U.S. Diesel Fuel Taxes by State | Impacts on Transportation Costs

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When looking at fuel costs in commercial transportation, state diesel taxes can be one of the biggest cost differentiators for a shipper. Where your over-the-road shipments are moving can dramatically change the cost of fuel to move your goods to market, and without a program that looks at the specific mileage traveled by state, tax variability creates significant price distortion.

Whether considering the taxes themselves, rate structures, or regulatory efforts at the state and federal level create complexities not accounted for in legacy fuel reimbursement programs, which can cost shippers millions.

What is the Purpose of Diesel Fuel Taxes?

Federal, state, and local governments rely on fuel taxes to fund construction, repair, and maintenance of road infrastructure. Infrastructure deterioration has become a nationwide problem, with pressure to increase funding increasing at the state and federal level.

A large-scale infrastructure bill intended to revamp the U.S.’ surface transportation framework has generally received bi-partisan support, though no formal action has been taken. The significant resources needed to enact it and disagreements on what should all be included in the infrastructure plan create the current sticking points. As a result, it has been left in the hands of state governments to address their growing infrastructure funding needs, setting the stage for more frequent state tax increases in recent years.

How are Diesel Prices Affected by Taxes?

The rate at which states have adjusted fuel taxes has grown in correlation with improvements in vehicle fuel efficiency. Improvements in fuel economy have reduced the number of gallons purchased, inherently equating to fewer tax funds. This decrease requires higher tax rates to balance the deficit. The steady adoption of more alternative energies has also displaced a portion of gasoline and diesel demand, giving legislators reason to adjust fuel taxes more often.

States have begun testing alternative ways to obtain tax revenue that differs from traditional per-gallon taxation. Utah and Washington started to explore the possibility of mileage-based taxes to eliminate the previously mentioned risks that negatively impact revenue, but a per-gallon fuel tax at the federal and state levels remain common practice. The differences in magnitude and mechanisms of calculation between states make fuel taxes anything but a one-size-fits-all cost consideration.

The maps above highlight the wide range of diesel taxes throughout the country. The map on the right illustrates how much tax makes up in the final cost of each state’s wholesale diesel price. Depending on geography, per-gallon taxes can range by as much as 60 cents per gallon and account for over 30 percent of diesel prices at the pump (based on average price and tax data collected from July 2020).

Diesel Fuel Tax by State: Recent Tax Changes

State budget proposals at the beginning and middle of each calendar year make January and July the most common months for diesel tax adjustments. The number of states changing their diesel tax rates on July 1 was on par with recent year trends, though the magnitude of the price changes was relatively low.

The vast majority of recent changes were the result of pre-existing legislation and not new government action. California, Indiana, and Illinois all raised taxes due to an inflation-based mechanism to ensure the value of the taxes collected keeps up with the buying power of a dollar. Nebraska, Maryland, Georgia, and Connecticut all have tax components that are tied to percentage-based adjustments on the wholesale cost of fuel. South Carolina’s increase is apart of previously passed legislation that will increase tax by two-cents per year through July 2022.

Lastly, Virginia is the only state to take formal action on taxes this year but decided to homogenize their fuel tax rate to a level that was previously only levied for counties along interstate-81.

Diesel Fuel Tax Implications from COVID-19

States have traditionally used low price environments as a time to increase tax rates. This is primarily driven by lower consumer price sensitivity when fuel prices are low, allowing for tax increases to meet less resistance. Alternatively, some states may also raise taxes to combat falling revenue if they utilize a percentage-based rate structure.

Fuel prices fell to multi-decade lows earlier in 2020, though no major tax legislation was passed. This can be attributed to the disruption to governmental procedures and alternate focus of legislators during COVID-19 response. A sputtering economy also made state governments resistant to increase costs to consumers.

The months and years ahead may see an increase in state-level fuel tax action. The significant demand destruction of gasoline and diesel has meant that state budgets will likely fall short from collecting taxes on far fewer gallons being purchased. When combined with the common tax actions taken in a low fuel cost environment—which is anticipated for the foreseeable future—a surge in the number and magnitude of tax changes is a likely outcome.

Diesel Fuel Taxes by State: Not All Programs are Created Equal

Some states have also instituted carbon pricing mechanisms that add a premium to fossil fuel consumption. Member states of the Transportation Climate Initiative (TCI) in the northeast continue to develop plans for a future carbon trading system in transportation, with the goal of rolling out a carbon pricing strategy in January 2022.

California is the most progressive state in taking carbon-related efforts, with its Low Carbon Fuel Standard (LCFS) program adding to the cost of diesel to, in turn, deter the purchase of fossil fuels and align to the state’s carbon reduction targets. California’s LCFS prices have ebbed and flowed in 2020—strongly influenced by volatile products demand from COVID-19 containment measures—but is set to add roughly 3.5 cents per year incrementally through 2030 (shown in the chart below).

California’s carbon fee alone now surpasses some states’ standard per-gallon diesel tax. This reinforces the differences in tax construct throughout the U.S., the varying objectives of each states’ tax legislation, and the sheer financial implications of tax as its own input in the price of diesel fuel.

Carbon pricing mechanisms have become a reality and have shown signs of early growth nationwide, while percentage, inflation, and the introduction of mileage-based taxes add to the tax distortion that exists throughout the country.  This moving target can, however, create opportunities for shippers interested in avoiding some of this tax cost because of the benefits of alternative energy types and intermodal conversion that mitigate exposure to traditional over-the-road diesel taxes.

Why Should Shippers Pay Attention to Diesel Taxes?

Diesel fuel taxes will remain an integral part of regulatory focus and state finances as long as traditional fossil fuels retain the lion’s share of the market relative to alternative energies. The more frequent and noticeable change is arguably justified, but the regional variance and differing tax composition make shippers’ networks and total fuel spend susceptible to changes that have already started materializing.

Across millions of miles and hundreds of thousands of shipments, shippers cannot afford to pay for taxes on an all-in, averaged basis like methods that include the Department of Energy’s (DOE) diesel fuel price index. This practice loses out on the granularity of over-the-road tax exposure and results in added costs for shippers.

For information about how to mitigate these challenges in fuel cost accounting, read about Breakthrough’s Fuel Recovery program.

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