutions and enforcement options. This report is divided into six chapters, the first being this introduction and background on the motor fuel excise tax evasion issue. Chapter 2 presents perspectives on state fuel tax enforcement practices and highlights information gathered through interviews with state motor fuel tax administrators. Chapter 3 presents strategies, methods, and tools used to mea- sure and evaluate motor fuel tax evasion. Chapter 4 examines the data required to support the methods and tools outlined in Chapter 3. Chapter 5 presents a methodology for identify- ing and quantifying state motor fuel tax EOE. This method- ology includes a decision tree to assist states in conducting EOE analysis, presents approaches and models for estimat- ing EOE and identifies the data needed to support the pro- posed estimation approaches. Conclusions are presented in the sixth and final chapter. This report also includes four appendices. Appendix A contains a glossary of motor fuel excise tax terms. Appendix B contains the interview protocol used to guide evaluators in their discussions with state motor fuel tax administrators and other industry experts. Appendix C encapsulates the interview responses. Appendix D presents an annotated bibliography. 1.2 Background The vast majority of financial support for our nationâs transportation system is provided by revenues from federal and state motor fuel and other highway taxes. Ensuring all motor fuel and highway-use tax funds are collected, remitted, and credited to the Federal and State Highway Trust Fund (HTF) is a priority; however, evasion of motor fuel excise taxes has made this priority difficult to achieve. In 1993, the evasion rate for the federal gasoline tax was estimated to be between 3 and 7 percent and the diesel tax evasion rate was estimated at 15 to 25 percent (FHWA, 1992). This level of evasion translated, at the time, to roughly $1 billion in annual lost revenue. These estimates were largely based on Congres- sional subcommittee testimony of state and federal represen- tatives, as well as convicted tax evaders. At the state level, estimates of annual motor fuel excise tax evasion have varied significantly, from as low as $600 million to as high as $2 bil- lion (Weimar et al., 2002). Since 1993, revenue for the HTF increased due to changes in legislation relating to enforcement and auditing, primarily directed toward diesel, kerosene, and aviation fuels. Simple, unscientific estimates that compare the growth rates of rev- enue indicators (i.e., vehicle miles traveled) with the actual C H A P T E R 1 Introduction and Background
revenue growth suggest that these recent changes in motor tax policies have reduced evasion and enhanced collections (Baluch, 1996). However, the results of post-1993 joint audits performed under the FHWAâs Joint Federal/State Motor Fuel Tax Compliance Project (JFSMFTCP, 1999) do not reflect broad-based motor fuel tax compliance. Historically, reliable estimates for motor fuel tax evasion rates and other highway user taxes have not been achievable. Significant research attempts have been made over the past two decades to understand the nature and magnitude of fuel tax evasion, resulting in a fairly large body of literature. The bulk of this literature aims at quantifying evasion and ex- ploring methods to increase compliance at federal and state levels. Relevant literature and information examined for this review fit into the following categories: literature relating to tax administration and enforcement, methods of quantifying evasion, sources of motor fuel consumption and revenue forecasting, and sources of studies that examine data. 1.3 Motor Fuel Tax Administration and Enforcement Federal and state motor fuel tax administration and enforce- ment practices have transformed considerably over the past two decades. Motor fuel tax administration law has, and con- tinues to be, changed to lessen the opportunities and incentives to evade. Further, many collection agencies have increased ef- forts to investigate and reconcile unlawful activity. This section will examine literature related to the following federal and state administrative and enforcement practices: point of tax- ation, diesel fuel dyeing, auditing efforts, uniform adminis- trative forms and procedures, electronic reporting, and fines and punishments. 1.3.1 Point of Taxation One of the central modifications to fuel tax administrative procedures since the discovery of the multi-million dollar fuel tax evasion schemes of the 1980s is the point of taxation. Fuel tax is generally collected and reported at one of three points in the distribution chain: at the terminal rack/import, at the wholesale level, or at the retail level. Each point of tax collection throughout the fuel distribu- tion chain has particular vulnerabilities to certain evasion techniques. For instance, taxing diesel fuel at the terminal rack, while allowing for tax-exempt uses of diesel, requires a credit or refund process, and consequently, opens the door to evasion schemes that exploit the refund or credit process. Fig- ure 1-1 depicts numerous evasion methods as identified by the Federation of Tax Administrators (FTA) and their links to the different points of taxation. This figure does not pro- vide a comprehensive list of evasion techniques. Rather, it identifies the evasion techniques most commonly associated with various points in the distribution chain. For example, failure to file and false exemption could be used at the termi- nal rack level to evade