Inter State Tax Coordination: Lessons (the case) from IFTA
Interstate Tax Coordination: Lessons from the International Fuel Tax Agreement
Dwight Denison
Associate Professor of Public and Nonprofit Finance
New York University –Wagner School of Public Service
The Puck Bldg., second floor
295 Lafayette St
New York NY 10012
Telephone: 212-998-7534
Fax: 212-995-3890
dwight.denison@nyu.edu
Rex L. Facer II
Assistant Professor
Romney Institute of Public Management
Brigham Young University
760 TNRB
Provo, UT 84602
Telephone: 801-422-9321
Fax: 801-422-0311
rfacer@byu.edu
For Presentation at the Spring Symposium’s State-Local Tax Program “The Political Economy of Intergovernmental Tax Administration and Compliance” of the National Tax Association on May 20, 2005, in Washington DC.
Preliminary Draft
Please to do not quote or cite without permission.
Comments and suggestions are welcome.
Interstate Tax Coordination:
Lessons from the International Fuel Tax Agreement[1]
Introduction
As regional economies have become more interconnected, the administration of tax revenue systems has become increasingly complex, motivating states to consider tax coordination efforts through a variety of arrangements to improve tax administration and enforcement. A tax coordination agreement permits the participating states to engage in specified collection or enforcement activities associated with a tax on behalf of another jurisdiction.
A growing concern over lost sales tax revenue on remote sales transacted through the internet has motivated many states to explore cooperative tax agreements for sales and use taxes. With the support of the National Governors Association (NGA) and the National Conference of State Legislatures (NCSL), an ambitious and controversial project known as the streamlined sales tax project (SSTP) has emerged to propose principles for sales tax coordination. While SSTP is center stage in tax cooperative agreements, another cooperative agreement, the international fuel tax agreement (IFTA), was initiated over twenty years ago. The purpose of this paper is to describe the history, background, and incentives that have helped IFTA to be relatively successful. We show how the combination of improved tax administration and lower transaction costs play a critical role in the success of IFTA. Last, we identify lessons from IFTA that have relevance for SSTP.
Back ground
While fuel taxes are excise taxes, they have historically been viewed as a use tax and most states have dedicated fuel tax revenue for transportation purposes. Motor fuel taxes were levied first in the states as early as 1919. A federal fuel tax of 1-cent-per-gallon was first adopted in 1933. In 1956 the importance of the federal fuel tax increased with the establishment of the Highway Trust Fund and the intensive investment in the interstate highway network that followed. The current federal fuel tax rate is now 18.4 cents per gallon for gasoline and 24.4 cents per gallon for diesel fuel. State fuel taxes range from a low of 7.5 cents per gallon in Georgia to a high of 31.0 cents per gallon in Rhode Island. More than half of the states (27) impose different rates based on the type of motor fuels (gasoline, diesel, and gasohol). Most of these states with rate differentials tax diesel fuel at a higher rate. A few states levy a reduced tax rate on gasohol (FTA 2005). A small number of states further allow local governments to impose a local-option fuel tax (e.g, Nevada).
While the fuels tax is a relatively small proportion of total state revenues, the tax funds a significant portion of transportation expenditures. Historically, the fuels tax has been somewhat complicated tax to administer and collect. For simplicity, states have allowed individual motorists to pay the fuel tax at the pump and not worry about the miles driven in a particular jurisdiction. On the other hand, states have attempted to enforce the fuels tax on large motor carriers based on some apportionment of miles driven in a state. Since highways are critical to the trucking industry, the industry has generally been willing to cooperate. However, over time the complexities of the system have increased as states employed different tax systems with different rates and definitions of taxable fuel transactions. Prior to IFTA, a single route from Denver to Los Angels would require the carrier to file tax forms in five different states or to obtain permits from those five states. Furthermore, the carrier could be potentially audited for compliance by each of the five states.
The complexity of the fuel tax system motivated a few states to experiment with coordination of fuel tax collection. In 1983, the International Fuel Tax Agreement was initiated with three states (Arizona, Iowa, and Washington). This early cooperative effort was designed to assist in the reporting and payment of fuel taxes. The agreement has evolved significantly through the years and currently the 48 contiguous U.S. states and 10 Canadian provinces have signed the agreement. In 1984, Congress supported the formation of the National Governor’s Association’s (NGA) Working Group on State Motor Carrier Procedures. The working group proposed a “Model Base State Fuel Use Tax Reporting Agreement” which was based on the early IFTA agreement and the Regional Fuel Tax Agreement among northeastern states. In 1987 six states adopted the NGA model. By 1990 16 states had joined IFTA, setting the stage for the next phase.
In 1991, President George H. W. Bush, signed the Intermodal Surface Transportation Efficiency Act (commonly known as ISTEA). Title IV of ISTEA acknowledged state agreements for commercial vehicle registration and fuel tax reporting. ISTEA authorized the Federal Highway Administration to fund a working group to assist with the IRP and IFTA.[2] Additionally, and perhaps most critically, ISTEA provided a significant incentive to encourage states to participate in IFTA. “[A]fter September 20, 1996, no State shall establish, maintain, or enforce any law or regulation which has fuel use tax reporting requirements (including tax reporting forms) which are not in conformity with the International fuel Tax Agreement” (ISTEA section 4008(g)(1)). States were also told that they could not “establish, maintain, or enforce any law or regulation which provides for the payment of a fuel use tax unless such law or regulation is in conformity with the International Fuel Tax Agreement . . .” (ISTEA section 4008 (g)(2)).
