Highway Financing: Factors Affecting Highway Funding Fluctuations
and Revenue Trends (20-MAR-02, GAO-02-527T).			 
								 
The Highway Trust Fund, authorized by the Transportation Equity  
Act for the 21st Century, "guaranteed" specific annual funding	 
levels for most highway programs on the basis of projected	 
receipts to the fund. It further provided for annual adjustments 
to these funding levels based on actual receipts and revised	 
projections of trust fund revenue. These adjustments are called  
the Revenue Aligned Budget Authority (RABA). The fiscal year 2003
RABA calculation appears reasonable based on the information GAO 
reviewed. While the RABA adjustment is clearly severe, it is a	 
reflection of the multiple ways a downturn in the economy affects
the calculation. In late January 2002, the administration	 
announced that the fiscal year 2003 RABA adjustment would be a	 
negative $4.965 billion. Within a few days of the announcement,  
the administration reported that an error had been made and the  
correct amount was a negative $4.369 billion--a $600 million	 
difference. Treasury is taking steps to improve its internal	 
controls in order to prevent this type of error from occurring	 
again. The use of ethanol blended fuel (gasohol) instead of	 
gasoline reduces Highway Trust Fund revenue because it is	 
partially exempt from the standard excise tax on gasoline and 2.5
cents of the tax received on each gallon of gasohol sold is	 
transferred to the General Fund. Further, gasohol use is	 
projected to increase and the impact of these tax provisions will
grow as well. There are several ways the RABA adjustment could be
changed to help reduce fluctuations in highway funding. However, 
Congress and the administration must weigh the advantages and	 
disadvantages of these and other ways to stabilize highway	 
funding and increase Highway Trust Fund revenues.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-527T					        
    ACCNO:   A02923						        
  TITLE:     Highway Financing: Factors Affecting Highway Funding     
Fluctuations and Revenue Trends 				 
     DATE:   03/20/2002 
  SUBJECT:   Federal aid for highways				 
	     Trust funds					 
	     Alternative energy sources 			 
	     Fuel prices					 
	     Budget authority					 
	     Accounting errors					 
	     Highway Trust Fund 				 
	     Leaking Underground Storage Tank Fund		 
	     Treasury General Fund				 

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GAO-02-527T
     
Testimony Before the Subcommittee on Highways and Transit Committee on
Transportation and Infrastructure U. S. House of Representatives

United States General Accounting Office

GAO Not to be Released Before 2: 00 p. m. EST Wednesday March 20, 2002
HIGHWAY FINANCING

Factors Affecting Highway Funding Fluctuations and Revenue Trends

Statement of JayEtta Z. Hecker Director, Physical Infrastructure Issues

GAO- 02- 527T

Page 1 GAO- 02- 527T Highway Trust Fund

Mr. Chairman and members of the subcommittee: We appreciate the opportunity
to provide testimony on important Highway Trust Fund issues. Our statement
today is based on our recent reports, our ongoing work on the impact of
alternative and replacement fuels on the Highway Trust Fund, and our review
of the fiscal year 2003 Revenue Aligned Budget Authority adjustment. 1 As
you know, the Highway Trust Fund is the principal mechanism for funding
federal highway programs authorized by the Transportation Equity Act for the
21st Century (TEA- 21). TEA- 21 ?guaranteed? specific annual funding levels
for most highway programs on the basis of projected receipts to the Highway
Trust Fund and provided for annual adjustments to these funding levels based
on actual receipts and revised projections of trust fund revenue. These
adjustments are referred to as the Revenue Aligned Budget Authority or RABA.
In fiscal year 2003, for the first time, the RABA adjustment is negative-
decreasing the guaranteed level of highway funding by $4.369 billion.
Consequently, the highway funding level for fiscal year 2003 will be over $8
billion lower than the fiscal year 2002 level.

Concerned about the significant drop in highway funding due to the RABA
adjustment, you asked us to assess the fiscal year 2003 RABA calculation.
Additionally, you expressed concerns about the amount of future revenue
forgone by the Highway Trust Fund due to gasohol usage and asked about ways
to increase revenues into the trust fund. In response, our statement
discusses (1) the reasonableness of the fiscal year 2003 RABA calculation;
(2) the $600 million error in the initial RABA adjustment released by the
administration; (3) the impact of gasohol usage on the Highway Trust Fund;
and (4) ways to reduce fluctuations in the RABA adjustment and industry
proposals to increase Highway Trust Fund revenue. (See app. I for
information on our objectives, scope, and methodology.)

In summary:  The fiscal year 2003 RABA calculation appears reasonable based
on the

information we reviewed. While the RABA adjustment is clearly severe, it 1
U. S. General Accounting Office, Highway Funding: Problems with Highway
Trust Fund Information Can Affect State Highway Funds, GAO/ RCED/ AIMD- 00-
148 (Washington, D. C.: June 2000); and U. S. General Accounting Office,
Applying Agreed- Upon Procedures: Highway Trust Fund Excise Taxes, GAO- 02-
379R (Washington, D. C.: February 2002). Our work was carried out in
accordance with generally accepted government auditing standards.