taxes but are more prevalent at the wholesale or retail level. The main disadvantage of a retail point of taxation for collecting motor fuel excise taxes is the time and money nec- essary for processing a high volume of returns and delin- quencies. Furthermore, moving the point of taxation up the distribution chain reduces the severity of down-stream eva- sion. One perceived advantage to taxing at the retail level is the decreased incentive to cheat because the volume of fuel sold by the taxpayer is lower at the retail level than at the dis- tributor level (FTA, 2004a). Taxing at the terminal rack for motor fuels is widely ac- cepted as one key measure a government can take towards in- creasing motor fuel excise tax compliance. Moving the point of taxation to the terminal rack decreases the opportunities for downstream tax evasion and greatly reduces the number of taxpayers, decreasing the administrative and enforcement bur- den on collection agencies. There are, however, a number of disadvantages that do occur, despite having fewer taxpayers. First, the number of refund claims inevitably expands since many jurisdictions have several exemptions for use of fuel either for nontaxable purposes or by nontaxable entities. This dramatic increase in refund claims opens the door to increased refund fraud. Further, the savings in administrative costs from fewer taxpayers may be counterbalanced by the costs of pro- cessing refunds for fuels with a large number of nontaxable purposes. For instance, in 1994, less than 50 percent of diesel fuel was consumed nationally for on-road, taxable purposes. Some argue that the best strategy for fuels with a large number of tax-exempt uses is tax collection at the retail level since it is closest to the end user (CSG&CGPA, 1996). 5 Source: Adapted from FTA, 2004a Evasion Technique Bootlegging Blending Daisy Chain Under Reporting Failure to File False Exemption Failure to File Under Reporting Direct Bootlegging Direct Blending Bootlegging Blending Refund Fraud Terminal Rack Wholesale Retail Figure 1-1. Evasion schemes associated with particular points of taxation.
At the federal level, the point of taxation for gasoline was moved to the terminal rack by the Tax Reform Act (TRA) of 1986. In 1990, the Revenue Reconciliation Act (RRA) tight- ened up administrative regulations by requiring that the im- position of gasoline tax take place at the point of import, the removal from the terminal or refinery, or the point of sale of any unregistered entity (KPMG, 2001). The point of taxation for diesel was moved to the terminal rack in 1994 by the Om- nibus Budget Reconciliation Act (OBRA) of 1993. At the state level, points of taxation vary widely since the administrative conditions facing states also vary widely. Some states have many refineries while others have none. A few states have few to no terminals and must import fuel from other states and foreign locations (CSG&CGPA 1996). Many states now collect fuel taxes at the terminal level. In general, the position holder or importer is responsible for remitting the tax. States that tax at the wholesale level generally hold licensed distributors accountable for the tax when fuel is sold to an un- licensed entity. A system that taxes at the retail level can either require that the tax be paid when the retailer purchases the fuel, or when the fuel is placed in a highway transportation tank. Figures 1-2 and 1-3 depict the point of motor fuel tax- ation for gasoline and diesel by state. Although it can be argued that a shift in the point of taxa- tion to the terminal rack may increase administrative issues around refunds for some fuel types, many states have seen in- creased revenues after moving the point of taxation up the fuel supply chain. Maryland experienced an increase in rev- enue of about 20 percent in 1985 after moving the point of taxation for diesel fuel from the end user to the wholesale level (CSG&CGPA, 1996). Moreover, New York estimated a 19 percent revenue gain the first year after the point of taxa- tion for motor fuel was moved up the distribution chain to first import in 1985 (FHWA, 1992). After moving aviation fuel taxation to the rack in 1996, Floridaâs aviation fuel tax collec- tions increased by 21.4 percent that year (KPMG, 2001). 1.3.2 Diesel Fuel Dyeing At the federal level, the OBRA of 1993 was perhaps the most significant piece of legislation designed to curtail motor fuel tax evasion. In addition to moving the point of taxation for diesel to the terminal rack, it also mandated a federal fuel dyeing program. All diesel fuel sold tax-free for exempt pur- poses (e.g., farm equipment and other off road vehicles) was to be dyed red beginning in 1994. Dyeing fuel red provides a quick and visible way of determining if tax-free fuel is being misused for taxable purposes. A federal penalty of $1,000 or $10 per gallon of fuel was also prescribed for motor carriers using dyed fuel for a taxable use (Baluch, 1996). The first year after the law took effect, federal diesel fuel revenues increased by $1 billion. Controlling for revenue growth due to in- creased fuel consumption and a $4.3 cents per gallon increase in the tax rate, it was estimated that $600 to $700 million of that $1 billion revenue increase was attributed to increased compliance (GAO, 1996). State enforcement programs benefited from the federal dyeing regulations since the same undyed fuel for highway 6 Terminal First Receipt/Sale Distributor Retail Source: FTA, 2002b Figure 1-2. State points of taxation for diesel fuel.