The federal legislation occurred in part because motor carriers believed that compliance with existing state laws was both difficult and burdensome. These laws required a motor carrier to report their fuel use tax liability to each state in which they operated. Both large and small carriers filed forms in multiple states and each form often required different information. A key component of the IFTA model is to allow carriers to designate a base reporting state. The carrier then reports to the base state all fuel tax liabilities (both in the base state and in any other state were they operated). The base state collects the net tax liability from the carrier. The base state then compares state tax collections with tax assessments and transfers funds to the appropriate states. Consequently, the costs of coordinating fuel tax compliance are shifted from the carriers to the state government.
Tax Principles
The decision for a state to cooperate with other states in the administration of the fuel tax should be considered in context of the generally accepted principles of taxation. The specific terminology used to discuss tax principles varies slightly from text to text (e.g., Brunori 2001, Mikesell 2003, Musgrave and Musgrave 1989, Smith 2000), but there is general agreement that a tax should be fair and equitable, possess economic neutrality, generate adequate revenue, be economical and easy to administer, and provide for accountability in the administration, enforcement, and compliance with the tax.
Fairness and equity. One of the most debated principles of taxation is fairness and equity. There are two types of equity in this debate. Horizontal equity posits that similar tax payers should be treated similarly. Vertical equity, on the other hand, is based on the ability to pay, which suggests that different tax payers should be treated differently. Perhaps less controversial are equity concerns of a use tax, because those who pay the tax are those who benefit from the service. The motor fuel tax is generally earmarked for transportation expenditures, so the fuel tax is viewed as a use tax paid by those who benefit from the transportation system. This is certainly the case for the fuel use tax paid under IFTA. Nevertheless, tax equity can still be a significant issue for fuel taxes. States respond to vertical equity concerns by setting fuel tax rates and permitting exemptions to the fuel tax base. Therefore, maintaining state control of tax rates and base exemptions is a political prerequisite of any cooperative tax administration agreement, especially since it allows individual states to achieve their own solutions for fairness and equity.
Adequate Revenue. A viable tax needs to produce sufficient revenue to fund the governmental services demanded by citizens. Important components of revenue adequacy are revenue stability and purchasing power. Stability implies that revenues will not vary dramatically from one year to the next. Stability is usually accomplished through a mix of tax revenue sources, much as a diversified investment portfolio balances risk over time. However, stability can also be maintained through a tax on an inelastic tax base (for an example see Denison, Hackbart, Ramsey 1999). The fuel tax base is less elastic in the short run compared to the sales and income tax base, and therefore somewhat more stable. Despite the base stability, the purchasing power of the fuel tax has been deteriorating over the last decades, primarily because the fuel tax is set as a unit charge per gallon of fuel, and therefore does not automatically keep pace with inflation (Facer and Kallioinen 2004; de Cerreno 2003). Revenue erosion also results from improvements in fuel efficiency. Revenue adequacy is another reason that a cooperative fuel tax agreement would need to maintain state control of tax rates.
Easy and Economical to Administer. The tax system should minimize the cost of compliance to the tax payer and the cost of collection for the government. The more complicated the tax system, the higher the compliance costs. As we discuss later in the paper, compliance costs provide a key motivation in the interstate cooperative agreements of fuel tax administration.
Economic Neutrality. A tax should interfere as little as possible with market decisions (unless the tax is intended to change tax payer behavior to mitigate negative externalities). Tax payers should not be encouraged or discouraged from engaging in transactions simply to gain positive or avoid negative tax consequences. One way to promote neutrality is through a broad tax base. Tax compliance is also enhanced when there are few exemptions and deductions to a tax base. Economic neutrality often conflicts with vertical tax equity issues. A broad base may cause the least amount of distortion in the market, but a broad consumption tax base may also be regressive, placing a proportionally higher tax burden on those with low incomes. In the case of the diesel fuel tax, exemptions are provided for off-road and home heating applications. Economic neutrality is generally considered in context of the distortionary impact of tax rates through a price effect, but excessive compliance costs on a tax also can increase production costs and thereby reduce the supply of a good or service. Cooperation across the states increases the states ability to monitor compliance (especially tax avoidance) that might otherwise go unnoticed.
Accountability. Accountability encompasses several issues (Brunori 2001). The government must administer and enforce the tax efficiently and fairly. Corruption in the administration or enforcement curtails accountability. The tax system should be open and transparent. Tax decisions should be made openly and the tax laws should be explicit. The tax should also be understandable to the taxpayer (Musgrave and Musgrave 1989, p.216). An accountable tax also means that the tax can be adequately enforced.
The fuel tax, as a benefits tax, is widely viewed as transparent. However, enforcement of the fuel tax has been a concern, as the relatively large tax rate provides lucrative incentives for corruption and evasion (Denison and Eger 2000, Denison, Eger, Hackbart 2000, Eger and Hackbart 2005). Denison and Eger (2000) highlight the prominent methods of fuel tax evasion which fall into four general categories:
• Failing to file reports
• Filing false information
• Claiming undeserved exemptions or credits
• Failing to pay assessed taxes
One of the policy options available to states in mitigating fuel tax evasion is to streamline the method of tax collection and to increase audit coverage (Denison and Eger 2000). The federal government and most states collect the motor fuels tax at “the rack”, the point that fuel is available for distribution at the wholesale level. Collecting the fuel tax at “the rack” has addressed many evasion issues from the federal perspective, but variation in state fuel tax rates still provides incentives for bootlegging schemes (Ibid 166). Fuel tax evasion has implications for interstate coordination. Eger and Hackbart (2005) find that increasing audit capacity can lead to increased state fuel tax assessments. Therefore, better coordination among states may improve audit coverage to detect and reduce bootlegging schemes. At the same time, evasion concerns may also cause some states to oppose relinquishing audit responsibility for out-of-state firms that have substantial operations in the state.
