Senate Joint Resolution 50, enacted by the 1980 Session of the General Assembly, mandated that the Joint Legislative Audit and Review Commission (JLARC) review the programs and activities of the Department of Highways and Transportation (DHT). The Commission was directed to make an interim report prior to the 1981 Session of the General Assembly, and a final report prior to the 1982 Session.

The report on highway revenues and methods of financing is one in a series on the transportation function in Virginia. It details the State's current highway financing structure and recent history, reviews the tax structure for equity and purpose of expenditure, presents estimates of future revenue to be generated by current taxes, and examines options for meeting future highway needs.

The Highway Trust Fund (pp. 3-20)

Virginia finances its highway system from a special Highway Maintenance and Construction Fund (HMCF). The fund is the receiving point for all revenues intended to support highway construction and maintenance, as well as for numerous fees-for-services. In FY 1981, revenues deposited in the fund from all sources totaled $811.4 million.

State Revenue Sources. Since the introduction of motor vehicle licensing charges in 1908, Virginia has collected and earmarked revenues for the construction and maintenance of highways. State highway revenues are presently collected from two sources, (1) user charges and (2) fees-for-service. User charges, such as the tax on gasoline, are taxes levied on highway users to pay for maintenance and construction of the highway system. Fees-for-service, on the other hand, are charges levied to recover the costs of providing vehicle and driver services, such as registration of titles or certification of driver competence.

User charge revenues constitute the largest component of the HMCF. In FY 1981, user charge collections totaled $468.6 million, or about 94 percent of State revenues dedicated to the HMCF. The most important user charges are motor fuels taxes, road taxes, and sales and use taxes. In the past, user charges created substantial increases in revenues because of increased fuel consumption and highway travel. Fuel cost and supply disruptions and the resulting decline in vehicle purchases in recent years have produced a changing environment for the HMCF, however.

Numerous fees-for-service are collected by DHT, DMV, SCC and the State Police and are earmarked for the HMCF. In FY 1981, these fees generated $30.7 million, or about six percent of total State revenues deposited in the fund. Between FY 1970 and FY 1981, total revenues from fees-for-service grew at about eight percent per year. Fees are distinct from user charges in that fees are not intended to fund highway construction and maintenance but instead to cover the cost of services provided.

Federal Aid. A major portion of Virginia's highway construction program is financed through federal aid. Although federal aid for vehicles highways is commonly thought of as a single program, it is in fact an amalgam of many categorical programs. Federal aid programs administered by the FHWA broadly cover most highway construction activities, ranging from interstate construction to highway planning and research. Although federal requirements do allow some flexibility, their categorical nature restricts the use of funds and mandates a number of State administrative and budgeting actions to ensure that matching funds are available as needed.

Over the past 12 years, the State has become more dependent on federal aid to finance highway construction. Between FY 1970 and FY 1981, federal aid awarded to Virginia increased about eight percent per year, in contrast to the six percent per year growth rate for State user charges. Federal aid is now two-fifths of total highway revenues, up from its historical average of about one-third.

Highway Fund Expenditures. In FY 1981, about $790.2 million in HMCF State and federal revenues were expended. HMCF expenditures have grown about seven percent per year over the past twelve years. Although construction has historically dominated DHT's highway program, aging highways and increased travel will result in increasing amounts of maintenance and reconstruction as the decade continues. By the mid-decade, it is likely that maintenance expenditures will surpass construction as the principal component of DHT's highway program.

In FY 1981, $51.6 million was transferred to at least partially support programs in 13 agencies. In most cases, funds have been used for activities related to transportation, although not related to construction and maintenance. Since FY 1970, transfers of highway revenues to other agencies have increased markedly.

Highway Tax Equity (pp. 21-50)

Taxing equity is important to highway financing. Equity is achieved when highway users contribute revenues equal to the costs that are incurred in providing a highway system suitable for their use. To the extent that some highway users do not contribute their full share of revenues, other highway users must subsidize them. When one user or class of users subsidizes another, a cross-subsidy is created.

During the course of this study, three cross-subsidies were identified:

(1) underpayment of cost responsibility by two-axle, six-tire trucks and three-axle, single unit trucks;

(2) effective reductions of heavy truck contributions through existing truck weight enforcement practices; and

(3) transfers of user charge revenues to subsidize programs and services not related to highway system expenditures.

Vehicle Cost Responsibility. A balanced tax structure should produce revenues from each user sufficient to cover all costs incurred on his behalf. In order to assess the equity of the current highway tax structure, SJR 50 of the 1980 Session of the General Assembly directed JLARC "to study the fair apportionment and allocation of the costs of building and maintaining the roads and bridges of the Commonwealth between motor vehicles of various sizes and weights."