Page 2 GAO- 02- 527T Highway Trust Fund

largely is a reflection of the multiple ways a downturn in the economy
affects the calculation. The RABA calculation consists of ?look back? and

?look ahead? components. About 80 percent of the fiscal year 2003 RABA
adjustment is attributable to the ?look back? portion of the RABA
calculation, which compares the actual Highway Account receipts for fiscal
year 2001 to the projections of receipts for fiscal year 2001 included in
TEA- 21 plus an adjustment for the RABA calculation made for that year. Our
review shows that the amounts distributed to the Highway Trust Fund for the
first 9 months of fiscal year 2001 were reasonable and adequately supported
on the basis of available information. The remaining 20 percent of the
fiscal year 2003 RABA adjustment is due to the ?look ahead? portion of the
calculation, which compares the Department of Treasury?s (Treasury)
projection of Highway Account receipts for fiscal year 2003 with the
projection of receipts for that year contained in TEA- 21. Although we did
not independently evaluate the methodology and the economic models Treasury
used to develop its revenue projections, our review of a qualitative
description of the process, key inputs, and changes to the models gave us no
reason to question the resulting projections. Similarly, our comparison of
projections prepared by Treasury and the Congressional Budget Office (CBO)
did not lead us to question the projections used for the fiscal year 2003
RABA calculation.

 In late January 2002, the administration announced that the fiscal year
2003 RABA adjustment would be a negative $4.965 billion. Within a few days
of the announcement, the administration reported that an error had been made
and that the correct amount was a negative $4.369 billion- a $600 million
difference. The error occurred in Treasury?s allocation of projected highway
tax revenues to the various accounts that receive them, rather than in
Treasury?s economic models for projecting such revenues. Treasury did not
detect the error until after the RABA adjustment had been released to the
public and the Federal Highway Administration (FHWA) had made its initial
calculations for distributing funds to the states. Treasury is taking steps
to improve its internal controls in order to prevent this type of error from
occurring again.

 The use of ethanol blended fuel (gasohol) instead of gasoline reduces
Highway Trust Fund revenue because it is partially exempt from the standard
excise tax on gasoline (18.4 cents) and 2.5 cents of the tax received on
each gallon of gasohol sold is transferred to the General

Page 3 GAO- 02- 527T Highway Trust Fund

Fund. 2 Based on our ongoing work, our preliminary estimates show that the
Highway Account did not receive about $6.01 billion (in constant 2001
dollars) from fiscal years 1998 through 2001 due to these tax provisions.
Further, gasohol use is projected to increase and thus the impact of these
tax provisions will grow as well. Using Treasury?s projections of gasohol
tax receipts, we estimate that the Highway Account will forgo an additional
$13.72 billion (in constant 2001 dollars) due to the partial tax exemption
from fiscal years 2002 through 2012. We also estimate that the Highway Trust
Fund will forgo about $6.92 billion from fiscal years 2002 to 2012 due to
the General Fund transfer (in constant 2001 dollars). 3 According to
Department of Agriculture (USDA) and ethanol industry officials, the partial
tax exemption for gasohol helps to create a demand for ethanol and make
gasohol price competitive with gasoline.

 There are several ways the RABA adjustment could be changed to help reduce
fluctuations in highway funding. For example, the RABA adjustment could be
distributed over 2 years. In addition, industry groups have proposed a
number of ways to increase Highway Trust Fund revenues. Ultimately, however,
the Congress and the administration must weigh the advantages and
disadvantages of these and other ways to stabilize highway funding and/ or
increase Highway Trust Fund revenues.

The Highway Revenue Act of 1956 established the Highway Trust Fund as an
accounting mechanism to help finance federal highway programs. In 1983, the
Highway Trust Fund was divided into two accounts: a Highway Account and a
Mass Transit Account. Receipts to the Highway Account are used to fund
highway programs, through which billions of dollars are distributed to the
states annually for the construction and repair of highways and related
activities. Treasury uses a revenue allocation and reporting process to
distribute highway user taxes to the Highway Trust Fund.

2 For the purposes of this testimony, we use the term gasohol to refer to
all types of ethanol blended fuels. While biomass methanol fuels are also
eligible for partial tax exemptions, Treasury does not separately track the
small amounts associated with them.

3 The General Fund transfer expires at the end of fiscal year 2005. To
reflect the expiration, Treasury reduces the total federal excise tax on
gasohol blends by 2.5 cents starting in fiscal year 2006. Under Treasury?s
approach, the Highway Account is neither benefited nor harmed by the
expiration. For the purposes of this testimony, we estimated the impact of
the 2.5 cent General Fund transfer assuming the transfer continued through
fiscal year 2012. Background: The

Highway Trust Fund and TEA- 21

Page 4 GAO- 02- 527T Highway Trust Fund

Financing for the Highway Trust Fund is derived from a variety of federal
highway user taxes including excise taxes on motor fuels (gasoline, gasohol,
diesel, and special fuels) and tires, sales of new trucks and trailers, and
the use of heavy vehicles. As table 1 shows, the excise tax rates and
distribution of the tax revenues vary. The different tax rates reflect
federal policy decisions. For example, in the 1970s and 1980s, the federal
government adopted numerous policies to encourage the use of alternatives to
imported fossil fuels and help support farm incomes. Among these policies
were tax incentives that targeted the use of alcohol fuels derived from
biomass materials, such as ethanol. 4 Ethanol blended fuels (gasohol) are
partially exempt from the standard excise tax on gasoline (18.4 cents). The
proportion of ethanol contained in each gallon of fuel determines the size
of the partial exemption. The most common ethanol blend contains 90 percent
gasoline and 10 percent ethanol and is currently taxed at 13.1 cents per
gallon- an exemption of 5.3 cents. 5 The federal government also uses the
distribution of excise tax receipts to different accounts to achieve policy
goals. For example, a small part of the excise tax on most motor fuels is
distributed to the Leaking Underground Storage Tank Trust Fund to clean- up
contamination caused by underground storage tanks. Additionally, 2.5 cents
of the tax received on each gallon of gasohol is transferred to the General
Fund, rather than the Highway Trust Fund, for deficit reduction purposes.