The principles of taxation provide an important framework for analyzing interstate cooperative agreements like IFTA. As commerce increasingly expands beyond state boarders, the tax administration costs borne by the government and the compliance costs borne by the tax payer increase. There are potential economies to scale in the administration, enforcement, and compliance costs associated with an excise tax that can be achieved through cooperative agreements. Nonetheless, the principles of equity, revenue adequacy, and accountability, necessitate that states possess the flexibility to change the tax rates and grant exemptions to the tax base as they see fit. States are also responsible for ensuring that taxes are properly assessed and paid. While some of this responsibility can be reasonably delegated to other jurisdictions, ultimately, it is the executive branch that will held accountable for instances of fraud and abuse. A viable cooperative agreement like IFTA must take these factors into account.
Economic incentives for coordinated fuel tax administration
People join clubs because the benefits of membership exceed the costs of membership (Cornes and Sandler 1996, p. 347, Buchanan 1965). Similarly, organizations enter into collaborative agreements, like IFTA, when the benefits of membership exceed the costs maintaining the relationship. In this section the economic incentives are discussed that could motivate and sustain collective enforcement of the fuel tax. The focus on the economic incentives is important in understanding how IFTA can be sustained. However, economic incentives alone do not explain the emergence of IFTA. Mancur Olson (1971) articulates that economic incentives are not always sufficient to motivate a group into collaborative action:
“It does not follow, because all of the individuals in a group would gain if they achieved their group objective, that they would act to achieve that objective, even if they were all rational and self-interested. Indeed unless the number of individuals in a group is quite small, or unless there is coercion or some other special device to make individuals act in their common interest, rational, self-interested individuals will not act to achieve their common or group interests." (pg. 2, emphasis in original)
One of the reasons that Olson (1971) gives for lack of collective action is that costs are readily identified, but the benefits are widely disbursed and perhaps exhibit free rider problems. We will return to this concern after the discussion of the economic benefits to interstate coordination from both the state tax administration and trucking industry perspectives.
State Perspective
It is reasonable to ask why states would choose to cooperate on the administration and enforcement of the fuel tax. The benefit of better audit coverage is one reason that states may choose to collaborate. Consider the simplified scenario with two states, A and B. Ovals A and B in Figure 1 represent the universe of trucking firms who are licensed to carry freight on each state’s roadways. The figure depicts in the overlap υ, the firms licensed to operate in both states. Define υ as the percentage of firms in A that are also licensed in B. Further, define p as the percentage of firms that State A audits each year as a matter of enforcement policy. In the absence of cooperation State A is responsible for tax collection and auditing of all firms licensed in the state.
Figure 1, Trucking Firms with Operating Permits in a Two State Scenario
[pic]
State A may decide to cooperate with State B on the enforcement of the fuel tax because auditing the dually licensed firms is shared. If State A continues to audit the same number of firms each year, the audit coverage will increase since the number of firms to audit has decreased. Specifically, the audit coverage is given by p/(1-.5υ).[3] Consider p = 3% and υ = 20% to illustrate the impact of cooperation on audit coverage. In this case, State A acting alone would audit 3% of the firms compared to .03/(1-.10) = 3.33% under cooperation. The greater the overlap of υ, the larger the audit coverage ratio increases through cooperation. Often a state will have an established policy for the audit rate, so a change in the number of taxpayers will reduce the overall audit costs if the same audit coverage rate is maintained. In the scenario, the total audit costs will be reduced by .5υ percent if the audit rate is held constant.
Increased audit coverage is a benefit to cooperation, but there are also transaction costs to cooperation. In particular, State A must ensure that State B is fulfilling the agreed auditing functions. Drawing from the transaction cost literature[4], the economic conditions for fuel tax enforcement cooperation are satisfied when AC > AC’ + TC, where AC is the auditing costs without cooperation, AC’ is the auditing costs with cooperation and TC is the transaction costs of monitoring the cooperative agreement. The equation can also be expressed as AC –AC’ > TC.
The underlying requirement for cooperation is that the after auditing costs are less than those audit costs without cooperation. The cooperative audit costs in the case of the fuels tax could be less than the non cooperative audit cost because geographically the audits are all completed in the state, reducing travel time and costs. Additionally, focusing on firms in the base state may facilitate better information exchange and therefore improve the efficiency of the audits. Perhaps the strongest potential cost reduction in audit costs is reduction of tax payers. As previously discussed, the number of tax payers decreases under cooperative agreements. Rather than increase audit coverage, the state may consider the level of the audit coverage as sufficient, and therefore realize savings because the number of audits each year can decrease. In fact, minimum audit coverage ratios of three percent are dictated in the IFTA agreement. The key point is that there has to be some efficiency through cooperation that reduces audit costs.
The second condition for interstate cooperation on the fuel tax is that the reduction in audit costs resulting from cooperation must be more than the transaction costs. Transaction costs are those costs incurred by the state while monitoring the cooperative agreements. In a simple two state scenario the transaction costs may be reasonable. However, as the number of members in the cooperative agreement increases, the transaction costs become more burdensome. For this reason the early cooperative fuel tax agreements initiated among just a few states. For IFTA to be a national success, the individual transaction costs would need to be significantly reduced.