The design for the cost responsibility study was based on Virginia's highway programs, actual construction and maintenance standards, and revenue sources. Grounding the design in actual conditions in Virginia was the best means of obtaining accurate, reliable estimates of highway costs and user payments.

The results of the study show a reasonably equitable tax structure, with an overall imbalance of revenues relative to cost responsibility of 3.1 percent. Passenger cars and light trucks (Class I) were found to be overpaying their cost responsibility by $18.9 million, while medium and heavy trucks (Classes II-IV) were found to be underpaying by a like amount. While the study finding showed general taxing equity, however, medium weight trucks were found to be underpaying their cost responsibility by proportions which suggest a need for a change in the tax structure. Two-axle, six-tire trucks underpaid their cost responsibility by 38 percent while larger, three-axle, single unit trucks underpaid by 17 percent.

The key consideration with regard to these vehicles is that they operate at weights which require significantly stronger pavements and bridges to accommodate their use. For example, although two-axle, six-tire trucks are less than four percent of the total traffic stream in Virginia, these vehicles were found to be responsible for 14 percent of pavement construction costs, eight percent of bridge construction costs and 22 percent of pavement maintenance costs. Despite this heavy cost responsibility, two-axle, six-tire trucks are exempt from the two-cent road tax surcharge and pay an average registration fee of less than $60 annually. The combination of motor fuel tax revenues plus relatively low registration fees does not adequately compensate the Commonwealth for the costs incurred on behalf of these vehicles.

Truck Weight Enforcement. The second cross-subsidy inherent in Virginia's financing structure flows from current truck weight enforcement practices. Although DHT and the Virginia State Police have made an active effort to enforce the weight laws, certain enforcement practices have resulted in effective exemptions from levies designed to recover highway costs resulting from overweight operation. Three serious problems appear to have had specific impacts on enforcement.

First, DHT contends that some courts are reducing or suspending liquidated damage assessments in a manner inconsistent with the statutory language of Section 46.1-342. An analysis of 1,858 citations showed that at least $1.0 million more in FY 1980 should have been assessed against overweight trucks than actually was assessed. The analysis supports the DHT contention that courts are not implementing the liquidated damage statute as intended by the legislature.

Second, rates established for liquidated damages assessments have not been increased in the 26 years since they were established. During the same period the costs of the enforcement program and the cost of pavement repair and replacement have increased many-fold. In the last decade, pavement maintenance costs alone have increased 250 percent. Additional revenues of approximately $4.3 million would be generated by the combined effect of interpreting more strictly the existing statute and increasing the liquidated damage rates to four cents per pound for violations up to 5000 pounds and ten cents per pound for violations over 5000 pounds.

The third problem is the unwritten policy whereby enforcement officers grant specific "administrative variances," or tolerances for trucks operating above the legal weight limits. A five percent tolerance has been in use since 1932. The tolerance is not based in statute and does not have the effect of law, in the opinion of the Attorney General.

Trucks registered in Virginia pay a graduated registration fee only up to the statutory maximum of 76,000 pounds gross vehicle weight, but may and do routinely operate at 79,800 pounds, according to DHT personnel. Because trucks do not compensate the Commonwealth for the weight allowed by the tolerance, the tolerance grants trucks a hidden exemption for the portion of the registration fee between 76,000 and 79,800 pounds. Based on 1980 registrations, the value of this exemption is approximately $2.0 million annually. Increasing gross weight limits to 80,000 pounds, without altering axle-weight limits, would eliminate this assumption without increasing pavement stress.

Subsidized Programs and Services. Diversions of user charge revenues to non-highway uses represents a third major cross-subsidy inherent in Virginia' s highway financing structure. Diversions of user charges currently occur in two principal forms, (1) user charge subsidies of services not fully supported by fees and (2) increased diversions of user charges to cover tax collection costs.

In FY 1981, seven of the vehicle and driver services provided by the Division of Motor Vehicles failed to recover $4.3 million in associated service costs. Because DMV is fully supported by the Highway Fund, this amount was diverted from user charges to pay for administrative costs. In most cases, small increases in fees would generate sufficient revenue to fully cover service costs.

DMV also requires a diversion of user charge revenues to cover the costs of tax collection. In FY 1981, $18.9 million was spent to administer and collect motor fuel taxes, sales and use taxes, vehicle licensing charges, and IRP fees. While DMV has traditionally used the HMCF for an appropriation sufficient to cover its operating costs, the proportion of revenues required to offset costs has steadily increased. This is because most fees, particularly for vehicle licensing, have not increased since the 1960s, despite inflation in operating costs.