4 Biomass- derived alcohol fuels are chemical compounds made from nonfossil
material of biological origin and constitute a renewable energy source. 5
Ethanol blended fuels containing 7.7 percent ethanol and 5. 7 percent
ethanol qualify for a 4.058 cents and 2.978 cents per gallon exemption,
respectively. TEA- 21 extended the exemption for gasohol fuels through
fiscal year 2007 and provided for a phased- in reduction in the exemption
for gasohol.

Page 5 GAO- 02- 527T Highway Trust Fund

Table 1: Excise Tax Rates and Distributions of Highway User Taxes, as of
July 2001

Cents per gallon Note: Tax rates for gasohol mixtures vary according to the
amount of ethanol contained in the mixture.

Source: FHWA and Treasury.

TEA- 21 continued the use of the Highway Trust Fund as the mechanism for
accounting for federal highway user taxes. TEA- 21 also established
guaranteed spending levels for certain highway and transit programs. Prior
to TEA- 21, these programs competed for budgetary resources through the
annual appropriations process with other domestic discretionary programs.
New budget categories were established for highway and transit spending,
effectively establishing a budgetary ?firewall? between those programs and
other domestic discretionary spending programs. Of the $217.9 billion
authorized for surface transportation programs over the 6- year life of TEA-
21, about $198 billion is protected by the budgetary firewall- about $162
billion for highway programs and $36 billion for transit programs.

Type of tax Tax rate Distribution of tax Highway Trust Fund Leaking
Underground Storage Tank Trust Fund General Fund Highway Account Transit
Account Motor fuels taxes Gasoline 18. 40 15. 44 2.86 0.10 - Diesel 24. 40
21. 44 2.86 0.10 - Alternative fuels taxes

Gasohol (10% ethanol) 13. 10 7.64 2.86 0.10 2. 5 Liquefied petroleum gas 13.
60 11. 47 2.13 - - Liquefied natural gas 11. 90 10. 04 1.86 - - M85 (from
natural gas) 9.25 7.72 1.43 0.10 - Compressed natural gas (cents per
thousand cu. ft.) 48. 54 38. 83 9.70 - - Truck- related taxes

Tires: 0- 40 lbs, no tax Over 40 lbs - 70 lbs, 15 cents per pound in excess
of 40 Over 70 lbs - 90 lbs, $4. 50 plus 30 cents per pound in excess of 70
Over 90 lbs, $10.50 plus 50 cents per pound in excess of 90 Truck and
Trailer Sales Tax 12 percent of retailer?s sales price for tractors and
trucks over 33, 000 lbs gross vehicle weight (GVW) and trailers over 26, 000
lbs GVW Heavy Vehicle Use Tax Annual tax: Trucks 55,000 lbs and over GVW,
$100 plus $22 for each 1,000 lbs (or fraction thereof) in excess of 55, 000
lbs (maximum tax of $550)

Page 6 GAO- 02- 527T Highway Trust Fund

Under TEA- 21, the amount of highway program funds distributed to the states
is tied to the amount of actual tax receipts credited to the Highway Account
of the Highway Trust Fund. TEA- 21 guaranteed specific levels of funding for
highway programs from fiscal year 1999 through fiscal year 2003, on the
basis of projected receipts of the Highway Account. TEA- 21 also provided
that beginning in fiscal year 2000, this guaranteed funding level for each
fiscal year would be adjusted upward or downward through the RABA
calculation as the levels of Highway Account receipts increased or
decreased. To determine the RABA adjustment, the Office of Management and
Budget and the Office of the Secretary in the Department of Transportation
rely on information on Highway Account receipts and revised Highway Account
projections supplied by Treasury. Specifically, the Bureau of Public Debt
provides the actual Highway Account receipts for the prior fiscal year, and
the Office of Tax Analysis (OTA) provides a projection of Highway Account
receipts for the next fiscal year.

On the basis of the information we reviewed, the fiscal year 2003 RABA
calculation- a negative $4. 369 billion- appears reasonable. The RABA
adjustment for fiscal year 2003 was calculated by (1) comparing the actual
Highway Account receipts for fiscal year 2001 to the projections of receipts
for fiscal year 2001 included in TEA- 21, and an adjustment for the RABA
calculation made for that year (the look back portion of the calculation)
and (2) comparing projections of Highway Account receipts for fiscal year
2003 with the projection of these receipts contained in TEA- 21 (the look
ahead portion of the calculation). The sum of these differences is the RABA
adjustment. Table 2 shows the RABA calculations for fiscal years 2000
through 2003. As shown, the RABA adjustments for fiscal year 2000 through
fiscal year 2002 were positive- increasing highway funding levels by a total
of over $9 billion. However, the RABA adjustment for fiscal year 2003 is
negative $4.369 billion. The Calculation of the

Fiscal Year 2003 RABA Adjustment Appears Reasonable

Page 7 GAO- 02- 527T Highway Trust Fund

Table 2: RABA Calculation for Fiscal Years 2000 through 2003

In millions of dollars Note: Actual receipts reflect certified net tax
receipts (excluding fines and penalties) after deduction of transfers and
refunds for the first three quarters of the fiscal year plus an estimate for
the fourth quarter. To account for the differences between actual and
estimated receipts for the previous year?s fourth quarter, Treasury makes an
adjustment to the current fiscal year?s receipts. Treasury prepares
forecasts of tax receipts to the Highway Account of the Highway Trust Fund
for the president?s budget and other analyses. The Congressional Budget
Office prepared the estimates of Highway Account receipts contained in TEA-
21.

