Taxes on gasoline and diesel aim to reduce vehicle travel by increasing the cost of driving, a mechanism referred to as the price effect.
However, the revenue generated from these taxes is frequently used to construct and expand urban highways, which encourages more driving this is called the capacity effect.
From 1981 to 2021, research in the United States revealed that the capacity effect outweighed the price effect by a factor of more than five.
With the growing prevalence of electric vehicles (EVs) pushing policymakers to explore alternatives to fuel taxes, it becomes increasingly critical to separate the revenue-generating function from the environmental purpose of driving taxes.
Using gasoline tax revenue to fund highway expansion compromises its environmental benefits.
Gasoline Taxes as Tools for Policy and Planning
Planners, policymakers, economists, and environmental advocates generally endorse higher gasoline taxes to offset the external costs of driving, such as climate change, air pollution, traffic congestion, and road safety issues.
These taxes act as an approximate Pigouvian (environmental) tax, encouraging individuals to drive less and purchase more fuel-efficient vehicles.
This effect is what is known as the price effect. While current gasoline taxes in the U.S. fall short of fully accounting for the externalities of driving (Parry & Small, 2005), they still partially contribute to reducing driving and fuel consumption to more optimal levels.
On the other hand, motor fuel taxes also serve as a user fee to fund the construction and maintenance of roadways. This, in turn, results in increased vehicle travel, an outcome referred to as the capacity effect.
Early in the 20th century, U.S. states and later the federal government adopted motor fuel taxes to fund ambitious road-building projects.
In a study analyzing the period between 1981 and 2021, the capacity effect was found to surpass the price effect by a factor of five, demonstrating a significant net increase in vehicle travel.
The capacity effect has a lasting impact because it accumulates over time as more highways are added, while the price effect tends to be temporary.
For instance, with a typical price elasticity of -0.22 (Gillingham, 2014), the federal gasoline tax of 18.4 cents per gallon reduced vehicle travel in urban areas by 46 billion kilometers in 2021.
However, 144,000 kilometers of urban highway lanes were added between 1981 and 2021, with federal motor fuel taxes accounting for an estimated 62,000 kilometers of this increase.
This new capacity contributed to a 24% rise in urban highway vehicle travel in 2021, equivalent to 246 billion kilometers.
The overall effect of federal gasoline taxes, factoring in both price and capacity effects, resulted in a net increase of 200 billion kilometers in vehicle travel annually a 19% rise.
Without significant changes in how transportation funds are allocated, proposals to reform highway financing, such as taxing miles driven, are unlikely to address this underlying issue.
Induced Demand and the Capacity Effect
The addition of new roadway capacity generates immediate increases in vehicle travel by reducing congestion and improving travel speeds, prompting individuals to take longer trips or shift from public transit to private vehicles.
Over time, this capacity further stimulates travel by fostering automobile-oriented developments such as suburban residential areas and large retail centers near highways.
Using an elasticity of vehicle travel with respect to road capacity of 0.78 (Duranton & Turner, 2011), the study estimated the capacity effect based on federal contributions to highway expansion.
Federal funding for such projects decreased from 87% in 1981 to 28% in 2021, with gasoline and diesel taxes covering a significant portion of the Highway Trust Fund.
In 2021, the federal gasoline tax of 18.4 cents per gallon and diesel tax of 24.4 cents per gallon generated $32 billion, accounting for 83% of the trust fund’s revenue (excluding transit allocations).
Of this, 24% was used for urban highway expansion between 1981 and 2021, contributing to 43% of the added capacity.
Although the counterfactual how much highway capacity would exist without motor fuel taxes cannot be determined, historical research suggests that federal matching funds have played a crucial role in enabling state highway expansion plans (Taylor et al., 2023).
Furthermore, the U.S. has built significantly more road capacity than international peers, where motor fuel tax revenues are not typically dedicated to highway construction.
Cumulative Impacts of the Capacity Effect
The capacity effect’s cumulative nature is a key reason it overshadows the price effect. Highway expansions funded today continue to influence travel patterns for decades.
Since road capacity is rarely reduced, its impact compounds over time. By contrast, behavioral responses to higher fuel prices, such as reduced driving or switching to public transportation, are reversible and short-term.
Fuel taxes also operate within a self-reinforcing cycle: expanded highways encourage more driving, which generates additional tax revenue, much of which is allocated to further road expansions.
Although this analysis focused on federal motor fuel taxes, state gasoline taxes, which average 27.8 cents per gallon (Federal Highway Administration, 2022), also contribute significantly to highway funding.
If roadway expansions consistently yielded net social benefits, the capacity effect would be less concerning.
However, research suggests that the costs of urban highway construction often outweigh the benefits, particularly as travel time reductions are minimal and highway expansions are frequently located in less impactful areas (Duranton & Turner, 2012).
Furthermore, political motivations, including racial biases and pork barrel projects, have historically shaped transportation spending more than cost-benefit analyses.
Taxation in an Era of Electric Vehicles
The rise of electric vehicles necessitates a rethinking of transportation taxes. Gasoline tax revenue is projected to decline, potentially leaving the Highway Trust Fund depleted by 2028.
At the same time, EVs introduce their own externalities, such as particulate emissions from tire and brake wear (Fussell et al., 2022) and increased road wear due to their heavier weight.
To address these issues, policymakers are considering alternatives such as per-mile fees, graduated registration fees, and taxes based on vehicle weight.
Any new tax structure for EVs must separate revenue generation from environmental goals.
If per-mile fees are used to fund highway expansions, they could exacerbate air pollution and other externalities. Instead, these revenues should be allocated to road maintenance, public transit, or other public services to preserve environmental benefits.
Ultimately, the effectiveness of environmental taxes hinges on how the revenue is used. Just as it would be counterintuitive to fund fossil fuel infrastructure with carbon tax revenue, using motor fuel taxes to expand highways undermines their environmental objectives.
To align taxation with sustainability goals, policymakers must ensure that revenue from driving-related taxes is used to promote environmentally and socially beneficial outcomes.