use was generally also taxed for state transportation programs. Many states have adopted IRS definitions of taxable uses of diesel fuel for ease of enforcement and are enforcing the law by performing spot-checks to ensure that dyed fuel is not being burned on-road. By 1995, almost half of the U.S. states had adopted penalty provisions for improper use of dyed fuel (Baluch, 1996). States that have conformed to OBRA have seen substantial increasesâdouble digit percentage increases in some casesâin diesel fuel tax revenue (Peters, 2002). 1.3.3 Auditing Efforts Desk and field audits are widely recognized by numerous studies as one of the most fundamental components of any program for reducing evasion (FHWA, 1992; CSG & CGPA, 1996; and WSLTC, 1996). Highly visible and vigilant revenue agencies decrease the incentive to cheat the tax collection sys- tem. Rigorous and frequent auditing efforts are among the most effective deterrents when dealing with businesses that are well-established and expect to stay in the fuel supply busi- ness for the long-term. However, daisy-chain-type evasion methods, and other criminal activities involving organized crime, are not typically deterred by increased audits because the entire operation is geared to produce erroneous paper- work designed to lead auditors to a dead end (FHWA, 1992). Federal and state agencies have increased the intensity of their enforcement projects over the past two decades. Sig- nificant funding for these efforts came from the Intermodal Surface Transportation Efficiency Act (ISTEA) of 1991, which allocated $5 million annually in HTF funds to the Internal Rev- enue Service (IRS) and state collection agencies for enhanced audit and enforcement operations. Further, some state collec- tion agencies have opted to create special evasion investigation units. Expenditures on state and federal audit operations have seen positive returns on investment. Out of 38 states, gasoline tax revenues averaged $443 per staff hour during the period of October 1992 through March 1993. For the same period and within the same states, diesel revenues were enhanced at the rate of $321 per auditing hour (CSG & CGPA, 1996). Further, FHWA reports that each dollar spent from HTF on compliance projects (i.e., audits and criminal prosecutions) has produced an estimated $10 to $20 in extra revenue from state and federal fuel tax violations (FHWA, 1999b). 1.3.4 Uniformity and Coordination Cooperative efforts between state agencies can be ex- tremely advantageous because in the absence of such agree- ments, people seeking to beat the system can take advantage of the disparities in reporting requirements and information exchange across state and international borders. However, the ability to cooperate and exchange information is made problematic when states have their own unique tax laws, report forms, definitions, exemptions, and compliance methods. Recognizing the importance of uniformity and coordination, states are working together in unison to create a more broad- based and consistent approach to enhancing collections and removing opportunities for evasion. 7 Distributor Retail Terminal First Receipt/Sale Source: FTA, 2002b Figure 1-3. State points of taxation for gasoline.
The International Fuel Tax Agreement (IFTA), created as a component of ISTEA in 1991, represents one of the first ef- forts toward uniformity. IFTA is an agreement between states that simplifies the reporting of fuel taxes by interstate haulers by establishing a uniform system for administering and col- lecting taxes. Congress ordered all states to participate in this program by 1996 or be faced with a reduction in federal high- way funds (Raven, 1999). Before IFTA, motor carriers were obliged to register, obtain permits and file tax returns with each state where they operated. Now, motor carriers choose a base jurisdiction in which to register and file a single return with a single payment to their base jurisdiction. The base jurisdic- tion processes the IFTA tax return for net fuel taxes and for- wards funds to, or requests funds from, each jurisdiction (MPR, 2004). By 1996, all 50 states and 9 Canadian provinces were IFTA members (CSG&CGPA, 1996). The FTA Uniformity Committee is another key cooperative effort. The Uniformity Committee encourages states to adopt an 11-point plan for improving motor fuel tax compliance. The major points in this plan include: uniform definitions for imports and exports, federal identification codes that distin- guish entities for reporting and information exchange, total accountability of fuel by licensing of all resellers and requir- ing third party reporting on the movement of fuel, uniform electronic reporting systems and trainings for auditors and in- vestigators. Further, the FTA Uniformity Committee created a model-legislation checklist for states that wish to change their point of taxation for fuels and implement the 11-point plan (FTA, 2003). In addition to legislative changes related to the administra- tion of fuel taxes, state and federal governments intensified en- forcement efforts during the early 1990s when combined state and federal revenue losses due to evasion were estimated at $3 billion (FHWA, 1999c). One feature of this continued en- forcement effort was the formation of the JFSMFTCP, a prod- uct of a long-standing cooperation between the IRS and the FHWA. The JFSMFTCP steering committee is chaired by the IRS and the FHWA and is composed of representatives from nine lead states that head regional task forces. Among the ac- tivities undertaken by the task forces to improve fuel tax com- pliance are training, joint criminal and audit investigations, and information exchange (Baluch, 1996). In 1991, Congress passed ISTEA that allocated funds to the JFSMFTCP to organize cooperative efforts on fuel tax enforce- ment (FHWA, 1992). This act provided $5 million annually in HTF funds to the JFSMFTCP through 1997. Of that $5 mil- lion, the JFSMFTCP allocated $2 million to the IRS to enhance its fuel tax enforcement efforts. The other $3 million was given to states for participation in regional motor fuel tax evasion task forces. By FY 1995, most of the states including the Dis- trict of Columbia had taken part in one or more of the nine regional task forces. 