Source: GAO analysis.

Eighty percent of the fiscal year 2003 RABA adjustment is attributable to
the look back portion of the calculation. The actual fiscal year 2001
Highway Account receipts were about $1.6 billion lower than projections in
TEA- 21. According to Treasury, actual fiscal year 2001 receipts were lower
than expected due to the slowdown in the economy, which especially affected
heavy truck sales, and increased gasohol use. We reviewed the amounts
distributed to the Highway Trust Fund for the first 9 months of fiscal year
2001, and concluded that these amounts were reasonable and adequately
supported on the basis of available information. With respect to the look
ahead portion of the calculation, we reviewed Treasury?s process for
projecting Highway Account revenues. Although we did not independently
evaluate the methodology and the economic models Treasury used to develop
its revenue projections, our review of a qualitative description of the
process, key inputs, and changes to the models gave us no reason to question
the resulting projections.

Fiscal "Look back" "Look ahead" year RABA

FY 2000 1998 actual Highway Account receipts 23, 135 2000 estimated Highway
Account receipts 28, 551 less: 1998 TEA- 21 estimated Highway Account
receipts 22, 164 less: 2000 TEA- 21 estimated Highway Account receipts 28,
066 less: look- ahead result for 1998 0 subtotal 971 subtotal 485 1, 456

FY 2001 1999 actual Highway Account receipts 33, 815 2001 estimated Highway
Account receipts 30, 368 less: 1999 TEA- 21 estimated Highway Account
receipts 32, 619 less: 2001 TEA- 21 estimated Highway Account receipts 28,
506 less: look- ahead result for 1999 0 subtotal 1,196 subtotal 1,862 3,058

FY 2002 2000 actual Highway Account receipts 30, 334 2002 estimated Highway
Account receipts 31, 732 less: 2000 TEA- 21 estimated Highway Account
receipts 28, 066 less: 2002 TEA- 21 estimated Highway Account receipts 28,
972 less: look- ahead result for 2000 485 subtotal 1,783 subtotal 2,760
4,543

FY 2003 2001 actual Highway Account receipts 26, 900 2003 est. Hwy. Account
receipts 28, 570 less: 2001 TEA- 21 estimated Highway Account receipts 28,
506 less: 2003 TEA- 21 estimated Highway Account receipts 29, 471 less:
look- ahead result for 2001 1, 862 subtotal (3, 468) subtotal (901) (4, 369)

Page 8 GAO- 02- 527T Highway Trust Fund

The Secretary of the Treasury transfers applicable excise tax receipts,
including receipts from gasoline and other highway taxes, from the General
Fund to the excise tax related trust funds, including the Highway Trust
Fund, on a monthly basis. These transfers are based on estimates because
actual data on which to base the allocations are not available when the
deposits are initially made. OTA prepares these estimates on the basis of
historical IRS certification data and actual excise tax revenue collections.
Subsequently, IRS certifies the actual excise tax revenue collections that
should have been distributed to the trust funds on the basis of tax returns
and payment data. 6 Using the IRS certifications, Treasury makes quarterly
adjustments to the initial trust fund distributions. For example, in March
2001, Treasury made an adjustment to decrease the fiscal year 2001 excise
tax revenue distributions to the Highway Trust Fund to correct for actual
collections in the fourth quarter of fiscal year 2000. The certified fourth
quarter receipts were $1.2 billion less than the amount initially
distributed on the basis of OTA?s estimates for that quarter. According to
an OTA official, OTA had calculated the original estimated transfer amounts
for the quarter using an economic model that assumed a higher rate of
economic growth through calendar year 2000 than was actually the case. 7 As
a result, the downward adjustment was made, reducing the fiscal year 2001
distributions to the Highway Trust Fund by $1. 2 billion, which contributed
to the fiscal year 2003 negative RABA adjustment. 8

Our past reports have identified errors and problems with Treasury?s excise
tax allocation process. 9 However, Treasury has made and continues to make
improvements to this process. On February 11, 2002, we issued a report on
the results of procedures we performed related to the distributions of
excise tax revenue to the Highway Trust Fund in fiscal

6 Typically, IRS certifies quarterly excise tax collections 6 months after
the end of the quarter. This is to allow sufficient time for receipt and
processing of the tax returns, including returns filed late. Even though IRS
certifies collections 6 months after the end of a quarter, certifications
for any given quarter routinely contain some amounts related to prior
quarters.

7 Prior to December 2000, the distribution process was linked to OTA?s
receipt estimates for inclusion in the president?s budget. 8 An adjustment
of this type is made every year to correct for the difference between the
actual amounts received in the fourth quarter of the previous year and the
estimated amounts for that quarter.

