In a Nutshell

• Motor fuel tax revenue in the 12 months following the onset of the COVID-19 pandemic was down by $218 million from the same period the previous year
• This COVID-19 impact appears to be temporary in nature, with revenue in recent months approaching more normal, pre-COVID levels
• The current spike in consumer prices arising as the economy transitions from COVID will likely trigger a higher-than-expected 0.8 to 0.9 cent per gallon increase in the motor fuel tax rate in January 2022 when the first statutory inflationary adjustment to that rate is implemented; generating $45-50 million in added revenue

For state government in Michigan, it appears that massive federal stimulus initiatives have helped avert what once looked like an unprecedented state revenue shortfall.  Severe declines in employment and wage incomes last year were initially expected to result in the loss of around $6 billion in state revenue. But, the combined impacts of a reopening economy, enhanced unemployment insurance benefits, federal stimulus checks, and other supports have driven state revenues back to pre-COVID levels.  However, one important state revenue stream has indeed experienced a significant decline: Michigan’s motor fuel taxes.

Revenues from the gasoline and diesel fuel taxes, which are major sources of funding for state road maintenance, actually declined by about 15 percent in the 12 months following the onset of the pandemic.   Looking ahead, however, these motor fuel tax revenues may see a boost from a strange and unexpected source: the recent uptick in inflation.

Motor Fuel Taxes During the Pandemic

Michigan’s long-running struggle to secure sufficient funding to address road infrastructure needs is well known.  A 2015 road funding deal between the legislature and then-Governor Snyder was designed to generate another $1.2 billion annually for road work.  Among other revenue enhancements, that 2015 plan included the first increase in motor fuel taxes in almost two decades – with the gasoline tax increasing from 19 cents to 26.3 cents per gallon.  It also gradually phased in an earmarking of state income tax revenues for road maintenance to help supplement other dedicated tax revenues.

However, the new revenue did not reverse the downward trend in Michigan road conditions. In 2019, Governor Whitmer proposed phasing in a 45-cent per gallon increase in the motor fuel tax to raise another $2.5 billion. When the legislature rejected that plan, the Governor announced a 5-year, $3.5 billion bonding plan for roads, with the first $800 million in bonds issued last September.  The bonding plan, however, will support only state-maintained roads, not those under county and municipal jurisdiction.

The COVID-19 pandemic has added another wrinkle to the state’s road funding dilemma. Public health restrictions during 2020 changed the way people lived and worked.  Business closures reduced employment significantly, and many who remained employed began working from home.  Business and recreational travel slowed tremendously.  All of this meant fewer miles travelled in a vehicle, and thus fewer gallons of gasoline purchased to support that travel.  In terms of road financing, the end result was a significant downturn in motor fuel tax collections.

The table below compares transportation revenue collections over the 12-month periods from April 2019 to March 2020 (pre-pandemic) and from April 2020 to March 2021 (the 12 months since the onset of the pandemic).  Overall, transportation revenues for the most recent 12-month period were down by just over two percent. However, this seemingly modest decline is the result of the interplay of two larger revenue changes.

Source: Michigan Department of Transportation

The final incremental increase in redirected state income tax revenue that was part of the 2015 roads plan resulted in an increase of $168 million in revenue during the latter period.  That was expected to result in a significant overall increase in resources for road repairs.  However, this bump in road revenues was entirely offset by the pandemic’s impact on base fuel tax collections. Fuel tax revenue declined $218 million over the most recent period, a 15 percent decrease.  Instead of boosting available resources, the increased income tax revenue simply helped mitigate the negative COVID impacts.

The good news on this front is that the motor fuel tax revenue declines appear to be mostly temporary.  As Michigan transitions back to a version of “normal”, travel patterns have as well.   Looking specifically at motor fuel tax collections for May, collections in 2021 ($110 million) are much closer to pre-COVID collections from 2019 ($113 million) than they are to COVID-impacted collections in 2020 ($64 million).

Motor Fuel Tax Revenues and Inflation: What Happens Next January?

In an ironic twist, road revenues next year may actually see an additional boost from another lingering economic impact of the COVID-19 pandemic: inflation.  A combination of supply chain hitches, pent-up consumer demand, the economic impact of multiple rounds of federal stimulus, and tight labor markets have resulted in a recent spike in prices for consumer goods across the country.  Between March and June alone, the U.S Consumer Price Index for all urban consumers (CPI-U) has jumped by just under 2.6 percent.  This three-month spike by itself is greater than the full-year inflation rate for any year since 2011.

While concerns grow regarding whether inflation may be a signal of an overheating economy, that same rise in prices will bring an increase in road revenues starting next January.  How?  The 2015 road funding package did more than just increase the motor fuel tax rate and dedicate a portion of income tax revenue to roads.  Lawmakers included a new annual inflationary adjustment to the tax rate starting in January 2022.  The adjustment is pegged to the national inflation rate as measured by the CPI-U. Each year, the motor fuel tax rate will rise by the percent growth in the average CPI-U across the two previously completed state fiscal years – with the overall adjustment capped at five percent.  That means the initial tax rate adjustment next January will be based on CPI-U inflation between fiscal years 2020 and 2021.

For the last decade, CPI fiscal year inflation rates have averaged a fairly modest 1.7 percent. Before the recent price spike, it would have been reasonable to assume something similar for FY2021.  Adjusting the current 26.3 cents per gallon motor fuel tax rate by 1.7 percent increases the rate by 0.4 cents to 26.7 cents per gallon.  That would be expected to generate somewhere around $20 million in additional transportation revenue.

Now, however, it appears we are on a different path for the inflation calculation as a result of the COVID-influenced price spikes.  Only three months – and thus three CPI data points – remain in FY2021.  Even if consumer prices stabilize and we experience no further increase in the CPI-U for July, August, and September, the FY2021 CPI inflation rate would end up just above 3.1 percent.  Conversely, if consumer prices in July, August, and September continue to rise at a rate similar to the last three months, FY2021 inflation could jump as high as 3.5 percent.

In the end, it seems very likely the motor fuel tax rate will jump by either 0.8 or 0.9 cents per gallon next January when the initial inflationary adjustment is implemented; that’s double the amount that seemed likely just a few months ago.  That translates to around $45-50 million in additional transportation funding per year.

To be sure, there are many reasons to be concerned about growing inflation; and an extra $50 million will not be sufficient by itself to fix all the damn roads.  But following a difficult 2020, the outlook for transportation infrastructure funding is looking at least a little better for 2022 and beyond.