WPRI Report:

The Truth Behind Wisconsin's Oil Company Tax:
Why You'll Pay More at the Pump

By George Lightbourn, Christian Schneider, and Benjamin Artz

Table of Contents:

I.      Executive Summary
II.     Introduction
III.    The Budget Dilemma
IV.    The Proposed Gross Receipts Tax
V.     Gasoline Taxes in Wisconsin and Around the Nation
VI.    The History of Failed Cost Controls
VII.   Three Reasons the Tax Will Be Passed on to Consumers

• The Reality of Economic Forces

• Litigation of No-Pass Through Laws

• Administrative Reality

VIII.  Summary
IX.    Endnotes

EXECUTIVE SUMMARY

Last February, in his speech before the full Legislature, Governor Doyle unveiled a plan to give all Wisconsin drivers a free lunch.  The centerpiece of his transportation budget was a new tax on oil companies, a tax that would pump $272 million into the state treasury in the coming two years.  That’s $272 million, and not a dime of it will come from anyone in Wisconsin.  According to the Governor, we will have miles of new roads, the potholes in the old ones will be smoothed and state government will be able to pay off some debt.  The free lunch will be paid by the oil companies.  They will be stuck with the bill and they will not be permitted to pass it on in the form of higher pump prices. 

Of course, that is not what will happen.  The reality is laid out in this report.  It details how the new tax, if approved by the Legislature, will indeed be paid by Wisconsin motorists. 

Just sixteen months ago Governor Doyle signed a bill erasing indexing of the Wisconsin gas tax from state law.  This year that change is saving motorists one cent per gallon.  Now along comes this new gross receipts tax and those same motorists will see the pump price of gas increase by five cents per gallon, beginning this fall.  The new tax will raise the gas tax five times what the old indexing system would have.

This report examines this proposed new tax from a variety of perspectives all of which suggest the new tax simply cannot work in the way the Governor has described.  The report includes an economic refresher showing that, if the no-pass-through feature stays, markets will adjust to the added cost and pump prices will rise.  There is nothing nefarious about this phenomenon; it is the way a free market works.

The report also identifies the no-pass-through feature for what it is: a cost control.  The federal government and a few states have tried to control the price of gasoline.  In every instance, the results were the opposite of what was intended.  Most recently, Hawaii scrapped its cost control after just eight months when it discovered that prices were actually higher after the controls were implemented than they were before.

A legal review shows that the new tax is built on shaky legal ground.  Similar no-pass-through provisions have been found to be a violation of the Commerce Clause of the U.S. Constitution.

Finally, the report notes that the staff at the Department of Revenue warned that, “The Department’s auditors may have no rational basis to isolate the cause of price increases as the oil company assessment (the gross receipts tax).”  Implementing the no-pass-through provision will prove to be nearly impossible. 

This tax should be called what it is – a five cent increase in the gas tax.  That is the reality that should frame the debate in the Legislature.  The no-pass-through provision, with its promises of jailed oil company executives and cheap gasoline, should have no place in a serious discussion of transportation finance.

INTRODUCTION

After having handily won reelection last November, Governor Doyle, surrounded by his budget team, turned his attention to the next two-year budget.  In his East Wing office, he dispatched hundreds of fiscal and policy decisions that would eventually fit within the covers of his budget book he delivered to the Legislature.  Compared to the previous two budgets Governor Doyle had prepared, this budget had a little breathing room.  The revenue forecast showed state revenues growing by 6.8% over the next two years. 

Yet, as the Governor and his top advisors buttoned down decision after decision, one stubborn problem remained.  There was a gaping hole in the transportation budget.  This was hardly a surprise since it was a hole Governor Doyle and the Legislature created in previous budgets.  They had used $1.1 billion from the transportation fund to cover shortfalls in the general fund and had backfilled the transportation fund by issuing debt.   