9 See, for example, GAO/ RCED/ AIMD- 00- 148. Treasury?s Excise Tax

Distributions to the Highway Trust Fund for the First 9 Months of Fiscal
Year 2001 Are Reasonable

Page 9 GAO- 02- 527T Highway Trust Fund

year 2001. 10 On the basis of this work, we believe the amounts distributed
to the Highway Trust Fund for the first 9 months of fiscal year 2001, which
were subject to IRS? quarterly excise tax certification process and which
were adjusted on the basis of this process, were reasonable and were
adequately supported according to available information. Additionally, we
believe the March 2001 adjustment made by Treasury to reduce fiscal year
2001 excise tax distributions to the Highway Trust Fund by $1. 2 billion was
reasonable and adequately supported.

IRS expects to deliver the results of its certifications for distributions
of excise tax revenue collected during the period July 1, 2001, through
September 30, 2001 to Treasury?s Financial Management Service by March 20,
2002. Consequently, the distributions of fourth quarter fiscal year 2001
excise tax revenue were based solely on estimates prepared by OTA. We did
not draw any conclusions about the reasonableness of the distributions made
to the Highway Trust Fund for the fourth quarter of fiscal year 2001.

One component of the look back portion of the RABA calculation is the
comparison of actual fiscal year 2001 Highway Account receipts with
projections of those receipts in TEA- 21. The actual receipts were about
$1.6 billion lower than the amounts contained in TEA- 21. According to
Treasury, the lower than expected highway excise tax receipts in fiscal year
2001 were due to several factors. Most importantly, the weakened economy
contributed to a decline in highway excise taxes paid. All but one of the
Highway Trust Fund receipt sources were lower in fiscal year 2001 than 2000.
For example, tax revenue from the retail tax on trucks dropped 55 percent
from fiscal year 2000 to fiscal year 2001. It is important to note that the
tax is applied to the sale of new trucks only. As the economy weakened,
large numbers of used trucks were placed on the market, which depressed
prices and sales in the new heavy truck market.

In addition to the economic downturn, the rise in the use of gasohol
contributed to decreased Highway Account receipts. The amount of gasohol
receipts allocated to the Highway Account rose by 17.5 percent between
fiscal years 2000 and 2001, which Treasury believes is evidence of an
ongoing substitution of gasohol fuels for gasoline. Because gasohol is taxed
at a lower rate than gasoline and a portion of the tax on gasohol is

10 GAO- 02- 379R. Fiscal Year 2001 Receipts

Lower Than Expected

Page 10 GAO- 02- 527T Highway Trust Fund

transferred to the General Fund, increases in gasohol use and corresponding
reductions in gasoline use decrease Highway Account revenues.

While not the main factor, the look ahead portion of the RABA calculation
also contributed to the overall negative RABA adjustment. As discussed
earlier, the look ahead is the difference between TEA- 21?s projections for
the next fiscal year to current projections from the president?s budget,
which are prepared by Treasury. Based on the general qualitative description
Treasury provided us about its methodology and economic models used to
develop Highway Trust Fund revenue projections, we have no reason to
question the projections for fiscal year 2003. Treasury generally performs
two forecasting exercises each year, including one for the president?s
budget. Treasury uses seven econometric models to forecast each highway
excise tax revenue source, such as the tax on gasoline. These models seek to
approximate the relationship between historical tax liability and current
macroeconomic variables, such as the gross domestic product. This estimated
relationship is the baseline, and Treasury uses it to project future excise
tax liability, given current law and the administration?s economic
assumptions. After calculating future tax liability, Treasury forecasters
convert the tax liability forecast to a tax receipts forecast using
information on deposit rules, payment patterns, and actual collections.

The administration?s economic assumptions drive the projections made with
each model. According to Treasury, receipts forecasting is a policy exercise
conducted for the president to show the state of the Highway Trust Fund if
the administration?s economic assumptions were to come to fruition.
Consequently, Treasury?s forecasts incorporate economic assumptions
formulated for the budget by the ?Troika,? which consists of the Council of
Economic Advisors, the Office of Management and Budget, and Treasury.
Because the goal is to provide a forecast consistent with these economic
assumptions, the models use these assumptions directly as explanatory
variables, or link other explanatory variables to the assumptions provided.
Several of the administration?s economic assumptions are publicly available,
such as the gross domestic product and consumer price index. However, most
Troika assumptions are not publicly available. Other variables specific to
the Highway Trust Fund are included in the economic models. Treasury
generally obtains this information from other federal agencies. For example,
Treasury incorporates USDA?s forecast of ethanol use in its gasohol model.
However, according to Treasury, the forecasters must ensure that the
Treasury Uses Seven

Economic Models to Forecast Receipts

Page 11 GAO- 02- 527T Highway Trust Fund

addition of these other variables does not create inconsistencies between
the projections and the administration?s assumptions.

It should also be noted that Treasury does not try to predict future
regulatory or legislative changes at the federal or state levels that could
affect Highway Trust Fund revenue but bases its projections on current law.
Any legislative or regulatory changes that affect Highway Trust Fund revenue
will affect the accuracy of the forecasts. Treasury continuously updates its
models to incorporate legislative, economic, and other relevant changes-
which are then reflected in the next forecasting exercise.

