John Hood: Sales Tax to Fund State Highways

RALEIGH — When the North Carolina General Assembly enacted its budget revision for the 2022-23 fiscal year, it contained a major change in how the state funds roads. 

Until now, the system relied overwhelmingly on revenue from taxes on motor fuels, taxes on vehicle sales, and annual vehicle registrations. Unlike many other states, North Carolina doesn’t have county road networks funded by property taxes. Nor do we levy general sales taxes for that purpose, although some counties impose a special sales tax for transit. 

Change is coming. Under the budget revision Gov. Roy Cooper just signed into law, the state will transfer $193 million in sales-tax revenue from the state’s General Fund to its Highway Fund. That amounts to 2% of sales taxes collected. By 2025, that ratio will rise to 6%, adding about $600 million a year to the Highway Fund. 

Traditionally, North Carolina properly placed transportation in a different fiscal bucket than the General Fund bucket containing schools and law enforcement. The latter programs are entitlements enshrined in the state constitution. Young North Carolinians are entitled to enrollment in public schools if that’s what their parents desire. And all North Carolinians are entitled to protection of life, liberty, and property by the state, which requires the provision of sworn officers, courts, and corrections. 

With few exceptions, it would be unjust and unconstitutional for the state to charge its residents directly for these services. You don’t pay tuition to attend a public school. You don’t pay the police a fee to chase down the burglar who just broke into your house.  

Instead, we pay for such government entitlements with generally applied taxes. That’s because the benefits of promoting public education and public safety extend well beyond those directly served — but there’s no practical way of specifically identifying the indirect benefit and charging a price for it. 

Instead, we “charge” in a more-roundabout way by taxing a resident’s financial “stake” in the community. For some services such as police and fire protection, the indirect benefit is related to how much physical property one owns, so property taxes make sense. For other services (such as education), the indirect benefit is related more to one’s overall standard of living, which is why properly structured sales or income taxes make more sense. 

Not all government activities meet this definition, however. Services such as roads, water, and sewer are best thought of as enterprises, not entitlements. They are essentially business operations with which government is involved for technical reasons (such as the existence of huge economies of scale or the difficulty of excluding nonpayers from using the service).  

For enterprises, it’s more appropriate to charge people according to how much they use the system. This works even for indirect beneficiaries — embedded in the prices you pay at the grocery store are the cost of its water hookup as well as the fuel taxes paid by the truckers who deliver groceries to it. 

Over time, the user-pay principle has become harder to sustain for North Carolina’s roads. Increased fuel efficiency, although a wonderful thing on balance, has reduced gas-tax collections per mile driven. In the past, lawmakers have raised the tax rate to compensate. That’s always been unpopular, and under present conditions would be politically suicidal. 

I’ve long been in favor of replacing gas taxes with per-mile charges based on GPS data, but that has its own technical and political challenges. So, in a column I wrote last year, I endorsed precisely what the legislature has just done: transferring to the Highway Fund sales taxes collected on driving-related purchases such as auto parts and vehicle repairs. They total about 6% of all retail sales. 

This isn’t a perfect solution, and I wish the General Assembly had discussed it more in public before including it in the 2022-23 budget. But this transfer comes closer to meeting our highway needs while respecting the user-pay principle than does any other solution that can be practically adopted at the moment.

John Hood is a John Locke Foundation board member. His latest books, Mountain Folk and Forest Folk, combine epic fantasy with early American history (FolkloreCycle.com).