1.3.5 Electronic Reporting Many states have moved to require all fuel taxpayers file their returns electronically. The traditional paper processing system takes much more time, space, and funds. Establishing an electronic reporting system liberates a good deal of these resources for both state collection agencies and industry by reducing tax administration and compliance costs. Further, electronic reporting systems enable the information to be eas- ily accessible for enforcement efforts within and between states. The FTA Uniformity Committee encourages states to not only adopt an electronic reporting system, but also to adopt uniform methods and standards for their systems so that states can share detailed information with each other in an efficient manner (FTA, 2003). 1.3.6 Fines and Punishments Many states increased their penalties and interest on delin- quent tax payments, with the intention of deterring evasion, for actions such as failure to fill out mandatory documents or pay compulsory taxes or knowingly providing false information on documents. A study of southern states found that great diver- sity exists between states on the nature and severity of penalties for fuel tax evasion (Denison and Eger, 2000). For instance, fuel tax evasion in Delaware was a Class E felony punishable by a fine of not more than $11,500 or by imprisonment of up to 5 years. Mississippi considered fuel tax evasion a misdemeanor with fines between $50 and $100, a mild punishment by comparison to Delaware. Further, in all but two of the 16 southern states re- viewed, liability for fuel taxes was ultimately placed on the offi- cers of a corporation. It is worth noting that the effectiveness of penalties for deterring tax fraud is still under considerable dispute (Denison and Eger, 2000). 1.4 Methods of Quantifying Motor Fuel Tax Evasion Many studies have examined and measured the extent of state and federal fuel tax evasion. An extensive literature re- view, however, reveals there is no consensus among the evasion studies on the extent of evasion. These studies do, however, identify a number of techniques that have been employed to quantify evasion levels, including (1) the audit review method; (2) comparison of fuel consumption with taxed vol- umes method; (3) comparison of fuel sales volumes with taxed volumes method; (4) border interdiction method; (5) sur- vey of tax administrators method; (6) the literature review method; and (7) the econometric analysis method. Studies employing these methods, including study findings and au- thors, are identified in Table 1-1 and are examined in detail in Chapter 3. 8
1.5 Motor Fuel Excise Tax Revenue Forecasting Motor fuel consumption and excise revenue forecasting models have been developed by the federal government and many state governments. These models vary in parameters, scope, and data used. They are used to forecast and detect trends in fuel tax revenue and fuel consumption by identify- ing and examining factors strongly correlated with these vari- ables. The fuel tax and consumption models examined in this section of the literature review have not been developed to address tax evasion directly. However, they can provide in- formation about other factors that affect fuel tax collections, and present variables that could be used in any econometric examination designed to detect evasion. The modeling needs of states and the federal government are similar, yet distinct. Figure 1-4 shows that state and fed- eral models are used for budgeting purposes; however, fed- eral models also are designed with revenue attribution and the revenue aligned budget authority mandate in mind. Rev- enue attribution is the process whereby the federal govern- ment determines how much fuel was burned on-road within each state, which in large part determines how much fed- eral highway funding is redistributed to the states. Revenue aligned budget authority (RABA) is a budget mechanism that adjusts federal highway funding based on actual tax collec- tions. RABA adjustments are based on disparities between forecast and actual collections. State models are primarily concerned with forecasting revenues to support highway con- struction, rehabilitation, and maintenance programs, as well as administrative/staffing overhead levels. 1.5.1 Federal Revenue Forecasting Models The federal models use data relating to travel, fuel effi- ciency (e.g., fuel consumption, imports and exports, fleet composition), and national economic variables to forecast revenue and satisfy federal budgeting regulations (e.g., mini- mum guarantee and revenue aligned budget authority). Fed- eral models examined in this section include: (a) the National Energy Modeling System (NEMS), (b) the Highway Revenue Forecasting Model, (c) the Joint Committee on Taxation Rev- enue Estimating Model, (d) the U.S. Treasury Office of Tax Analysis Fuel Tax Revenue Forecasting Model, (e) the FHWA Fuel Consumption Forecasting Model, and (f) the FHWA Gasohol Consumption Estimation Model. 