U.S. Senate Republican Policy Committee - Larry E. Craig, Chairman - Jade West, Staff Director

October 6, 1997

Highways Not Historically Underfunded

Riding the Paper Tiger:
The Highway Trust Fund "Surplus"

Congress continually is confronted with conflicts when it considers spending matters: how much money should it devote to one area and how will this in turn affect other federal priorities? One area presents a particular conundrum within the realm of balancing fiscal priorities: highway spending. It's common to hear conversation that highway spending should be handled differently, in part because of a misconception that the highway trust fund is self-replenishing, and that spending and revenues on highways are completely separate, and so will not affect any other federal program. That is compounded by a further misconception that the Highway Trust Fund historically has spent less than has been available in transportation-tax revenues -- to the point that a multibillion-dollar "surplus" has accumulated in the trust fund.

In fact, the highway trust fund is not wholly separate from the rest of the budget "pie," and further, the "surplus" only exists on paper and -- if the total impact on the federal budget were calculated -- it shouldn't exist even there.

This discussion is particularly critical given the upcoming debate in the Senate of the surface transportation reauthorization legislation, and the enlargement of the revenue stream to the Highway Trust Fund via the transfer to it of the 1993 4.3-cents-per-gallon gas-tax hike (as provided under the 1997 budget agreement).

The Highway Trust Fund's "Surplus" Illusion

The Highway Trust Fund is composed of two separate accounts. The original highway trust fund was created in 1956 (Federal-Aid Highway Act of 1956, P.L. 84-627) and then separated into two accounts in 1982 with the creation of a separate transit account (Surface Transportation Assistance Act of 1982, P.L. 97-424). Both accounts are funded by excise taxes -- the most commonly known being the 18.3-cents-per-gallon tax on gasoline. The Joint Tax Committee (JCT) describes the funding sources for the two accounts:

"The Highway Fund's Highway Account receives revenues from all non-fuel highway transportation excise taxes and revenues from all but 2.85 cents per gallon (2.0 cents prior to October 1, 1997) of the highway motor fuels excise taxes... The Highway Fund's Mass Transit Account receives revenues equivalent to 2.85 cents per gallon...of the highway motor fuels excise taxes." [JCT document: JCX-50-97, 10/1/97]

The historical cash flows of these two accounts is shown in Charts 1 and 2 [attached]. The balances in both accounts have led to much misunderstanding -- the largest of which is that these are "surpluses" of unspent tax receipts that are readily available for spending.

CHART 1: Federal Highway Spending, 1957-1996 -- BAR GRAPH - YEARLY BREAKDOWN
CHART 2: Federal Highway Spending, 1983-1996 -- BAR GRAPH - YEARLY BREAKDOWN

Trust Fund Balances Required by 'Byrd Test' and 'Rostenkowski Test'

In fact, substantial balances have been required by law for both accounts since their creation. The requirement for the Highway account is known as the "Byrd Test." CBO states that "unfunded authority ["the unpaid budget authority for which there is currently no 'cash' to cover the future expenditures"] cannot exceed the projected receipts for the next two years." The transit account's requirement is known as the "Rostenkowski Test." CBO states that "unfunded authority cannot exceed the projected receipts for the subsequent year [this will change to two years beginning in 1998]" (CBO, Projection of Trust Fund Balances, September 10, 1997). If these two tests are not met, spending in both accounts is limited through a process much resembling that of a sequester under the budget process.

Trust Fund Balance Reflects Commitments Made, But Not Yet Paid For

The long and short of it is that the Highway Trust Fund accounts by law make commitments to spend money in advance of receiving the revenue: Highway Account spending runs two years ahead of its receipts, while Transit Account spending runs one year (two years in 1998) ahead of its receipts. This means that:

In 1996, the Highway Account's future commitments were almost four times its cash balance -- $42.1 billion dollars versus $12.1 billion -- while the Transit Account's future commitments were half its cash balance -- $4.7 billion versus $9.5 billion. Here's the situation put in simple terms by a DOT official in testimony before Congress: "The cash balance is not a 'surplus,' since there are outstanding commitments against it, that is bills for commitments already made that will have to be paid. The situation might be compared to a personal checking account: you may have written checks that have not cleared your bank yet, so the bank's statement of your balance looks better than you know it to be" [Kate L. Moore, Assistant Secretary for Budget and Programs, U.S. Department of Transportation, testimony before the Investigations and Oversight Subcommittee of the House Public Works Committee, 5/8/90].

These legal requirements have a significant impact on the maintenance of a cash balance, according to the Department of Transportation. Using the Highway Account's seemingly large $12.1 billion balance as an example (and without including the additional 4.3-cent revenue infusion added under the BBA), even if obligations were increased to the maximum limit, the Byrd Test would limit the amount that could be drawn down to just $3.6 billion by 2003. This would still leave a cash balance of $8.5 billion by 2003 -- any further commitments would result in across-the-board reductions in the account -- despite the apparent $8.5 billion cushion that exists. Even if there were no legal requirements, the Federal Highway Administration (FHWA) prefers to keep a cushion of $2 billion to $3 billion (an amount determined in a 1984 OMB/FHWA study) in accordance with prudent cash management to allow for unexpected emergencies.

In any case, the Highway Account's cash balance is due to interest accumulated in earlier years on the necessary cash balances and since has been enlarged through compounding. The Transit Account has actually spent slightly less -- $3 billion -- over the course of its existence than it has received in tax revenue due to the slow startup of transit projects in the early years of the trust fund as well as the fact that its use is limited to capital and capital-related spending -- not operations and maintenance, which is funded out of the General Fund and represents the majority of federal transit spending.