There are fortunately economies to scale in the monitoring the international fuel tax agreement. Transaction costs were reduced by creating an organization (IFTA Inc.) that became the clearing house for information and provided oversight of state compliance with the agreement. Another important step in reducing the transaction costs is uniform definitions across states. For IFTA, this required that the membership agree upon the definition of vehicles subject to the fuel tax.
Trucking industry perspective
As indicated previously, prior to IFTA, a freight trucking company was required to file fuel tax returns in each state where the company had logged miles. The impact of compliance cost can be substantial for those companies operating in several states. The trucking industry was very interested in reducing their compliance costs. To understand the burden of compliance costs, consider a simplified income function where total revenues minus total costs and taxes is equal to income. Expressing total revenue, variable costs, and excise tax in terms of Q miles of freight the income equation is
RQ – VQ –FC –µQ – CC = π
Where R is the average revenue per freight mile, Q is the total quantity of freight miles, V is the variable cost per mile, FC is the total fixed costs, µ is the excise tax per mile, CC represents the compliance costs of the excise tax. It is useful to consider the break-even framework to illustrate the trucking industry’s concern with the compliance costs. Setting π =0 and solving for Q provides the breakeven formula
Q*= (FC + CC) /(R –V –µ)
A firm will generate profits as long as R is more than V + µ, and the firm can operate at some volume of miles more than the breakeven quantity. The problem is that compliance costs, CC, are not fixed and are endogenous with Q. Compliance costs are driven by two activities: filing taxes and responding to audits. Thus, CC equals the total filing costs plus the expected audit costs. The total filing costs are the sum of the costs of completing the tax filing for each state where the firm had operations. Total Filing cost = [pic] where s is the number of states where the firm logged miles and c is the average filing cost for state s.
The annual audit costs are the average cost of undergoing an audit multiplied by the probability of an audit. For a firm that operates within a single state this calculation is straight forward. However, firms operating in more than one state increase the probability of getting audited. If a state selects firms to audit independent of other states, then audits would be disjoint events and the probability of a firm being audited is additive such that ρ=[pic] where ps is the probability of getting audited in state s.[5] The probability of getting audited in a year increases substantially for those firms with operations in three or more states. For example, assuming p= 3% for all states, a firm with operations in three states would have a 9% probability of audit compared to a 3% chance for a firm in one state. A firm operating in ten states would have a 30% chance of getting audited.
It is evident in the break-even context that a firm is left in the difficult position of increasing the volume of miles driven without venturing out of the state, because doing so increases both tax compliance costs and the break-even quantity. Fuel price, fuel tax increases, and increased competition following deregulation reduced the contribution margins of the trucking firms. These pressures pushed the break-even point higher, motivating many firms to expand operations to other states. However, the interstate expansion also increased compliance costs, while at the same time price pressures from increased competition were moving downward (see Blair, Kaserman, and McClave 1986 for a discussion of the impact of trucking deregulation). We do not have data on the actual compliance costs. Nonetheless, we do know that the trucking industry lobbied congress to intervene to reduce the costs for trucking firms to comply with the fuel tax. They were successful in that a key component of the ISTEA of 1991 was to require the implementation of a base jurisdiction to coordinate the collection and enforcement of the fuel tax and a uniform definition of qualified vehicle.
The implementation of ISTEA is a major factor in the Olson (1971) sense that provided the impetus for the contiguous 48 states to join IFTA. It is interesting however, that ten of the provinces of Canada have elected to join IFTA, and they do not have to respond to the U.S. federal directive. Additionally, Oregon which is not a fuel tax state entered IFTA. For trucks over 26,000 pounds, Oregon recovers highway-use costs through a weight-mile tax rather than a diesel fuel tax. Oregon does participate in IFTA so that Oregon-based companies who operate in states that do charge a fuel tax can file their fuel taxes through Oregon. Otherwise, Oregon-based companies would either have to shift to a different base state or purchase single-trip permits to satisfy their fuel tax liability. Under IFTA, carriers without an IFTA license cannot individually file quarterly fuel tax reports and make payments to states and provinces who are IFTA participants.
State Cooperation through IFTA
The legal basis for IFTA is through interstate compacts that are permissible under Article I, Section 10, Clause 3 of the U.S. Constitution. The International Fuel Tax Agreement is a unique hybrid agreement, consisting of three types of interactions among the states (see Sundeen and Goehring 1999 for a full discussion of these issues). IFTA is partially an interstate compact, authorized by Congress in ISTEA, partially reciprocal state statutes, and partially reciprocal administrative agreements.
Interstate Compact
Interstate compacts are contracts between states that require the consent of Congress. Sundeen and Goehring (1999, p. 10) argue that Congressional consent for IFTA was granted through ISTEA. They further argue that the scope of the agreement falls within the compact clause for five reasons. First, states delegate rulemaking authority to IFTA and are then bound by those decisions. Second, IFTA includes Canadian provinces and foreign relations authority is reserved for the federal government. Third, the base jurisdiction concept allows states to perform extra-jurisdictional tax functions. Fourth, IFTA governing documents can be interpreted as superseding existing state tax laws. Finally, the federal legislation notes that IFTA addresses an area of federal concern. Accordingly, the interstate compact aspect of IFTA authorized by ISTEA gave states flexibility in addressing the coordination of the fuel tax as long as three core provisions are met:[6]
• A base jurisdiction concept which allows motor carriers to report and pay fuel use taxes to a single jurisdiction.