9 Author(s) Date Tax Evasion Estimate Method Eger 2002 Wisconsin gasoline taxes due to falsified agricultural refund requests Upwards of $4 million annually Econometric method, comparison of predicted and actual agricultural refund requests KPMG 2001 Federal diesel taxed due to jet fuel diversion $1.7 - $9.2 billion over 10 years Comparison of fuel supplied to taxed gallons Denison and Hackbart 1996 Kentucky fuel taxes $26-$34 million Survey of tax administrators, econometric analysis Council of State Governments, Council of Governorsâ Policy Advisors 1996 All state fuel taxes $666 million - $1.5 billion Literature review, survey of state tax administrators, econometric analysis WSLTC 1996 Washington fuel taxes $15-$30 million Literature review, border interdiction, random audits Revenue Canada 1996 Canadian fuel taxes $55-$110 Million Comparison of monthly motor fuel sales volumes with gallons taxed Mingo & Associates, Inc. 1996 All state diesel taxes 21 percent Comparison of fuel consumption to taxed gallons Federal Highway Administration 1994a Federal and state fuel taxes $1 billion (Fed fuel taxes), $3 billion (Fed/state fuel taxes) Literature review, analysis of auditing data Federal Highway Administration 1992 Federal gasoline and diesel tax $466.1 million (gasoline tax), $860.2 million (diesel tax) Literature/testimony review, analysis of auditing data Mitstifer, National Association of Truck Stop Operators 1992 Federal diesel tax $3 billion Comparison of diesel fuel consumed (based on reports from truck stops) to taxed gallons Addanki et al. 1987 Federal gasoline taxes More than $500 million Econometric Analysis, Comparison of fuel consumption with taxed gallons Addanki et al. 1987 NY gasoline taxes $168.4-$254.5 million Econometric analysis Source: Weimar et al., 2002 Table 1-1. Summary of fuel tax evasion studies.
1.5.1.1 National Energy Modeling System (NEMS) At the federal level, the U.S. Department of Energy (DOE)âs Energy Information Administration (EIA) implemented NEMS, an expansive energy forecasting model for the mid- term period through 2025. NEMS is a computer-based model that forecasts the production, conversion, consumption, and import of petroleum products, as well as energy prices con- ditional on correlations with âmacroeconomic and financial factors, world energy markets, resource availability and costs, behavioral and technological choice criteria, cost and per- formance characteristics of energy technologies, and demo- graphicsâ (DOE, 2003). NEMS is designed as a modular system. The Transporta- tion Demand Module (TRAN) is one of seven modules and is of particular interest for this study because it provides mid- term forecasts of fuel consumption and explores the factors that correlate with motor fuel consumption. The TRAN itself is composed of several semi-independent models that address different aspects of the transportation sector. Combined, these models predict transportation fuel demand by trans- portation fuel type including gasoline, diesel fuel, aviation fuel, and other alternative fuels. These forecasts are developed and then published in the EIAâs Annual Energy Outlook. 1.5.1.2 Highway Revenue Forecasting Model (HRFM) HRFM is one more federal model that estimates federal fuel consumption. HRFM provides both short- and long- term estimates of federal fuel tax revenue. HRFM was devel- oped by FHWA in 1981 but has since been updated. FHWA used this model in the 1997 Federal Highway Cost Allocation Study (HCAS) to attribute federal highway user revenues by tax type to vehicle classes and weight category (FHWA, 1997). HRFM estimates fuel consumption by multiplying miles per gallon (MPG) and vehicle miles traveled (VMT) for each ve- hicle class and operating weight. Estimation of fuel tax col- lections then is based on fuel consumption and the tax rate. 1.5.1.3 Joint Committee on Taxation (JCT) Revenue Estimation The Joint Committee on Taxation (JCT), established under the Revenue Act of 1926, is another source and form of tax rev- enue forecasting. The JTC utilizes a variety of econometric models to estimate the impacts on revenue from changes in tax legislation. A description of JTC methodology is provided in the 1995 U.S. Congress report, Written Testimony of the Staff of the Joint Committee of Taxation Regarding the Revenue Estimating Process (JCT, 1995). Most of the revenue estimates by the JCT follow the same basic methodology. It is first determined what the revenue yield is under a current legislation. Then, they esti- mate what the revenue yield would be if the proposed change in legislation were to pass. The JTC uses IRS Statistics of Income (SOI) as a starting point for many of their analyses but also re- lies on other federal agencies (Weimar et al., 2002). An overview specifically relating to highway excise taxes, highway motor fuels tax rates, and highway fuels tax exemptions is presented in the 1998 amendment the Chairmanâs Amendment Relating to Extension of Highway Trust Fuel Excise Taxes and Related Trust Fund Provisions (U.S. Congress, 1998a). 1.5.1.4 U.S. Treasury Office of Tax Analysis (OTA) Fuel Tax Revenue Forecasting OTA also has created federal revenue forecasts for fuel tax revenue. Seven different OTA models forecast highway user tax sources such as gasoline, gasohol, and diesel. These fore- 10 States State / Federal ⢠Budget development ⢠Cash-flow analysis for transportation projects ⢠Highway cost allocation ⢠DOT, DMV staffing levels Federal Government ⢠Transportation program funding levels ⢠Federal budget development ⢠Attribution of excise tax revenue to states ⢠Minimum guarantee ⢠Revenue aligned budget authority Modeling Needs Figure 1-4. Federal and state revenue forecasting modeling needs.