According to Treasury officials, Treasury?s modeling framework for
projecting highway excise tax receipts has not changed in recent years.
Treasury?s framework consists of a series of econometric models that
approximate the relationship between historical tax liability and current
macroeconomic variables, which are then used to project future tax liability
given current law and certain economic assumptions. Although the overall
framework has remained consistent, Treasury officials noted that the
specific economic models used to project receipts are continuously evolving
to reflect current circumstances. For example, the models are constantly
updated to incorporate the most current information on tax collections and
reported tax liabilities, as well as enacted legislation. In addition to
these routine changes, the models have occasionally undergone other
modifications. Treasury identified 15 major changes to the models since
1998. These changes ranged from moving the highway- type tire tax from an
annual model to a quarterly model and revising the ethanol forecast in the
gasohol model to reflect the phasing out of methyl tertiary- butyl ether
(MTBE) in certain states. According to Treasury, the identified changes were
designed to improve the models? forecasting ability.

Although Treasury does not use an independent reviewer to validate the
models, Treasury officials noted several ways they validate them. First, the
Director of Treasury?s Office of Tax Analysis reviews the results of the
model for accuracy and soundness at least twice a year. Second, Treasury
officials compare the projected receipts with actual receipts to assess the
validity of the models. In comparing the projected and actual receipts,
Treasury forecasters try to determine the cause of any substantial
differences and make changes to the model, as appropriate. Third, trust
Treasury?s Highway Trust

Fund Forecasting Framework Has Remained Consistent

Page 12 GAO- 02- 527T Highway Trust Fund

fund agencies, such as FHWA, receive the forecasts semiannually and may
offer comments to Treasury on the projections. 11

In order to help determine the reasonableness of Treasury?s projection, we
compared it with CBO?s forecasts. This comparison does not raise any
questions about the reasonableness of Treasury?s projections. For example,
despite different methodologies and assumptions, Treasury and CBO
projections of Highway Account receipts for the budget window are very
similar. (See fig. 1.) Both agencies forecast steady growth in receipts from
fiscal years 2002 through 2012. For example, both Treasury and CBO project
the average annual growth of highway- related excise taxes will be about 3
percent.

11 FHWA is developing a model to project Highway Trust Fund receipts.
Treasury?s Current

Projections Are Similar to CBO?s Forecast

Page 13 GAO- 02- 527T Highway Trust Fund

Figure 1: Comparison of Treasury and CBO Projections of Highway Account
Receipts, 2002 to 2012

Source: Treasury and CBO.

In January 2002, the administration announced that the fiscal year 2003 RABA
adjustment would be a negative $4.965 billion. The administration
subsequently announced that an error had been made in calculating the RABA
adjustment and that the correct amount was a negative $4.369 billion- a $600
million difference.

The error, which was made in Treasury?s allocation of projected highway tax
revenues to various accounts rather than in its economic models, affected
the look ahead part of the fiscal year 2003 RABA calculation. Specifically,
it occurred in Treasury?s allocation of projected revenues from gasohol
sales to the General Fund, the Leaking Underground Storage Tank Trust Fund,
and the Highway and Transit Accounts within the Highway Trust Fund. In
short, the error resulted in the incorrect distribution of projected gasohol
receipts among the funds. $600 Million Error in

RABA Adjustment Occurred Outside of Treasury?s Models

Page 14 GAO- 02- 527T Highway Trust Fund

Because gasohol has six different blends- all with different tax rates and
distributions- the gasohol allocations are complicated and require many

?links? among several spreadsheets. With respect to gasohol, the Highway
Account receipts are calculated after allocations for the other accounts-
the Mass Transit Account, the Leaking Underground Storage Tank Trust Fund,
and the General Fund- have been calculated. This is because the Highway
Account is a ?catch- all? for taxes not already attributed to other
accounts. A misalignment occurred between the different spreadsheets used to
distribute gasohol tax revenues to the different accounts, which caused too
much of the gasohol revenues to be transferred to the General Fund.
Therefore, the error incorrectly lowered projected Highway Account revenue
beginning with fiscal year 2002.

According to a Treasury official, a number of factors contributed to the
error, including tightened time constraints during this budget cycle for
Treasury forecasters to calculate and review their projections for the
fiscal year 2003 budget. Each forecaster is responsible for reviewing his/
her own calculations. In hindsight, however, this official said that the
internal quality checks his office made were insufficient, especially on the
gasohol calculations, which are very complex. He noted that Treasury plans
to take several steps to avoid such an error in the future, including
requiring another Treasury forecaster to spot check the projections.

The use of gasohol instead of gasoline affects the amount of Highway Account
revenue for two reasons. First, gasohol is partially exempt from the
standard gasoline excise tax. Second, 2.5 cents of the tax received on each
gallon of gasohol sold is transferred to the General Fund. (See fig. 2.)
Based on our ongoing work, our preliminary estimates show that the partial
tax exemption resulted in $3.86 billion in revenue forgone by the Highway
Account during fiscal years 1998 through 2001. 12 We also estimate that the
General Fund transfer caused a reduction of $2.15 billion in Highway Account
revenue during the same period.

12 All estimates of revenue forgone by the Highway Account are presented in
constant 2001 dollars. Gasohol Usage Has

Significant Impact on Trust Fund

Page 15 GAO- 02- 527T Highway Trust Fund

Figure 2: Distribution of Gasoline and Gasohol Taxes to Different Accounts

Source: GAO analysis.

