WPRI Report Cont'd:

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

By George Lightbourn, Christian Schneider, and Benjamin Artz

THE PROPOSED GROSS RECEIPTS TAX

The gross receipts tax proposed in the Governor's budget would impose a quarterly tax of 2.5% on the gross receipts of every supplier selling gasoline to retailers in Wisconsin. The tax would be assessed on the first sale of motor vehicle fuel in the state, which is usually the terminal where the gas is metered out. The tax would go into effect in October of 2007 and is estimated to generate $272.1 million in the coming biennium.

While it is a tax on gasoline, it differs from what is commonly referred to as the gas tax in two significant ways. First, the gas tax is an excise tax and is attached as a fixed amount per gallon. By contrast, the gross receipts tax is assessed as a percentage of revenue and, as such, is dependent on volume and price. As volume or price change, the proceeds from the tax will change. For example, at the time the Governor announced the tax in his budget speech, the wholesale price was approximately $1.69 per gallon. By April 17, the price had risen to $2.18 per gallon. Had the tax been in place during that time, it would have generated an additional $9 million based on the price increase alone.

Several states have taxes in place that are tied to both volume and price. For example, a number of states attach a sales tax to gasoline sales. A complete listing of fuel taxes can be found in Appendix A.

The other difference between the gross receipts tax and the excise tax is that, as proposed, the payers of the tax are precluded from passing on the tax to retailers. The intent is to assess the tax a tax on oil companies, not on motorists. The Governor even included stiff penalties for companies discovered passing the tax along to consumers. Specifically, any company would have to pay a fine equal to the amount they have illegally passed on to consumers and those responsible could face up to six months imprisonment. The fact that the tax would be absorbed by oil companies and that stiff penalties would be imposed was a major feature of Governor Doyle's budget speech.

By taking a snapshot of current gasoline prices, it is possible to estimate how much the new tax will add to a gallon of gas in the upcoming two years.  The revenue estimates in the Governor’s proposal assumed gasoline and diesel prices to be $2.51 in 2007, $2.50 per gallon in 2008, and $2.49 in 2009.  Naturally, if those costs are higher, the amount the tax collects will be greater.  These estimates exempt taxes from the equation (32.9 cents in state tax, 18.4 cents in federal gasoline tax, and 24.4 cents for federal diesel tax), which leaves the wholesale price as the basis for the estimate.  According to these assumptions, the tax would amount to five cents per gallon on gasoline and 4.8 cents per gallon on diesel fuel.  Of course, in theory, this tax is supposed to be paid by the oil companies rather than consumers.

The Department of Revenue (DOR) is assigned responsibility for administering the tax, and four positions were added to the agency budget to carry out the new responsibility. Based on discussions with DOR officials, the department has yet to determine how they will implement the no-pass-through provision. There exists no detailed explanation of how they will ascertain whether or not the tax has been passed along by suppliers. While it is not unusual for the administrative agency not to have a detailed plan for the operation of a new program until later in the process, in this case the ambiguity is troublesome. It is troublesome because the Governor has gone to considerable lengths to ensure consumers that the tax will not be passed on to them. Yet it is conceivable, and even likely, that there is no way for the Department of Revenue to determine whether the tax has been included in the price of gasoline.

Given the fact that this significant question has yet to be addressed, the entire initiative is open to speculation that this new tax is simply an attempt to disguise a five-cent per gallon increase in the gas tax. Until the administrative agency can identify how the no-pass-through provision will be enforced, that is a reasonable conclusion.

GASOLINE TAXES IN WISCONSIN AND AROUND THE NATION

Wisconsin

Currently, Wisconsin imposes a 30.9 cent per gallon excise tax on motor fuel sold in the state. In addition, a two cent per gallon tax assessed to pay for the state's petroleum inspection program. The 32.9 cent fuel tax is collected by the Wisconsin Department of Revenue and deposited in the transportation fund. The tax is imposed when the fuel is withdrawn and metered out at the terminal or refinery rack, and is collected monthly from licensed suppliers, which is typically the terminal operator. Gas tax revenues in fiscal year 2007 are estimated to yield $971 million to the transportation fund, which will account for 61% of all the revenue to the fund.