casting models are greatly reliant on data from the Office of Management and Budget (OMB), the Council of Economic Advisors and the Treasury Department (Weimar et al., 2002). 1.5.1.5 FHWA Fuel Consumption Forecasting Model The Oak Ridge National Laboratory (ORNL) developed both a model to estimate national highway travel by vehicle type in 1995 and a model to estimate off-highway recreational fuel consumption by vehicle type at the state level in 1994 which was updated in 1999 for FHWA (Hwang, 2000). The national model is composed of a short-term module and a long-term module. While the short-term module is primarily driven by economic variables, the long-term module is more reliant on demographic factors and trends in key factors such as the dematerialization of GNP (Hwang, 2000). 1.5.1.6 FHWA Gasohol Consumption Estimation Model As a part of the allocation of HTF funds for each state, a rule-based model estimating gasohol consumption was de- veloped by ORNL for FHWA in 2003. This model is imple- mented as a spreadsheet application and is made up of three sub-modules: one to compute a control total of gasohol and ethanol gallons on which taxes are collected by the U.S. Trea- sury, another to estimate gasohol usage for states that have re- liable data, and another to calculate gasohol for states that do not have reliable data. The model used HTF revenue data from Treasury, state fuel usage from Highway Statistics, re- formulated gasoline (RFG) data from the U.S. Environmen- tal Protection Agency (EPA), and data from the Petroleum Marketing Annual (PMA). 1.5.1.7 State Revenue Forecasting Models Several U.S. states have their own fuel tax revenue forecast- ing models. The main objective of these models is to accurately forecast tax revenues apportioned to the stateâs transporta- tion system. These estimates strongly influence transportation budgets and the decision process for new transportation proj- ects. The Pacific Northwest National Laboratory (PNNL) re- viewed several state fuel tax revenue models, focusing on states that use regression analysis to forecast revenue (Weimar et al., 2002). PNNL reviewed models from Oregon, Indiana, Mary- land, Virginia, Washington, and Wisconsin. PNNL found that the majority of the tax revenue forecasting models were trans- fer function models, meaning they combine causal relationship models with time series models. Oregonâs Revenue Forecasting Model was cited to be rep- resentative of most of the models PNNL encountered, where Motor Vehicle Fuel Consumption = F(Fuel economy, price of gast-1 / price indext-1, Oregon employment participation rate, Oregon populationt-1, % change in real personal in- come) (Malik, 2002). PNNL noted there were a number of commonalities be- tween the state models reviewed such as the inclusion of fuel prices and macroeconomic factors as independent variables, and the separation of diesel and gas estimates. These state models appeared to provide relatively accurate forecasts (generally within 3 percent of actual collections). 1.6 Data Sources Accurate and reliable data are essential to uncovering the magnitude of motor fuel tax evasion and also are necessary in related endeavors such as motor fuel tax revenue forecasting. Data pertinent to this subject fall into three categories: motor fuel volumes, travel, and auditing data. Chapter 4 discusses, examines the reliability of, and makes comparisons between relevant and available federal and state data. Further, detailed data recommendations for each proposed EOE estimation approach are presented in Chapter 5. 1.7 Fuel Tracking The ability to track fuel through the distribution system can provide valuable data for estimating evasion and can serve as a key component of a program designed to improve motor fuel tax compliance. Recognizing that such a system could prove beneficial, Congress allocated HTF funds as part of the Transportation Equity Act of the 21st Century (TEA-21) for the development of what is now known as the Excise Files In- formation Retrieval System (ExFIRS). ExFIRS, in the process of development by the IRS, is an electronic system designed to gather and analyze motor fuel industry records to aid identi- fication and prevention of fuel noncompliance. It is composed of 10 subsystems that support the collection and analysis of motor fuel industry operational information. The Excise Summary Terminal Activity Reporting System (ExSTARS) is perhaps the most significant of these subsystems. ExSTARS is designed to track all movements of petroleum through state-designated fuel sales terminals. Since all federal excise taxes on fuels are imposed at the terminal rack, the IRS can balance all terminal disbursements with tax returns. It should be noted that while ExSTARS provides data on desti- nation states for fuel leaving terminals, it does not supply exact destination location within states. At the state level, the usefulness of ExSTARS will vary from state differences in the point of taxation. Some states tax at the rack while others tax at the point of first import, either wholesale or retail level. If the point of taxation for an indi- vidual state is at the terminal rack, similar to the federal gov- ernment, the state may be able to make direct comparisons 11