The hole in the transportation fund presented both a fiscal and a political challenge for the Governor.  Fiscally, the gap was too large to be finessed with a transfer of one-time funding or a technical adjustment.  There simply had to be more money added, which led to the Governor’s political problem.  The logical source of transportation funding is the gas tax, but gas tax increases are always a dicey proposition.  An increase now would be a particularly tough sell since, just over a year ago, the Governor and the Legislature had repealed the indexing of the gas tax.   Rather than increasing every April 1 as had been the case for twenty-two years, the tax would remain fixed at 30.9 cents per gallon.  How could he act so soon to increase the hated gas tax?

To solve this dilemma, Governor Doyle turned to the unlikeliest of sources, Tommy Thompson. What was Governor Doyle’s solution?  He borrowed a long forgotten idea from the playbook of Governor Thompson.  In spite of the fact that the two men have never been close, Governor Doyle followed Governor Thompson’s lead and turned to a gross receipts tax on oil companies to resolve a shortfall in the transportation fund.  Governor Thompson’s gross receipts tax was removed by the Legislature.  Removing Governor Doyle’s gross receipts tax may prove more difficult for the current Legislature. 

In a bold political move, Governor Doyle announced that he would force the oil companies to eat his 2.5% gross receipts tax. When the Governor delivered his budget and announced his new oil company tax, he cast it as an initiative that was pro-consumer.  He decried the gas tax increases and toll roads that governors in other states had served up.  In fact, giving the Wisconsin taxpayers a “refund” is how Governor Doyle portrayed the new tax.  The state would get miles of smooth new roads and the taxpayers wouldn’t pay a dime.  Big oil companies would be forced to cover the cost entirely out of their profits.  To ensure that the tax would not be passed on, the Governor included criminal penalties for companies caught adding the tax to the pump price.  In that one stroke, the Governor had solved both his fiscal and his political problem.

This report puts the gross receipts tax and its no-pass-through feature under a microscope.  Has the Governor found a way to create a tax that will not affect consumers?    According to basic economic theory he has not.  According to the courts he has not.  And even according to the Wisconsin Department of Revenue he has not. 

What Governor Doyle has done is to propose a tax that will be almost certainly be passed on to consumers.  The bad news to the motoring public is that the new tax will add five cents to the price of a gallon of gas beginning this fall.  This far surpasses the one cent increase they would have paid under indexing.

This report will explain the budget hole the Governor’s new tax is intended to fill.  Further, the report will detail why, in spite of the way the new tax has been portrayed, it will indeed show up at the pump.  The analysis here might surprise a few people who have been promised the ultimate free lunch, as well as those who might have been looking forward to “sticking it” to big oil.

Of course, the new tax will only become law if the Legislature agrees with the Governor and leaves the new tax in the budget.  But will the tax be included in the bill sent to the Governor later this summer?  The options available to the Legislature are:  

• Eliminate the tax and cut spending commensurately;

• Enact a traditional gas tax increase to support the level of spending in the Governor’s budget; or

• Cobble together short-term funding and push the ultimate solution off to a future budget.

It will be interesting to watch as the Legislature grapples how to fund the transportation budget.  Clearly the fact that the tax will add five cents to the pump price should influence their deliberations.

THE BUDGET DILEMMA  

The focus of this report, Governor Doyle’s proposed 2.5% tax on the gross receipts of oil companies, is estimated to produce $272 million of new revenue in the coming two-year budget.  Is that significant in the context of the overall transportation budget and why is the new money so necessary?  Those two questions will be addressed in this section.  As to the importance of the new revenue, suffice it to say that without the revenues from the tax, the budget would be significantly unbalanced.  And the imbalance would affect the general fund as well as the transportation fund. 

In order to understand the need for the money from the new tax, it is necessary to go back four years - since the budgeting decisions made over the past two biennia have created the need for new revenue in the current proposed budget.  At the center of the Governor’s budget dilemma stands the transportation fund.  For four years the transportation fund has been used to make up for shortages in the general fund.  This time, as the Governor prepared his two-year budget plan for the 2007-09 biennium, he likely recognized that the overextended transportation fund could not be relied upon to supplement the general fund.  More importantly, if he wanted to accomplish his transportation agenda it would be necessary to add significant revenues to the fund.