Interest is Simply an Intergovernmental Transfer

Even if one were willing to call the entirety of the cash balances as "spendable," which they are not, they are comprised of nothing more than interest the government has paid to itself -- an intergovernmental transfer -- that represents no actual increase in resources. To reiterate, the Highway Trust Fund's "interest" does not represent an increase in wealth (as would occur in a private-sector trust fund) but is strictly a transfer of an IOU from one pocket of the government to another.

In fact, the balances are neither "surpluses" nor unspent tax receipts -- as both charts make clear. Much of the balances are "working" balances needed either to meet the law or the possibility of emergency needs.

Highway/Transit Spending Has Increased Dramatically

Highway Trust Fund programs have done very well under the present system. Overall, Highway Trust Fund spending has outgrown overall domestic discretionary spending: after factoring out inflation, it has grown 1.73 percent on average in an annual basis in real terms whereas overall domestic discretionary spending has grown 0.4 percent from 1980-95; from 1990-95, the comparison is 4.02 percent versus 3.67 percent.

Subsidies from the General Fund: The Untold Story

The element generally missing from the Highway trust fund story is not the issue of a trust fund "surplus" but of the general taxpayers' contribution. In fact, the general taxpayer has been a significant "road builder" -- albeit a silent one -- over the trust fund's life. The general taxpayer has underwritten road costs in two ways: by actual spending from the General Fund, and from reduced revenue to the General Fund due to the impact of the excise tax on income tax receipts.

Actual Spending Accounts for $73 Billion in Trust Fund Spending

Direct spending from the General Fund is documented in by Charts 1 & 2. This is money that has gone for highway spending outside that designated by the trust fund. Such programs include the Appalachian Regional Commission (ARC), safety programs, the Interstate Transfer Program, and demonstration projects (some programs that were formerly funded through the General Fund, such as the Federal Lands Program, Indian reservation roads, etc., have been shifted to the Highway Trust Fund, thus accounting for the decline in General Fund spending from the levels of the 1970s and 1980s seen in Chart 1). While individually these may seem relatively small to the trust fund's multibillion annual budget, they add up to a significant total over time.

Reduced Revenue Has Cost Taxpayers an Additional $86 Billion

The reduction in income tax revenue resulting from the effect of the excise tax -- known as the "income tax offset" -- is not as simply explained but is no less of a real subsidy. The effect of an excise tax is essentially to move consumer income from areas where it otherwise would have been subject to different taxes, thus creating a difference between the "gross" and the "net" effect of the excise tax. The Joint Committee on Taxation explains it as follows:

"The [Tax] Code transfers amounts equivalent to "gross receipts" raised by the transportation excise taxes, rather than the "net revenues" produced by those taxes, to the transportation Trust Funds. Net revenues equal approximately 75 percent of gross receipts. The concept of net revenues reflects budget scorekeeping conventions that discount excise tax revenues by the amount that income tax receipts are expected to decrease as a result of monies being removed from the private economy for the payment of excise taxes"
["Present Law and Background Information on Federal Transportation Excise Taxes and Trust Fund Expenditure Programs," JCT, 11/14/96].

Roughly, this can be compared to the difference between a worker's gross pay and his net pay after the IRS gets through with his paycheck. The only distinction is that while the worker would love to keep his paycheck intact, the Highway Trust Fund in essence does. It gets credited for the gross amount raised by the excise taxes even though the net amount is that which actually flows to the Treasury. This difference between gross and net receipts is not shared between the General Fund and the Trust Fund, however. In order to pay the gross amount, the General Fund absorbs a loss of revenue -- a loss equal to 25 percent of the gross excise tax revenue. In effect, the General Fund has, is, and will continue to silently subsidize the Highway Trust Fund in this way. Over the life of the Trust fund, this has amounted to $85.7 billion (25 percent of the $342.8 billion collected).

Future General Fund revenue losses from the gas tax will be even more significant because of the transfer of the 1993 4.3-cents-per-gallon gas tax from the General Fund to the Highway Trust Fund: loss to the General Fund roughly will double over 1997 to 2007. During the entire life of the Highway Trust Fund, the loss to the General Fund has been $85.7 billion; over just the 1997-2007 period it will increase by another $80.6 billion.

This is a real loss with real consequences. Because these excise tax revenues exclusively go to the Highway Trust Fund, the effect of the "income tax offset" is either to require additional income taxes to make up for the shortfall experienced there, or to require reductions in spending outside the Highway Trust Fund to make up the difference.

This subsidy is significant. If we charged the contribution from the General Fund to the Highway Trust Fund and simply took the 1996 transactions and (incorrectly) assumed that the cash balances in the Highway and Transit Accounts were completely "surplus" money, it would take just 3.3 years to completely remove the Highway Account's cash balance and just 4.5 years to completely remove the Transit Account's cash balance.

Caging The Paper Tiger

The Highway Trust Fund "surplus" is no more than a paper tiger, existing only on paper. It does not represent historical underfunding of highways. Highway proponents who want additional spending have a legitimate case to make for more highway spending -- just as do proponents for additional spending in other areas. What they do not have is a trust fund "surplus" or a "silver bullet" that makes the tough choices of prioritizing among federal programs go away.

It is a myth that spending additional dollars for highways is somehow separated from the budget prioritizing process or that it is different from the requests for other programs. The decision about giving additional dollars to highways should be made by first honestly calculating the total amount of federal dollars -- trust fund and General Fund dollars -- already going to highways. The enlargement of the Highway Trust Fund's revenue stream via the 4.3-cent gas tax hike enacted as part of the 1997 budget agreement only exacerbates the conundrum of how to distribute resources. Policy makers might consider that one option would be to end the General Fund subsidization of the Highway Trust Fund's responsibility.