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State Budget Update

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Governor Signs Complex Gas Tax Swap

On March 22, 2010, Gov. Schwarzenegger signed two major pieces of legislation that fundamentally restructure California’s system of transportation finance — AB 6 and AB 9 of the Eighth Extraordinary Session. The bills are a modified version of the Governor’s January budget proposal, which called for the elimination of the statewide sales tax on gasoline and diesel fuels.

The bills provide the General Fund with approximately $1.1 billion by shifting the cost of debt service on outstanding transportation bonds from the General Fund to various transportation funds. Relieving the General Fund of these interest obligations results in approximately $11 billion in General Fund savings over the next 10 years.

Mechanics of the Tax Swap

The tax swap, contained in AB 6, affects four different taxes — the state portion of the sales tax on gasoline, the excise tax on gasoline, the state portion of the sales tax on diesel fuel, and the excise tax on diesel. Local sales taxes remain unchanged and will continue to include gasoline and diesel fuel. AB 6 contains the following key changes:

  • Beginning July 1, 2010, eliminates the 6 percent statewide sales tax on gasoline, and with it, the funding source for Proposition 42 (the 2003 constitutional amendment that required most gasoline sales taxes to go to transportation) and “the spillover,” a funding formula dedicated to public transit.
  • Raises the excise tax on gasoline by 17.3-cents on July 1, 2010, for a total excise tax of 35.3 cents per gallon. Starting March 1, 2011, and each March 1st thereafter, authorizes the State Board of Equalization (BOE) to estimate how much revenue would have been raised by the sales tax on gasoline and adjust the gasoline excise tax to raise an equivalent amount.
  • Retains the existing sales tax on diesel fuel and raises it by another 1.75 percent on July 1, 2011 to generate about $120 million in additional funds for public transit, for a total of approximately $436 million in FY 2011-12.
  • Offsets the diesel sales tax rate increase by lowering the diesel excise tax from 18 cents per gallon to 13.6 cents, effective July 1, 2011. Similar to the gasoline excise tax, the excise tax would be adjusted by the BOE on March 1st of each year to maintain revenue neutrality.

Companion Bill Adopted to Avert Governor’s Veto

In response to a veto threat from the Governor, the Legislature passed and the Governor signed a companion bill, SB 70, to exempt consumers of dyed diesel fuel (including freight rail, commuter rail, transit buses, and off-road vehicles) from the diesel fuel sales tax rate increase. Since these sectors are not subject to the diesel excise tax, they would have experienced a tax increase without this exemption.

Public Transit Bears the Brunt of General Fund Savings

While the overall tax swap is revenue neutral by design (in order to allow for passage by a simple majority vote), public transit loses over $1 billion annually due to the elimination of the sales tax on gasoline, as discussed in greater detail below. AB 9 also appropriates $142 million in Public Transportation Account (PTA) funds to the General Fund to offset the cost of public transit bond debt service in FY 2009-10 and another $254 million for FY 2010-11. An earlier version of the proposal, which ultimately was removed due to opposition by the Schwarzenegger Administration,  included a regional motor fuel fee option — subject to voter approval — that had the potential to backfill, at least partially, for this loss of state transit funding.

Bay Area to Receive Almost $150 Million for Public Transit Service for FY 2010-11

AB 9 stipulates how the excise taxes on gasoline and diesel fuel — and the sales tax on diesel — will be distributed, and appropriates $400 million to the State Transit Assistance (STA) program, the only source of state support for public transit operations. For Bay Area transit operators, this will provide approximately $147 million in FY 2010-11. While the bill appropriates the funds in the current fiscal year, transit agencies will not be able to access the funds until July 2010, as the law will not take effect for 90 days. For FY 2011-12 and beyond, the bill directs 75 percent of PTA revenues to the STA program and supplements these funds with some State Highway Account (SHA) funds for a total STA program of about $350 million per year. This figure includes approximately $128 million per year for the Bay Area. Click here for an estimate of the amount of STA funding provided to Bay Area transit operators over the next two years.