The State Corporation Commission also receives an annual transfer of revenues from the HMCF to cover costs associated with (l) administering the State's road tax on heavy trucks and (2) issuing motor carrier permits to taxicabs and common carriers of property. Fees generated from motor carrier permits are deposited into the Highway Fund. In FY 1981, $3.4 million was transferred from the Highway Fund to the SCC. The cost of administering the programs jointly exceeded revenues by $1.4 million.

Highway Tax Sufficiency (pp. 51- 70)

Throughout much of the past three decades, the Department of Highways and Transportation has operated in a revenue-rich setting. Inflation in construction and maintenance costs, the aging of Virginia's highways, and the resulting increased need for highway maintenance will make highway programs in the 1980s more difficult to fund.

Highway Programs in the 1980s. Until FY 1977, the State consistently operated a construction program above FY 1970 spending levels, even adjusted for inflation. Since FY 1977, increases in the State's construction spending have lagged behind inflation. In FY 1981, an additional $62.4 million in construction spending would have been required to match FY 1970 spending.

In contrast, maintenance expenditures since 1970 have continued to grow at a pace exceeding inflation. This trend in increased maintenance expenditures is projected to continue over the next decade, as highways continue to age and heavy trucks increase their use of the State's highways. As a result, DHT anticipates that by FY 1985 highway maintenance – once a relatively low cost program compared to construction – will require all currently available highway maintenance and construction funds. Without additional revenue, such projections signify an end to Virginia's highway construction program.

Future Highway Needs. As part of the SJR 50 mandate, JLARC staff conducted an independent analysis of highway maintenance, construction, and transit needs. The analysis used available information about road conditions, traffic patterns, federal aid policies, and public transportation operations in Virginia to develop alternative highway spending options for the 1982-84 biennium (High way Construction, Maintenance, and Transit Needs in Virginia, November 1981):

Option I. -- Minimum Budget: $1.56 billion
Option II. -- JLARC High Priority Budget: $1.68 billion
Option III. -- JLARC High Priority plus Supple mentation Budget: $1.74 billion
Option IV. -- DHT "Critical Improvements" Budget: $1.96 billion

These options provide a range of possible 1982-84 highway programs for consideration by the General Assembly. The minimum program provides only sufficient funds to fully match available federal aid for highway and transit programs. The maximum is based on a draft of the "critical improvements" program developed by DHT.

Revenue Forecasts. An accurate forecast of future revenues is a critical prerequisite to careful planning and effective operation of the State's highway program. Because Virginia's highways are funded on a "pay as you go" basis, each year's construction and maintenance activity is directly tied to revenues received during the year.

Virginia has been among the few states to use forecasting models to predict future highway revenues. However, three modeling efforts funded since 1977 have not produced results within accepted standards of accuracy. In the absence of a reliable model, the State has continued to base its forecasts on estimates negotiated between the three collection agencies. As with the modeling efforts, however, estimates produced by the three agencies have also been inaccurate. As a result, highway program planning must still be conducted within an atmosphere of uncertainty. The Secretary of Transportation should take steps to improve the State's forecasting of highway revenues and to ensure that forecasting methods are as reliable and accurate as possible.

As part of this study, JLARC staff, in cooperation with the Highway and Transportation Research Council, developed an independent revenue forecasting model. The SJR 50 model was developed after a review of other revenue forecasting models, including the three models previously constructed for Virginia.

The SJR 50 revenue forecast indicated that approximately $44.5 million less can be expected over the next biennium than is projected in documents compiled by the Secretary of Transportation. Increases in vehicle fuel efficiency, the stagnant economic climate, and high interest rates all help to explain the lower revenue estimates.

Both SJR 50 and official revenue forecasts make it clear that future revenues will not be sufficient to comply with statutory allocation formulas and match available federal aid. For the minimum budget option, a revenue shortfall between $7 million and $51 million for the biennium is likely, with the shortfall occurring in the second year. For the other three options, the magnitude of the shortfall steadily increases.

Highway Financing Options (pp. 71 - 101)

The four financing options contained in this report are based on the four highway programs already described. The SJR 50 revenue forecasts show that for the 1982-84 biennium, additional funds ranging from $51 million to $417 million would be required to fully support the program.

Legislative actions contained in the four financing options are based on a combination of, (1) efficiency savings identified in the JLARC staff review of DHT administration; (2) adjustments in several fees-for-service and vehicle licensing charges to cover collection costs; (3) changes in truck weight regulation practices; (4) increases in the road tax and weight - graduated vehicle registration charges for equity purposes; and (5) increases in motor fuel taxes, by either cents-per-gallon increases or adoption of one of several forms of variable taxes. Each table which outlines the financing option illustrates the ways in which tax policies can be combined to generate needed revenue and maintain tax equity.