Treasury projects that gasohol use will continue to rise steadily through
fiscal year 2012. According to Treasury, such an increase will occur at the
expense of gasoline as some states ban the use of MTBE as an oxygenate
additive. Using Treasury?s highway excise tax revenue projections, we
estimate that the partial tax exemption will lower Highway Account revenue
by a total of $13. 72 billion from fiscal years 2002 through 2012. (See fig.
3.) We also estimate that the Highway Account will not receive $2.36 billion
due to the General Fund transfer from fiscal years 2002 through 2005, when
the transfer ends. 13 In addition, if the amount of the transfer is not
dedicated to the Highway Account following fiscal year 2005, we project that
the Highway Account will forgo $4.56 billion from fiscal years 2006 through
2012. State or federal legislation or regulations that result in gasohol use
above what is currently projected, such as a

13 The General Fund transfer expires at the end of fiscal year 2005. To
reflect the expiration, Treasury reduces the total federal excise tax on
gasohol blends by 2.5 cents starting in fiscal year 2006. Under Treasury?s
approach, the Highway Account is neither benefited nor harmed by the
expiration. For the purposes of this testimony, we estimated the impact of
the 2.5 cent General Fund transfer assuming the transfer continued through
fiscal year 2012.

Page 16 GAO- 02- 527T Highway Trust Fund

nationwide ban on MTBE, would increase the negative impact on the Highway
Account absent other changes.

Figure 3: Estimated Revenue Forgone by the Highway Account Due to Gasohol
Tax Provisions, 1998 to 2012

Note: Estimates for fiscal years 1998 to 2000 are based on actual excise
taxes collected. We estimated fiscal year 2001 receipts using actual
receipts collected for the first three quarters and a projection of receipts
collected for the fourth quarter. Estimates for fiscal years 2002 to 2012
are based on Treasury?s projections. Estimates are in constant 2001 dollars.

Source: GAO analysis.

According to USDA and ethanol industry officials, the partial tax exemption
for gasohol is intended to create a demand for ethanol that will raise the
price of ethanol at least to the point where producers can cover costs.
These officials stated that if the partial tax exemption on ethanol was
removed, the price of ethanol would no longer be competitive with gasoline
and the demand would disappear. In this case, ethanol fuel production would,
for the most part, not continue. Furthermore, ethanol industry officials we
talked to warned that because a substantial amount of the corn grown in the
United States is used for ethanol, the collapse of the ethanol industry
would affect the corn and agriculture markets which could in turn affect the
federal government?s agricultural support payments.

Page 17 GAO- 02- 527T Highway Trust Fund

As the Congress considers the reauthorization of surface transportation
programs, there are several ways it could restructure the RABA adjustment to
reduce fluctuations in highway funding. Furthermore, industry officials have
identified a number of possible ways to increase Highway Trust Fund
revenues. Ultimately, the Congress and the administration must weigh the
advantages and disadvantages of changing the RABA adjustment and/ or Highway
Trust Fund revenue streams. The discussion that follows is not intended to
show support for any possible alternatives but instead to describe some of
the ways highway funding could be increased.

The RABA formula as defined by TEA- 21 contains look back and look ahead
components that tend to accentuate the impact of any shifts in Highway
Account receipts. For example, the recent downturn in the economy is
reflected in several elements of the fiscal year 2003 RABA calculation.
First, the actual receipts for fiscal year 2001 were lower than expected.
Second, the downturn caused a need to correct for optimistic projections of
fiscal year 2001 receipts made in December 1999. Third, the fiscal year 2003
projections are lower than those contained in TEA- 21 because the updated
projections reflect the current economic conditions.

There are several changes that could be made to reduce the potential for
dramatic swings in funding for highway programs but maintain a tie to actual
receipts credited to the Highway Account. For example, changes to the RABA
adjustment that could smooth out the impact of significant funding changes
would include (1) eliminating the look ahead part of the RABA calculation,
(2) averaging the look back part of the calculation over 2 years, and (3)
distributing the RABA adjustments over 2 years. In figure 4, we show the
actual RABA adjustments under the current structure and the adjustments that
would have been made using these three options from fiscal years 2000
through 2003. Ways to Reduce

Highway Funding Fluctuations and Industry Proposals to Increase Revenues

Page 18 GAO- 02- 527T Highway Trust Fund

Figure 4: Comparison of Different RABA Options

Dollars in millions Source: GAO analysis.

As shown, the three options appear to produce less dramatic shifts in
funding than the current RABA mechanism over the past four years. However,
we did not analyze how these options would perform against different trust
fund scenarios or economic cycles in the future.

Industry groups have proposed various ways to increase Highway Trust Fund
revenue such as crediting the Highway Trust Fund for the interest earned on
its balances, increasing the use of tolls, and/ or establishing an indexing
system to help ensure that gas tax revenues are linked to inflation.
Although each of these actions would increase Highway Trust Fund revenues,
we have not evaluated their fiscal or public policy implications.

Another way to enhance Highway Trust Fund revenues would be to increase
highway excise taxes. Although no tax increase is attractive,

-$5,000 -$4,000

-$3,000 -$2,000

-$1,000 $0

$1,000 $2,000

$3,000 $4,000

$5,000 2000 2001 2002 2003

Fiscalyear

Current Eliminating the lookahead Distributing adjustment over 2 years Using
2-year average for lookback

"Average" "Eliminating"

"Current" "Distributing"

Page 19 GAO- 02- 527T Highway Trust Fund

there are some equity arguments that support an increase in certain highway
user taxes. For example, for some time FHWA has reported that heavy trucks
(trucks weighing over 55,000 pounds) cause a disproportionate amount of
damage to the nation?s highways and have not paid a corresponding share for
the cost of the pavement damage they cause. Currently, heavy vehicles are
taxed at the rate of $100 per year plus $22 for every 1,000 pounds (or
fraction thereof) they weigh over 55,000 pounds. However the tax is capped
at $550. In 2000, we reported that the Joint Committee on Taxation estimated
that raising the ceiling on this fee to $1900 could generate about $100
million per year. 14

Mr. Chairman, this concludes my prepared remarks. I would be pleased to
answer any questions you or other members of the Subcommittee may have.