Wisconsin has had a fuel tax since 1925, when it was set at two cents per gallon and deposited in the state's general fund. In 1945, Wisconsin created the transportation fund, where fuel tax revenue was then deposited. Lawmakers saw a natural connection between paying a fee to drive and developing and maintaining highways.

The fuel tax remained below ten cents per gallon until 1980, when it began to increase rapidly. In the early 1980's, escalating fuel costs and the rising cost of highway construction prompted the Governor and the Legislature to approve higher gas taxes. Fuel consumption between 1979 and 1982 declined 14%, due in large part to more fuel-efficient cars being produced, modifications in driving habits for consumers, and a slowing economy.

In response to the compound impact of rising costs and declining fuel consumption, Wisconsin passed a law that provided for indexing of the state's gas tax. Under indexing, the state's gas tax was automatically increased each April based on inflation and consumption (in 1998 consumption was eliminated as an indexing factor). Indexing proved to be a convenient, albeit controversial, method for keeping dollars flowing into the transportation fund. Even with indexing in place, the gas tax was further increased through legislation twice, in 1987 and 1997.

Chart 1 shows the historical motor fuel tax rate in Wisconsin, and the reason for the increase:

Chart 1

Source: Legislative Fiscal Bureau Informational Paper 41, "Motor Vehicle Fuel and Alternative Fuel Tax" p. 2.

Gas tax indexing allowed for growth in the transportation fund even when the number of gallons being purchased by drivers dropped:

Chart 2

(Note: Total gallons consumed is depicted on a per-year basis, while the tax collected is shown on a per-fiscal year basis. Thus, where the chart says "1997," for the taxes collected, it actually means the 1997-98 fiscal year. Source: Legislative Fiscal Bureau)

Chart 2 shows the annual percentage increase in the number of gallons of gasoline purchased in Wisconsin versus the amount of tax collected from the purchase of gasoline. The chart illustrates that in years where the number of gallons purchased actually decreased (2000 and 2005), the amount of gas taxes collected still grew.

During its lifespan, indexing the gas tax proved somewhat controversial in that no approval was required to increase the tax. Periodically, there were moves to repeal the indexing mechanism, and in 2006 indexing was eliminated. The final indexing adjustment was made on April 1 of 2006. Estimates peg the elimination of indexing as costing the transportation fund $26 million in 2007-08 and $49.1 million in 2008-09.

Had indexing not been eliminated, it is estimated that the 30.9 cent gas tax would have risen to 31.9 cents in April of 2007. Subsequently, the tax would have risen to 32.5 cents in 2008 and 33.2 cents in 2009, an increase of less than one cent per year. This compares to the approximately five-cent per gallon impact of the proposed gross receipts tax. The no-pass-through provision was a critical element of the Governor's budget strategy. Without the provision, when the new tax goes into effect in the fall of 2007, it would have been portrayed as increasing the gas tax more than five times the increase that would have occurred under indexing.

Gasoline can either be imported to Wisconsin by pipeline or boat, or it can be manufactured or refined in the state and stored by a refiner without having to pay the tax until the product is actually metered out. The tax on gasoline imported into Wisconsin by any other method is payable by the licensed supplier. After crude oil is refined into gasoline and other petroleum products, the majority of gasoline is shipped first by pipeline to storage terminals near consuming areas. After shipment through the pipeline, gasoline is typically held in bulk storage terminals that often service many companies. At these terminals the gasoline is loaded into tanker trucks destined for various retail gas stations. It is at this point that the gas tax is paid.

There are 65 licensed, unrestricted suppliers that remit nearly all of the tax revenues to the state. There are 86 other restricted suppliers, or suppliers that deliver across state lines, who pay a small portion of state revenues.

Wisconsin's current motor fuel tax is an excise tax, meaning the tax is charged to the consumer, and not the seller. Excise taxes tend to be product-specific and usually represent a set rate per unit, as opposed to general sales taxes that are applied as a percentage of the cost of sale. For instance, the excise tax on motor fuel is 30.9 cents per gallon, rather than being applied as a percentage of the cost of gas. Other excise taxes in Wisconsin include taxes on cigarettes, tobacco, beer, and liquor.