• A uniform definition of a taxpayer for purposes of a fuel tax agreement.
• The retention of the taxing sovereignty of each state to determine tax rates, exemptions and exercise other substantive tax authority.
Procedurally, the base jurisdiction concept requires that a carrier selects a base jurisdiction in which the carrier has qualifying vehicles registered in the state.[7] Next, the carrier must provide operational control and maintain or make available within the state any operational records for audit purposes. Finally, the carrier must log some travel miles within the state’s boundaries. The base jurisdiction concept requires states to process tax information for other participating states. Additionally, when the base state takes any enforcement activity it also acts on behalf of the other states.
The second core provision is the uniform definition of a taxpayer. As stipulated in ISTEA and in the agreement (IFTA Articles of Agreement R245), a
“qualified vehicle motor vehicle means a motor vehicle used, designed, or maintained for transportation of persons or property and:
.100 Having two axles and a gross vehicle weight or registered gross vehicle weight exceeding 26,000 pounds or 11,797 kilograms; or
.200 Having three or more axles regardless of weight; or
.300 Is used in combination, when the weight of such combination exceeds 26,000 pounds or 11,797 kilograms gross vehicle or registered gross vehicle weight. Qualified Motor Vehicle does not include recreational vehicles.” (emphasis in original)
Carriers with qualifying vehicles must either seek individual trip permits or an IFTA license in order to travel in a jurisdiction other than their base jurisdiction. Licenses can be canceled by the carrier or it may be suspended or revoked by the base jurisdiction. If a license is revoked or suspended, the base jurisdiction must notify all member jurisdictions of this action within 10 days. Licensees are responsible for maintaining records and submitting quarterly tax reports.
The third core provisions acknowledges that the fuel tax is an important revenue source for state transportation funding, and allows states to maintain control of the tax rates to ensure that sufficient resources are available to fund transportation services.
Reciprocal State Statutes
While the core concepts of IFTA fits within the scope of the compact clause, several aspects of IFTA are outside of the core concepts. These include establishing reciprocal collection procedures and clarifying the rights of taxpayers. Many of IFTA’s cooperative provisions occur through reciprocal state statutes. These reciprocal statutes are often necessary before a state can legally delegate some of the tax collection and enforcement authority to another state. Reciprocal state statutes for taxation were validated by the Supreme Court in U.S. Steel Corp. vs. Multistate Tax Comm’n. Reciprocal state statutes are approved by the legislature and signed into law by the governor.
Reciprocal administrative agreements
Reciprocal administrative procedures, on the other hand, are not directly approved by the legislature. These administrative agreements can adapt to changes as needs arise. The reciprocal administrative agreements provide the mechanisms for carrying out the core provisions outlined above. Central to this IFTA has three governing documents, IFTA Articles of Agreement, IFTA Audit Manual, and the IFTA Procedures Manual. Manuals promote uniform implementation of the agreement and consistency in administration. Each of these documents addresses different aspects of the agreement. The Articles of Agreement are the agreed upon principles guiding and governing IFTA. The Audit Manual addresses how states should carry out audits to comply with IFTA standards. The Procedures Manual details the basic elements required for compliance with the agreement and provides instructions on a range of issues including licensing and base jurisdiction reporting.
The base state concept is one of the most fundamental aspects of IFTA. The base state concept “allows a licensee to report and to pay motor fuel use taxes to a base jurisdiction for distribution to other member jurisdictions in which the licensee traveled and incurred motor fuel use tax liability” (Articles of Agreement R130.100.005). In order to facilitate this cooperation the Agreement acknowledges the role of both reciprocal statutes and reciprocal administrative procedures.
If member jurisdictions no longer believe there is an advantage to being a part of the agreement, they may withdraw from the agreement. The jurisdiction must give six months notice. All of the licensees in that base jurisdiction are then unable to file fuel tax payments and liability through the base state and must use individual trip permits. Withdrawal by one jurisdiction does not alter the status of the agreement among all other jurisdictions. Additionally, members may amend the agreement as detailed in the articles of agreement.
Consistency in implementation
Through the agreement, and the governing documents, participating jurisdictions agree to have consistent implementation so there is not an inherent advantage in choosing one base state over another. For example, member jurisdictions agree to audit an average of 3 percent of carriers each year. Of these audits 15 percent must be low mileage carriers and 25 percent must be high mileage carriers. Auditors are from the base jurisdiction, but are required to give all member jurisdictions equal consideration in the audit. The audit focuses on the licensee’s distance accounting system. Auditors are to verify that all travel is included in the reporting by the licensee. Auditors are to use generally accepted audit procedures such as sampling in their audit analysis.
IFTA Inc.
The International Fuel Tax Agreement Incorporated (IFTA Inc.) is a not-for-profit association incorporated in Arizona. Membership in the agreement also constitutes membership in IFTA Inc. The association was originally funded through a series of federal grants in addition to state contributions, but the association is now sustained through membership dues.[8] The membership elects a nine-member board to oversee the activities of the association. The executive director of IFTA Inc. serves as a non-voting ex officio member of the board. IFTA Inc. coordinates the activities of the member jurisdictions to facilitate administration of the agreement. IFTA Inc. does not possess any taxing authority, that sovereign role is maintained exclusively by the individual states.