For questions regarding this testimony please contact JayEtta Z. Hecker on
(202) 512- 2834 or at heckerj@ gao. gov. Individuals making key
contributions to this testimony included Nikki Clowers, Helen Desaulniers,
Mehrzad Nadji, Stephen Rossman, Ron Stouffer, and James Wozny.

14 U. S. General Accounting Office, Budget Issues: Budgetary Implications of
Select GAO Work For Fiscal Year 2001, GAO- OCG- 00- 8 (Washington, D. C.:
March 31, 2000). Contact and

Acknowledgements

Page 20 GAO- 02- 527T Highway Trust Fund

To determine the reasonableness of the Revenue Aligned Budget Authority
(RABA) calculation we relied in part on previous work done by GAO under an
agreement with the Department of Transportation?s Inspector General which
resulted in a February 2002 report: Applying Agreed- Upon Procedures:
Highway Trust Fund Excise Taxes (GAO- 02- 379R). Under that agreement we (1)
performed detailed tests of transactions that represent the underlying basis
of the amounts distributed to the Highway Trust Fund, (2) reviewed the
Internal Revenue Service?s quarterly certifications of these amounts, and
(3) reviewed the Office of Tax Analysis? process for estimating amounts
distributed to the Highway Trust Fund in the fourth quarter of fiscal year
2001. We also interviewed knowledgeable Department of Treasury, Office of
Management and Budget, and Department of Transportation officials who
provided documentation and described the processes used to develop the
calculation. We obtained from the Treasury?s Office of Tax Analysis (OTA) a
general description of its economic models, including key inputs and changes
made to the models since 1998, which are used to estimate future Highway
Trust Fund revenues. Additionally, we reviewed related OTA internal analyses
and reports. However, we did not evaluate or certify Treasury?s economic
models that forecast future Highway Trust Fund revenues. We met with
Congressional Budget Office (CBO) officials who described their process for
projecting Highway Trust Fund revenues. CBO officials also provided their
Highway Trust Fund revenue forecast, which we compared to Treasury?s
projections.

To determine how the $600 million error in the initial RABA adjustment was
made, we interviewed Treasury and DOT officials. We also reviewed Treasury?s
workpapers to determine the source and cause of the error.

To evaluate the impact of gasohol usage on the Highway Account we
interviewed Department of Energy, Transportation and Agriculture officials
and representatives from the Renewable Fuels Association, the American Road
and Transportation Builders Association and the Alliance of Automobile
Manufacturers. We reviewed Department of Energy and Agriculture reports and
analyses on ethanol production and consumption. To calculate the revenue
forgone to the Highway Trust Fund as a result of the gasohol tax provisions
we used a methodology we developed in a prior study of alcohol fuel tax
incentives. 1 In particular, we used actual and

1 U. S. General Accounting Office, Tax Policy: Effects of the Alcohol Fuels
Tax Incentives,

GAO/ GGD- 97- 41 (Washington, D. C.: March 6, 1997). Appendix I: Objectives,
Scope, and

Methodology

Page 21 GAO- 02- 527T Highway Trust Fund

projected excise tax receipts on gasohol and gasoline used for gasohol; tax
rates for gasohol, gasoline used for gasohol, and gasoline; and information
on the distribution of the receipts from these fuels to the Highway Account,
Mass Transit Account, the Leaking Underground Storage Tank Trust Fund, and
General Fund to calculate the revenue forgone by the Highway Account due to
gasohol tax provisions. Our data sources included the Statistics of Income
Bulletin and Treasury?s latest projections of gasohol tax receipts and
refunds and credits. In addition, Treasury provided information on the tax
rates and the distributions of the tax receipts to different accounts by
year. Our estimates of the future impact of gasohol use are based on
Treasury?s projections of gasohol tax receipts and as a result, our
projections incorporate the same assumptions used by Treasury.

The estimates that we present are ?static? estimates in that they do not
take into account the potential changes in motor fuel consumption in
response to the elimination of the exemptions. The projections do not
represent the amount of revenue that would be saved if the exemptions were
eliminated because they do not account for the behavioral responses that
might alter the total consumption in the future. Rather, the estimates that
we have made are of the reduction of excise tax revenues due to the
exemptions.

To identify possible ways to change the RABA adjustment to reduce the wide
shifts caused by the current formula, we relied on discussions we had with
Treasury and DOT officials. We attempted to show how the options we
identified would result in less fluctuation if they had been applied
throughout the TEA- 21 time period. We did not attempt to project how these
alternatives would affect future funding levels under different highway
receipt scenarios. To identify ways to enhance Highway Trust Fund revenues
we used our past work on heavy truck use. In addition, we interviewed
government and industry officials from such organizations as the American
Road and Transportation Builders Association. We did not attempt to evaluate
the fiscal or public policy implications of any of these proposals.

(544027)
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