Major Changes to Public Transit Revenue Sources

The elimination of the sales tax on gasoline results in the loss of three sources of PTA funds:

  • The spillover — a law that provided transit with significant revenue whenever gasoline prices grew at a faster rate than other goods. As shown below, the spillover was an extremely volatile funding source.
  • 20 percent of Proposition 42 funds
  • The sales tax on the first nine cents of the gasoline excise tax (commonly referred to as the “Proposition 111” portion)

Public Transit Revenue Sources Eliminated by Tax Swap Proposal

(Dollars in millions)


FY 2008-09

FY 2009-10

FY 2010-11





Proposition 42




Sales tax on Proposition 111
(9-cents of gas tax)








A Loss of Potential Windfalls, But Improved Stability

Though the tax swap eliminates the upside potential for public transit to receive funding windfalls (as occurred in FY 2006-07 when the STA program received an unprecedented $624 million due to a $668 million spillover), it may ultimately provide significantly greater stability for public transit since PTA funding will come almost entirely from the diesel sales tax. This may reduce the Legislature’s temptation to divert these funds in the future.

While not required by statute — and still subject to appropriation on an annual basis — estimates that the package will enable an STA program of at least $350 million per year appear reasonable. This is a significant improvement in comparison to the status quo or historic funding levels. As part of the FY 2009-10 budget, the Legislature suspended the STA program altogether through FY 2012-13, resulting in zero state support for public transit for the next three years. Looking back over the last 10 years, STA averaged $150 million per year, excluding the FY 2006-07 outlier year, as shown here

Actual STA funding levels in a given year will depend on diesel fuel prices, diesel fuel consumption and the extent to which the Legislature transfers to the PTA certain State Highway Account funds. Additionally, passage of the Local Taxpayer, Public Safety and Transportation Protection Act on the November 2010 ballot would reduce STA’s share of PTA revenues to 50 percent rather than 75 percent, resulting in a statewide total of approximately $240 million rather than $350 million.

How Will New Gasoline Excise Taxes Be Spent? 

AB 9 provides for the new gasoline excise tax revenue to be distributed as follows:

  • Fund debt service on highway-related transportation bonds as the first priority from the new gasoline excise tax increase. As a result, about $600 million would go towards the General Fund in FY 2010-11. This amount grows each year, peaking at approximately $1.3 billion in FY 2017-18.
  • In FY 2010-11 only, split the remaining funds available after debt service (approximately $1.3 billion) 50/50 between the State Transportation Improvement Program (STIP) and local streets and roads.
  • Beginning in FY 2011-12, split the balance remaining after debt service (approximately $1.6 billion) as follows:
    • 44 percent to STIP projects
    • 44 percent to local streets and roads
    • 12 percent to the State Highway Operation and Protection Program (SHOPP)

Legislation Designed to Hold Local Streets and Roads & the STIP “Harmless”

The shares for the STIP and local streets and roads were determined so as to provide at least as much funding to these categories as would have been generated by the portion of the gasoline sales tax that went towards Proposition 42. Under Proposition 42, local streets and roads and the STIP each received 40 percent of revenues, with the remainder allocated to public transit. Under the new framework, funding for local streets and roads and the STIP will depend not only on the overall revenue stream — which will continue to depend on gasoline prices and consumption — but also on how much is set aside for debt service.  Based on projections by the Department of Finance, it appears likely that the STIP and local streets and roads will actually receive a net gain in funding relative to Proposition 42. For Bay Area local streets and roads, the swap results in an additional $500,000 region-wide in FY 2010-11, growing to a $20 million gain in FY 2011-12. For the STIP, it results in a net gain of $407,000 region-wide in FY 2010-11, growing to a $15 million gain in FY 2011-12. Click here for a comparison of how Bay Area jurisdictions will fare under the new structure versus Proposition 42. 

Impact to State Highway and Protection Program (SHOPP)

According to the state’s 10-Year SHOPP plan, current funding levels are less than half of what is needed to maintain the system in a state of good repair. Given this shortfall, the Legislature took the opportunity to provide the SHOPP with 12 percent of the new excise tax remaining after debt service, or approximately $190 million in FY 2011-12. However, the SHOPP likely will see reduced funding from the diesel excise tax due to the reduction in that tax to offset the diesel sales tax increase for public transit. Since SHOPP funding levels are determined by Caltrans and the California Transportation Commission, it is impossible to say exactly how the SHOPP will fare as a result of these bills. Additionally, since the SHOPP is developed on a needs-basis, there is no “formula” to calculate a Bay Area share for the long term.

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