between ExSTARS data and state tax returns. If a stateâs point of taxation is below the rack, data on how much fuel enters the state may still prove useful, though ExSTARS in practice has limited application in this case because it doesnât iden- tify the company that receives the fuel delivery (FTA, 2004c). As of September 2004, ExSTARS was in full operation but the data are not yet comprehensive, with the vast majority of the data reported electronically but with a small share of the total data (roughly 10â20 percent) submitted on paper forms and entered into the database in a summarized ver- sion (Anders-Robb, 2004). For states, the other notable subsystem of ExFIRS is the Excise Tax Online Exchange (ExTOLE). This system pro- vides a convenient way for states to share information that could help in enforcement, compliance, and investigation ef- forts. ExTOLE allows states to do more scrupulous back- ground checks before issuing registrations, determine where the taxpayers are in operation, and view fuel distribution ac- tivity in other states. It should be noted that retrieval of in- formation from this system will not be made available to IRS taxpayers (FTA, 2004b). Some states are opting to implement their own fuel tracking systems, choosing automated systems over manual accounting (Table 1-2). Other states have adopted fuel tracking systems developed by Lockheed-Martin and ZyTax (FHWA, 1999a). 1.8 Other Relevant Studies There are a number of other studies of some relevance to this study. These studies include highway cost allocation studies (HCASs), reviews of highway apportionment models, and examinations of alternatives to motor fuel taxation. These studies, though unrelated to motor fuel tax evasion, provide some insight into the collection of motor fuel taxes, weaknesses in motor fuel tax compliance programs, the process for estimating VMT and MPG, and variables that could be used to model motor fuel tax evasion. 1.8.1 Highway Cost Allocation Studies To evaluate highway-related costs attributable to various types of vehicles, FHWA performs periodic HCASs. The pri- mary purpose of these studies is to evaluate the equity of fed- eral highway user fees by examining which user fees cover highway cost responsibility for different vehicle classes. Those paying more than their share of highway costs are, for all in- tents and purposes, subsidizing the operations of others. To discern how fair federal highway fees are, equity ratios are cal- culated for each vehicle class by comparing total revenue for each vehicle class to the costs each vehicle class imposes on the highway infrastructure. To calculate revenue by vehicle class, detailed assumptions regarding VMT and MPG by ve- hicle class are made. To the extent that detailed data by user class can enable more detailed understanding of motor fuel consumption, the findings could be useful in allocating total fuel consumption to various fuel types and user classes in an evasion model. In an HCAS, an equity ratio of 1.0 means that a particular vehicle class is exactly covering its share of the cost responsibility. The most recent analysis found that the equity ratio for combination trucks weighing less than 50,000 lbs. was 1.4 while the equity ratio for combination trucks weigh- ing more than 100,000 is 0.4 (FHWA, 2000a). 1.8.2 Highway Apportionment Models In 1991, ISTEA authorized $155 billion for surface trans- portation programs from 1992 to 1997. Each fiscal year, FHWA apportions highway funds to the states based on their highway apportionment model. During the ISTEA reautho- rization process in 1997, the General Accounting Office (GAO) conducted a review of the FHWA highway appor- tionment model for Congress to assess the modelâs impact on equity between states (GAO, 1997). The GAO concluded that the model accurately captures the highway funding allocation process and is internally consistent and adaptable. However, the GAO report found that the model was likely not to be used widely because it required specialized skills to use. Fur- ther, GAO found that the data used for the model was not properly verified and FHWA did not have the coordination and expertise to do so at the time (GAO, 1997). In 2000, the GAO further reviewed the highway apportion- ment process by evaluating the relationship between the FHWA process for allocating HTF to states and the Treasuryâs process for assigning tax receipts (GAO, 2000). Because busi- nesses that operate in several states send in their taxes from the state where they are based, the Treasury does not provide data on fuel tax receipts at the state level to FHWA. Therefore, the 12 Tracking System Virginia ACS Nevada ACS Mississippi ACS Arkansas ACS Michigan ACS Colorado Explorer Wisconsin Synergy South Carolina ZyTax Tennessee ZyTax North Dakota ZyTax California In-house Illinois In-house Missouri In-house Nebraska In-house Montana In-house Source: Anders-Robb 2004, FHWA 2003a, FHWA 2002, FHWA 2001, FHWA 1999a. Table 1-2. State tracking systems.