IFTA Inc. does not collect any tax payments or returns. It does assist the base jurisdictions in processing tax returns and audits by providing technical assistance to the member jurisdictions and licensees. IFTA Inc. also operates a clearinghouse for information on tax rates and jurisdictional audit reports. IFTA maintains a web site of current tax rates and exemptions for each of the 58 member jurisdictions (). IFTA also provides to member jurisdictions information on revoked and suspended licenses and other important information for coordinating the administration of the fuel tax.
IFTA Inc. also plays a critical role maintaining the international fuel tax agreement. The principles of the agreement can be modified through consensus and that process is facilitated through the organizational structure of IFTA Inc. The Agreement Procedures Committee is charged with maintaining the articles of agreement and the procedures manual, and reviewing ballot proposals for changing the agreement. IFTA Inc. administers the ballot process for committee membership and referendums. Amendments to the agreement require approval by three-fourths of the member jurisdictions, non-votes are considered negative votes.
Another key task for IFTA Inc. is to enforce the agreement among the members. A Program Compliance Review Committee is formed of member representatives, supported by staff, to ensure the uniformity and integrity of program compliance reviews. The purpose of the reviews is to ensure that member jurisdictions are meeting their IFTA obligations. This includes record keeping, allocation of tax revenues to other member jurisdictions, verifying that audit standards are met, and ensuring that appropriate appeals processes are available. This assurance is critical for sustaining the cooperative agreement.
IFTA Inc. also supports several other standing committees. The Audit Committee maintains and reviews the specific audit procedures for conducting audits. These procedures are detailed in the IFTA Audit Manual. The Law Enforcement Committee serves as a liaison between IFTA and enforcement community, and promotes uniformity in the enforcement of the agreement. Last, the Industry Advisory Committee serves as a formal channel for representatives of the motor carrier industry to present industry concerns and interests to IFTA.
The appeals process for licensees is governed by the laws in the base state. However, where a base state does not have provisions for appeals a licensee or applicant may appeal through procedures detailed in the agreement. If further disputes arise IFTA Inc. may seek to mitigate those through the Board of Trustees of IFTA Inc.
Account Analysis
One of the interesting questions is how motor carriers use IFTA. Clearly, identifying a base state is a key issue for carriers. An equitable distribution of carriers among states is also a concern for the states. The following analysis examines the patterns of accounts across jurisdictions. Table 1 shows information about the number of carriers who have registered with a state as the base jurisdiction. Also shown is the fee charged for decals, the audit ratio, average fleet size and current tax on diesel fuel. Pennsylvania has the most accounts with more than 15,000 accounts. Other states with a large number of accounts are California, Illinois, New Jersey, New York, North Carolina, and Ohio. In general states with a large number of motor carrier accounts are states with a large population base and high gross state product. The states with relatively few accounts are Delaware Montana, Nevada, Vermont and Wyoming. These states conversely have a smaller population base and gross state product.
While the national average audit ratio is three percent, the states vary from a low of 1.5 percent in Kansas to a high of 4.7 percent in Idaho. The national average fleet size is about 11 trucks per firm, but Oklahoma and Tennessee have substantially more qualifying vehicles per account.
One of the concerns with the base state registration is that trucking firms may distribute across states in an inequitable fashion. The data in Table 1 does not suggest a significant problem of jurisdiction selection bias. The trucking firms appear to register in the states with larger population and gross state product. A simple regression analysis is employed to examine this further. The number of account registrations in a state is presumed to be a function of gross state product and the total number of lane miles of state roads in the state. The log-linear regression results are reported in the second column of Table 2. The regression is statistically significant and explains about 73% of the variation in the state accounts. The coefficients on both gross state product and state lane miles are statistically significant. The findings corroborate the initial presumption that trucking accounts are registering in states with more demand for trucking services. Another important point is that the states with more economic activity, as measured by gross state product, will likely have the tax base resources to carry out the audit responsibilities of more accounts.
Several other variations of the regression model where considered to see if decal price, audit ratio, average fleet size, and diesel tax rate help explain the distribution of accounts. The coefficient of tax rate was not statistically significant alleviating fears that carriers are selecting a base jurisdiction based on tax rates. In fact, in all cases none of these other variables where statistically significant. On the margin some of these factors may be relevant, but not in a systematic way. Table 3 identifies those states with more and less accounts than the regression model predicts (top and bottom 10% of regression residuals). One could easily speculate reasons why these states are in to top and bottom deciles. For example, CT is in close proximity to NY and NJ, and has a comparably high decal price which may explain the reduced number of accounts in CT. NJ has higher than expected accounts, perhaps as a result of cheaper property values and close proximity to metropolitan New York. Nevertheless, there do not appear to be systematic distortions in the way the accounts are distributed among the states.
Lessons from IFTA for SSTP
By most measures IFTA has been a successful experience in interstate tax coordination. We know turn our attention to whether there are lessons from IFTA that can be learned and transferred to the tax coordination efforts of streamlined sales tax project.
One of the key differences occurs in the definition of the tax base and the taxpayer and how information is collected. A factor in the success of the IFTA stems from the relationship between trucking firms and their clients. There exists a classical principal-agent problem between a trucking firm and its clients. Technology like trip recorders and electronic vehicle management systems (EVMS) has been employed to provide information in mitigating the principal-agent problem (Hubbard 2000; Hubbard 2003). The same technology is also of great benefit to fuel tax auditors in verifying the allocation of miles to a state, and this information imposes very little additional financial burden because the information would otherwise have been required as part of the freight contract. In contrast, the sales and use tax is imposed on market transactions. To facilitate collections, sales vendors are asked to collect and remit the sales tax on behalf of the consumer.[9] Here also is a principal-agent problem in that the vendor is acting as an agent for the state. In this case the government is requesting information, not the consumer to the transaction as is typical in the freight contracts. Therefore, the tracking information required to demonstrate compliance represents a financial burden for which the vendor is compensated by the state. Sales vendors with nexus are compelled to collect and remit taxes to the state, and out of state vendors can volunteer to collect the sales tax, but are not compelled to do so. Currently there are relatively few vendors who voluntarily collect the use tax for states where the vendor has no nexus. Cornia et al. (2004) argue that if states agree to stream line the sales tax system, then the vendors could be enticed to collect the use tax.