Other States

Wisconsin's Governor Doyle is not alone in proposing a gross receipts tax on gasoline. Pennsylvania Governor Rendell has introduced a 6.17% gross receipts tax that also includes a no-pass-through feature. The actual language used to implement the tax has yet to be introduced, but it is clear that the Pennsylvania proposal is considerably different than what has been introduced in Wisconsin. One difference is that the Pennsylvania tax will apply to every company in the supply chain with the exception of retailers. It will apply to oil producers, oil haulers, refiners and distributors. A second major difference is that the new gross receipts tax will be offset by exempting oil companies from the state's 9.9% corporate income tax. There is no similar provision in the Wisconsin proposal.

The other state that is relevant to the Wisconsin discussion is Connecticut, which currently has a 6.1% tax on oil company gross receipts. The gross receipts tax, which Connecticut has imposed since the 1980s, has recently become a favorite of Connecticut politicians. In 2005, the Governor and Legislature didn't simply raise the rate, but also codified future increases in state law. The rate rose from 5.8% to 6.1% in 2006 and is scheduled to gradually increase to 8.1% by 2013. The tax rate increases were put into law as a way to support future transportation spending. With the recent spike in the price of gasoline, there was some consideration given to capping the rate, but more recently, discussion of a cap has waned.

Overall, gas taxes among the fifty states are a crazy quilt of taxes and fees. No two states tax in the same manner or at the same level. It seems that the design of gas taxes provides state governments the chance to exhibit creativity. According the American Petroleum Institute³, the average state gas tax is 45.8 cents per gallon (including the 18.4 cent federal excise tax). State taxes range from eight cents in Alaska at the low end, to 40.2 cents in California, 42 cents in Hawaii and 42.4 cents in New York. The complete list of state gas taxes is included in Attachment A. In displaying state gas taxes, the American Petroleum Institute includes excise taxes as well as other taxes. Where other taxes are not based on a rate per gallon, the API has converted the revenue into a rate per gallon.

Wisconsin's rate of 32.9 cents per gallon (including the 2 cent petroleum inspection tax) is the seventh highest in the nation. If the proposed gross receipts tax was in effect, it would raise the rate to 37.9 cents, making it the fourth highest.

THE HISTORY OF FAILED COST CONTROLS

Governor Doyle's announcement of a proposed tax on oil companies, and the related no-pass-through provision, produced a skeptical response from the public. The public is rightfully skeptical since they have been exposed to market forces their whole lives. They know what happens when anyone, from government to the corner retailer, artificially manipulates prices. They know that price manipulation affects the supply of goods. They have come to expect that when the price of any product is synthetically lowered, they will experience shortages. Conversely, overpriced items will quickly gather dust while the public waits for the price to lower to an acceptable level.

The no-pass-through feature of the proposed oil company gross receipts tax is a form of a price control. It is the State of Wisconsin's attempt to raise a significant amount of money by manipulating the natural tendencies of the market for gasoline. Price controls, especially controls on the price of gasoline, have a sorry economic history. Since the early 1970s, when OPEC jolted gasoline prices by restricting supply, government has periodically dabbled in price controls. In every instance, the effect of the control proved to be counterproductive. As a result, nowhere in America is the price of gasoline controlled. If the proposal forwarded by Governor Doyle is enacted into law, Wisconsin will have the only price controls in America.

Let's briefly review the history of price controls on gasoline. In 1971, the Nixon administration enacted broad price and wage controls in an attempt to control inflation. The Economic Stabilization Act of 1970 was originally intended as a ninety-day restriction on wages and prices. The controls were left in place for nearly three years, during which time inflation actually increased from approximately 4% to just under 14%.⁴ Only later did it become accepted that monetary policy, not government regulation, was the most effective way to address inflation.