The 2003-05 Budget

Let’s back up and look at what caused the current shortfall in the transportation fund.  The transportation fund is one of several segregated funds within the state budget.  The segregated nature of the fund means that transportation revenues and expenses are not to be commingled with the general fund.  The principle behind keeping these funds separate is that transportation users, mostly drivers, are assured that their user fees are to be used exclusively for transportation purposes.  For decades there was a fiscal brick wall between the transportation fund and the general fund.  Rarely was there movement of dollars or expenses between the two funds.  However, four years ago, in constructing the 2003-05 budget, the Governor and the Legislature effectively replaced that brick wall with something akin to a tennis net.  For the past four years, revenues and expenses have flowed freely between the two funds.  

In 2003, Governor Doyle entered office while state finances were still reeling from the effects of the 2001 recession.  Also pinching the state budget was the full effect of a tax cut package which was phased-in between 2001 and 2003.  Overall, the new governor was welcomed to the East Wing of the Capitol with a $3.2 billion mismatch between revenues and spending.

His first budget was marked by some significant cuts, including a $250 million reduction in the University of Wisconsin budget and eliminating the requirement to pay for 2/3 of local school costs.  In order to avoid even deeper cuts, the Governor and the Legislature turned to the transportation fund.  The budget Governor Doyle signed into law included a $675 million transfer of transportation revenues to the general fund, including $400 million for shared revenue payments to local government and $100 million for school aids.  

To mitigate the impact that this transfer would have on transportation projects, the Governor and the Legislature significantly increased the degree to which highway construction and rehabilitation costs were debt financed.  Table 1 shows the new bonding authorized in that budget. 

Table1

New Transportation Bonding in the 2003-05 Budget

  Source: Legislative Fiscal Bureau Comparative Summary of Budget Provisions Enacted as 2003 Act 33

The move to increasingly rely on debt to finance road projects did not thrill the road builders. The road building community has historically advocated a conservative use of debt financing and they made their displeasure known. The Executive Director of the Transportation Development Association of Wisconsin, in discussing the 2003 budget as initially introduced, predicted the transportation fund would be “devastated” after 2005.  He referred to Governor Doyle’s plan to bond for portions of the rehabilitation fund “unprecedented,” and said the proposal went against the Governor’s promise not to bond for day-to-day operations.  “Rehab is an everyday operation for transportation.  There’s never been bonding for rehabilitation,” he said.¹

The Governor’s Secretary of Transportation felt compelled to articulate the pragmatics of budgeting.  He emphasized that the focus of the administration was getting through the next two years.  The future,” he said, “can wait.”  “The Governor’s philosophy, and our philosophy, is let’s fix this now,” said the Secretary.  “We’ll face what we have to face in the next biennium.  I think that’s a sound strategy to have economically."²

When the budget was signed, the Governor and legislators alike hailed the tough job they had done in closing a seemingly insurmountable budget gap.  Little note was made about the hole that was building in the transportation budget.  Also not mentioned at the time were the expenses that had been pushed off into the future.  When work began on the next two-year budget, it became apparent that, once again, the general fund would have insufficient revenues to support the ongoing spending needs. 

The 2005-07 Budget:

While the subsequent 2005-07 biennial budget was slightly less contentious, the state entered the biennium facing a deficit largely due to the use of one-time money (including transportation revenue) in the previous budget. By this time, the Governor and the Legislature had overcome whatever shyness they might have had about dipping into the transportation fund.  In the course of budget deliberations, the Governor and the Legislature both forwarded ideas for the general fund to use transportation revenues.  In the final analysis, the Governor settled the matter with one sweep of his veto pen.  In a controversial move, he vetoed 752 words to cobble together a single sentence.   When the words of that sentence were reassembled, $427 million had been transferred from the transportation fund.  In its place, the Governor and Legislature authorized $250 million in new bonding to fund highway rehabilitation.