The burden of the compliance cost is an important factor in comparing the tax coordination of IFTA and the sales tax. Fuel tax compliance costs are borne by the freight companies who are the tax payers. Compliance costs represent a material cost, and as compliance costs increased, the trucking firms mobilized to lobby for change. Similarly, the compliance costs of the tax on remotes sales are borne by the consumer. However, the tax on remote sales is difficult to enforce, and therefore the tax itself is often evaded and compliance costs are immaterial. Shifting the collection and remittance of the use tax to remote vendors will improve collections, but both vendors and consumers will resist. Vendors will resist (unless compensated) because they will now incur tax administration costs. Many consumers will resist because improved compliance forces them to pay full tax obligations on remote sales, when some or all of the taxes could previously be evaded (Goolsbee 2000; Alm and Melnik 2005).
A related consideration is that fuel tax is collected at “the rack,” or the wholesale level. Trucking companies therefore pay the tax at the pump to reimburse wholesalers for the tax already paid. Thus IFTA basically ensures that taxes are distributed to the appropriate jurisdiction according to miles traveled. This is substantially different from the use tax where vendors are not currently required to collect the tax from remote customers. When a vendor has nexus, the tax is collected at the register (retail level) and not at the wholesaler level. The fuel tax can easily be collected the wholesale level because it is a unit based excise tax. However, the sales tax is based on the market value of the transaction which is frequently unknown prior to the sale.
Another important difference between the fuel tax and the sales tax is that the fuel tax is levied as a use tax on the right for the tax payer to physically use the roads in the jurisdiction. The remote sales tax is a tax on a sales transaction that occurs between a tax payer and vendor in different states. Furthermore, the sales transaction can be completed without the tax payer physically entering the other state. This has significant implications for enforcement. The fuel tax agreement can be enforced by restricting the tax payer’s access to any of the other jurisdictions through revoking permits and decals. A revoked permit prohibits motor carriers from operating in any of the IFTA jurisdictions except through individual trip permits, and therefore represents a substantial economic incentive for a trucking company to comply with the taxes. On the other hand, it is comparably more difficult logistically and politically to restrict remote sales transactions when a tax payer is noncompliance with the use tax.
Conclusion
In this paper we have discussed IFTA as an example of interstate tax coordination. There are many factors that are vital to the success of the IFTA. First, there was consensus that the diesel fuel tax be apportioned among the states based on actual mileage in the state by a qualifying vehicle, and it was straightforward to define qualifying vehicles. With a uniform definition of the base, it is vital that that states maintain control over tax rates in order to meet revenue demands. Still, even with the unified base and jurisdictional control of the tax rates, without the impetus of the federal intervention, IFTA participation of the contiguous states would have taken longer, and perhaps never would have reached the current levels of participation. Tax compliance costs played a critical role in mobilizing the trucking industry to lobby congress for federal intervention.
An important factor to the continuing success of IFTA is that it is dynamic agreement that can be modified to accommodate emerging needs. The maintenance of the agreement is importantly facilitated through an organizational structure that provides governance, accountability, and timely tax rate information. Some, but not all, of these factors are adaptable to other tax coordination efforts, such as the SSTP.
References
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Federation of Tax Administrators (FTA). 2005. Motor Fuel Excise Tax Rates, January 1, 2004. (accessed February 8, 2005).
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International Fuel Tax Agreement (IFTA). Articles of Agreement. Phoenix, Arizona: IFTA Inc.
International Fuel Tax Agreement (IFTA). Procedures Manual. Phoenix, Arizona: IFTA Inc.
International Fuel Tax Agreement (IFTA). Audit Manual. Phoenix, Arizona: IFTA Inc.