In 1973, it was generally feared in Washington that when the controls were lifted, the price of gasoline would skyrocket and damage the nation's economy. Thus, in 1973, when the controls were lifted for other commodities, the federal government extended the price controls on gasoline and related products. The actual regulation was embodied in the Emergency Petroleum Allocation Act of 1973, a complex series of regulations that created a two-tiered system of price controls on domestic oil. The EPPA significantly affected the economics within the oil industry.⁵ However, the lasting overall impact was a restriction in the supply of oil.

The reaction of the market to the price controls embodied in the EPPA and the subsequent Emergency Policy and Conservation Act of 1975 was swift and severe. As economists had predicted, the price caps resulted in restricted supplies. Motorists were subjected to Sunday closures, even-odd day purchasing and even restrictions on the amount that could be purchased in any single trip. The market forces worked with the certainty and efficiency of gravity.

By the late 1970s, pressure mounted for the federal government to lift the price controls. However, there lingered a residual concern that the complete lifting of controls would lead to rising prices and rising oil company profits. This led the federal government to a gradual lifting of controls and the simultaneous imposition of a windfall profit tax. The tax was actually an excise tax on the domestic production of oil. It was applied to the difference between a base price of oil (adjusted quarterly for inflation) and the current market price. Different tax rates were applied to different tiers of oil and exceptions to the tax were made for government and other public uses.

Not surprisingly, the windfall profit tax proved to be a considerable administrative burden, requiring an army of government regulators. Worse, the revenue raised by the tax fell far short of expectations. By 1988, the federal government was more than willing to let the tax lapse. The federal government's forays into the control of gasoline prices, while providing popular talking points for elected officials, provided uniformly disappointing results, especially at the pump. Since the tax was attached to the production of domestic oil, the production of domestic oil lagged and the country became increasingly dependent on foreign oil, just the opposite of the original intent.

Move forward to February of 2007: The rhetoric used in Governor Doyle's budget address harkened back to the language used in the 1980s in describing the need for price controls. The following quotes from the Governor's 2007 speech could just as easily have emanated from the Carter administration:

"Oil companies have gouged this country in every way they can think of."

"Exxon announced forty billion dollars in profits…That's not just pure profit, it's coming right out of our pockets."

"Let's turn the tables on big oil."

Those listening to Governor Doyle's budget speech heard him say, "It will be illegal for them (oil companies) to pass the fee on to consumers." Economists listening to the same speech heard, "State government will attempt to manipulate natural market forces affecting gasoline."

From time to time, state governments have attempted to regulate the price of gasoline. Most recently, Hawaii implemented price controls on gasoline in September of 2005. The Hawaiian controls attempted to limit gasoline prices based on the prices charged at the major centers on the mainland. The intent was to reduce the gap between Hawaiian prices and mainland prices. They failed to heed the advice of the Federal Trade Commission, which warned,

"A significant body of research and experience suggests that price controls have a poor record of improving consumer welfare in markets where competition is possible, and may in fact cause more harm than good in the long term."⁶

After just eight months, Hawaii decided to end its attempt to control the price of gasoline. The gap between the price of gasoline in Hawaii and the mainland had actually increased from forty-four cents per gallon to fifty cents per gallon.⁷ Hawaiian regulators, in imposing price caps, had actually succeeded in doing exactly the opposite of what they had intended; they raised the price of gasoline. Although the controls used by the State of Hawaii differed from the controls proposed in Wisconsin, there is a lesson to be learned from Hawaii.

The lesson is obvious; attempts to control the price of gasoline, either through blunt price controls, or through subtler taxing mechanisms that attempt to suppress prices, have all failed. With the demise of the Hawaiian cost controls, there are no controls in effect anywhere in the United States. If Wisconsin enacts the no-pass-through legislation proposed by the Governor, it will be the only state in the nation where price controls are in effect. As with the experiment in Hawaii and the experience at the federal level, it is likely that any such artificial price controls will be counterproductive and doomed to failure. Those advocating price controls in Wisconsin seem intent on ignoring the lessons of history and continue to suggest that the Wisconsin system for controlling the price of gasoline will be the first to succeed.

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