Further exacerbating the fiscal challenge facing the Governor was the repeal of gas tax indexing.  In 2005, the Governor signed the repeal of gas tax indexing, which further restricted growth to the transportation fund.  According to the Legislative Fiscal Bureau, indexing repeal reduced revenues to the transportation fund by an estimated $5.2 million in 2006-07, $26 million in 2007-08, and $49.1 million in 2008-09.

Table 2 shows the net effect of the transfers out of the transportation fund in the previous two budgets:

Table 2

Loss to Transportation Programs Associated with Transfers in 2003-05 and 2005-07

Source: Legislative Fiscal Bureau, 2007 Informational Paper 40, “Transportation Finance,”p. 6.

The imbalance between transfers out of transportation and bonding provided to replace those transfers presented two problems as the Governor prepared the 2007-09 budget.  First, additional transfers from the transportation fund were probably unsustainable.  It would not be possible to continue to supplement the general fund while also funding an acceptable highway construction and rehab program.  Thus a new revenue source had to be found to replace the $330 million that had come from the transportation fund.   A second and related issue was that the debt service on transportation bonds that had been earmarked for repayment by the general fund would have to be shifted back to the transportation fund where they belonged.  This post-election budget would be the logical time to put the transportation fund back onto sound footing.

The 2007-09 Budget

Entering the next two years, the Governor needed to address the long-term repayment of transportation debt for the debt service from previous bonding. The Governor’s budget currently before the Legislature estimates debt service on the bonds issued to offset transfers to the general fund to be $175.9 million for the biennium.  The Governor’s budget proposes splitting payment on the debt service for these bonds, assigning $69.9 million to the transportation fund and $106 million to the general fund. 

The decision in previous budgets to back-fill transportation funds with borrowing has been a costly one.  By the end of the 2007-09 budget, Wisconsin taxpayers will have had to pay $332 million in interest on the bonds used to replenish the transportation fund.  When these replacement bonds are retired, they will have cost taxpayers an extra $1.1 billion in debt service.

The residual effects of previous budgets created transportation-related problems in both the transportation fund as well as the general fund.  Strategically, the Governor needed to add new revenues and to isolate the impact of the new revenues within the transportation fund.  The Governor’s budget attacked both problems with vigor by creating new taxes and fees. 

The major revenue increases included in the Governor’s budget came in the form of an increase in auto registration and titling fees, and the subject of this report, the gross receipts tax on oil companies.   The auto fee increase will generate an estimated $171.8 million while the oil company tax will generate an estimated $272.1 million. 

With the repeal of the indexed gas tax, base transportation revenue growth is projected to be modest, growing by just $75 million in the coming two-year budget.  Revenue from the new taxes and fees account for 85.5% of the growth in the transportation fund for the 2007-09 budget.  Without the new fees, the Governor could not have funded general fund programs and paid the debt service on the past replacement bonds, as his budget proposes.  In addition, it is likely that cuts would have to be made to the spending plan for road construction and renovation.  The new revenues are the lynchpin of the Governor’s transportation budget.

Table 3

New Revenues to the Transportation Fund 2007-09

Source: Legislative Fiscal Bureau, Summary of Governor’s Budget Recommendations

Table 4 lists the major transportation spending increases included in the Governor’s budget.  Not only did the Governor’s budget include many expected increases, e.g. transportation aids, it also transferred $164 million of spending obligations related to 16 programs from the general fund to the transportation fund.  Therefore, the new revenues accomplished several objectives, including supporting a robust highway package, and it permitted the transportation fund to pick up part of the responsibility to fund debt service on transportation bonds issued in the previous two budgets.  Further, the new money allowed the Governor to once again aid the general fund through the back door, this time by moving whole programs over to the transportation fund.  As the legislative debate of the budget unfolds, it will become apparent that the impact of the new transportation money affects nearly every nook and cranny of the budget.

Table 4

Major transportation expenditures in the proposed 2007-09 budget

*- Funding was replaced by new bonding

Source:  Legislative Fiscal Bureau, Summary of Governor’s Budget Recommendations

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