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Table 1: Select Audit Statistics for U.S. IFTA accounts, 2004
|State |Accounts |Decal Price |Audit Ratio |Average Fleet |Diesel Tax |
| | | | |size | |
|Alabama |4,595 |22 |0.017 |8.6 |0.190 |
|Arizona |3,100 |0 |0.018 |3.9 |0.260 |
|Arkansas |3,132 |0 |0.027 |7.3 |0.225 |
|California |12,006 |2 |0.021 |5.1 |0.278 |
|Colorado |2,615 |0 |0.026 |11.1 |0.205 |
|Connecticut |2,583 |10 |0.039 |6.5 |0.260 |
|Delaware |1,493 |5 |0.033 |4.9 |0.220 |
|Florida |9,507 |4 |0.021 |5.9 |0.291 |
|Georgia |7,145 |3 |0.030 |8.8 |0.120 |
|Idaho |3,070 |0.6 |0.047 |13.6 |0.250 |
|Illinois |11,890 |3.75 |0.038 |13.7 |0.296 |
|Indiana |6,983 |0 |0.041 |24.3 |0.270 |
|Iowa |6,516 |0.5 |0.030 |12.4 |0.225 |
|Kansas |3,116 |0 |0.015 |14.6 |0.260 |
|Kentucky |3,845 |0 |0.035 |9.9 |0.187 |
|Louisiana |2,153 |2 |0.027 |23.6 |0.200 |
|Maine |2,697 |5 |0.017 |3.8 |0.263 |
|Maryland |6,382 |0 |0.029 |7.3 |0.243 |
|Massachusetts |4,422 |8 |0.032 |7.4 |0.210 |
|Michigan |5,708 |0 |0.026 |9.7 |0.265 |
|Minnesota |5,711 |1 |0.031 |21.8 |0.200 |
|Mississippi |3,752 |0 |0.030 |6.5 |0.180 |
|Missouri |6,299 |0 |0.024 |14.6 |0.170 |
|Montana |1,497 |2 |0.033 |8.6 |0.278 |
|Nebraska |4,216 |1 |0.036 |13.0 |0.248 |
|Nevada |1,565 |0 |0.042 |4.2 |0.270 |
|New Hampshire |2,817 |10 |0.036 |3.7 |0.180 |
|New Jersey |12,024 |10 |0.032 |5.7 |0.175 |
|New Mexico |1,875 |3.5 |0.019 |5.9 |0.210 |
|New York |10,983 |8 |0.024 |5.3 |0.328 |
|North Carolina |10,919 |0 |0.036 |9.7 |0.246 |
|North Dakota |2,081 |1 |0.029 |5.3 |0.210 |
|Ohio |11,714 |0 |0.032 |12.8 |0.280 |
|Oklahoma |3,546 |0 |0.019 |60.1 |0.130 |
|Oregon |4,449 |0 |0.038 |9.8 |0.000 |
|Pennsylvania |15,101 |5 |0.037 |8.2 |0.312 |
|Rhode Island |1,414 |10 |0.017 |4.4 |0.300 |
|South Carolina |3,815 |0 |0.028 |11.8 |0.160 |
|South Dakota |4,132 |0.5 |0.019 |6.8 |0.220 |
|Tennessee |5,105 |0 |0.041 |37.0 |0.170 |
|Texas |9,873 |0 |0.029 |12.2 |0.200 |
|Utah |2,412 |4 |0.036 |13.9 |0.245 |
|Vermont |1,575 |0 |0.030 |4.2 |0.260 |
|Virginia |7,176 |10 |0.028 |5.6 |0.185 |
|Washington |4,393 |10 |0.034 |6.8 |0.280 |
|West Virginia |2,717 |5 |0.033 |5.4 |0.254 |
|Wisconsin |4,332 |2 |0.025 |18.7 |0.321 |
|Wyoming |1,128 |3 |0.036 |11.5 |0.140 |
|Total |249,579 |3.16 |0.03 |11.16 |0.226 |
Table 2. Log Linear Regression of IFTA Accounts in Base State in Year 2004.
|Independent Variables |Coefficient |Coefficient |
| |(Standard Error*) |(Standard Error*) |
|Gross State Product |0.470 |0.462 |
| |(.060) |(.066) |
|State lane miles |0.157 |0.169 |
| |(.072) |(.082) |
|Diesel Tax rate |- |0.116 |
| |- |(.119) |
|Constant |4.475 |4.564 |
| |(.610) |(.581) |
|Number of observations |48 |48 |
|F Statistic |[2, 45] 71.58 |[ 3, 44] 48.91 |
|R-squared |0.7297 |0. 7325 |
|All variables are measured in natural logs. |
|* robust standard errors |
Table 3. Bottom and top 10% percentiles of Accounts Regression*
|States with less accounts than predicted: |States with more accounts than predicted: |
|Colorado |Iowa |
|Connecticut |New Jersey |
|Louisiana |Pennsylvania |
|Nevada |South Dakota |
*See Table 2, second column
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[1] We are grateful to many people for their assistance in this research. Specifically, Roger Tew, former Utah State Tax Commissioner, and Lonette Turner, Executive Director of IFTA, Inc., provided useful background information and data on the International Fuel Tax Agreement. However, the authors alone bear responsibility for the analysis and conclusions in this manuscript.
[2] IRP (the International Registration Plan) was initiated in 1974 to facilitate and coordinate reciprocal recognition of commercial vehicle registration.
[3] This formulation assumes for simplicity that States A and B share the auditing function equally. If Å is not shared equally then appropriate proportion can be substituted for the .5 in the formula.
[4] Most consider Coase (1937) the orgin of the transaction literature that dnd B share the auditing function equally. If υ is not shared equally then appropriate proportion can be substituted for the .5 in the formula.
[5] Most consider Coase (1937) the orgin of the transaction literature that deals with the way activities cluster into organizations. See Jarillo (1988) Blois (1990) and Williamson (1979) for discussion of transaction costs and organizational cooperation.
[6] A state may also take into account the number of miles logged by a firm on state roads in deciding whether to audit. In this case the probability of audit is given by ρ= [pic]where s is the number of states the firm logged miles, p is the probability of an audit in state s, and w is the weight (Firm miles in state / Aggregate miles in state) for each state s.
[7] Grounded in ISTEA 91 -- section 4008
[8] These vehicles would be registered through the International Registration Plan (IRP), a multi-state cooperative agreement overseeing vehicle registration.
[9] Membership dues generate $580,000 per year, which is $10,000 from each member.
[10] For simplicity all of the sales tax is considered to pass to the consumer. Musgrave and Musgrave (1989, p 250) discuss that the incidence of the sales tax depends on the price elasticity of taxed items.
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