FHWA disaggregates the data, relying on travel and fleet fuel efficiency data to allocate funds to states. This process is known as the âattribution process.â GAO found that there is little assurance that HTF allocations to each state are accurate. The report outlines a number of recommendations to in- crease the reliability of the information and processes used to distribute highway funds. Because the highway apportionment model is used to estimate fuel consumption within each state in the nation, the model could be used as an important logic check when validating the evasion model with state data. 1.8.3 Examinations of Alternatives to Motor Fuel Taxation Literature pertaining to alternatives to motor fuel taxation provides a picture of the transportation funding process and its challenges as a whole. A 1993 NCHRP study puts forward an alternative approach to highway funds generation (Wein- blatt, et al., 1998). The study builds a methodology for devel- oping alternative revenue source scenarios and for evaluating these revenue source alternatives. The study points out sev- eral challenges to the current revenue generating system: petroleum-based fuels may become increasingly scarce, tax rates are fixed per gallon and will not keep pace with inflation, improved fuel efficiency may reduce overall highway rev- enues, and issues relating to the prevalence of alternative fuels complicate the collection and enforcement processes for gov- ernment agencies. Some conclusions of this research are that motor fuel taxes will remain a key component of transporta- tion revenue creation for the next 20â30 years; fees based on VMT are desirable but hinge on political and technological factors; and changes made to alternative sources of funding should be done gradually rather than precipitously. A further NCHRP study reviews alternative tax systems specifically for heavy vehicles and develops six criteria by which these systems can be evaluated (Weinblatt, et al., 1998). These criteria are adequacy, administrative efficiency, equity, economic efficiency, evasion and avoidance, and feasibility. Given these criteria, the authors found there was no unam- biguously superior taxation system. Rather, the choice between systems involves tradeoffs between the criteria. For instance, one important trade-off mentioned was between administra- tive efficiency and evasion. Enforcement can decrease evasion but at a cost to both the public and private sectors. Further, the feasibility criteria may come at a cost of economic effi- ciency because the political arena is where choices among tax- ation systems are made. For example, political opposition may be insurmountable at this point in time for a proposition to increase highway taxes to internalize the full marginal so- cial costs of highway use and fuel consumption. Further, there are limitations in the availability of data to be used to perform thoughtful tax system analysis. A 1995 study prepared for FHWA examines a wide range of alternative tax sources for HTF including the addition of alternative fuels in the existing tax system (Jack Faucett Asso- ciates, 1995). The study concludes that the most likely and promising candidates for expanded HTF revenue are vehicle use taxes, VMT fees, vehicle sales fees, and pavement damage/ weight distance taxes. Further, the study evaluates the poten- tial for extending the tax system to alternative fuels. Among the findings from this portion of the study are that tax rates based on energy content would be most equitable and non- liquid fuels would require a totally different user tax system and also would open up extensive opportunities for evasion. This study also attempts to quantify the likely impact of fuel efficiency and the use of alternative fuels on future HTF revenues (Jack Faucett Associates, 1995). The study forecasts HTF revenues based on eight future scenarios depending on factors such as fuel choice, technology, vehicle retirements, and driver behavior. With respect to fuel efficiency, this study forecasts expected average MPG and concludes that given those MPG forecasts, fuel consumption will be reduced by 3.3 percent in 1999 and 15.1 percent in 2014, decreasing HTF funds by 2.7 percent and 12.1 percent for those years. 1.8.4 Montana Motor Fuel Tax Evasion Study Simultaneously with this project, Battelle conducted a study for the State of Montana, which estimated the amount of motor fuel tax errors, omissions, and evasion using the preliminary methodology developed by this project (Balducci et al., 2006). The evasion was estimated using several of the techniques discussed in Chapter 5 of this report. Six types of motor fuel tax evasion were identified: border schemes, dyed fuel schemes, alternative fuel schemes, IFTA fraud, failure to file schemes, and refund and credit schemes. Approximately 16.3 percent of taxable diesel fuel tax was not being properly paid while only about 2.1 percent of gasoline fuel was not being paid in 2004. The methodology and results of that project can be found at http://www.mdt.mt.gov/research/projects/admin/ evasion.shtml. 13
