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Federal Document Clearing House
Congressional Testimony
July 17, 2002 Wednesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 3888 words
COMMITTEE:
SENATE FINANCE
HEADLINE: FUEL TAX
FRAUD
TESTIMONY-BY: MARY E. PETERS,, ADMINISTRATOR
AFFILIATION: FEDERAL HIGHWAY ADMINISTRATION
BODY: STATEMENT OF
MARY E. PETERS,
ADMINISTRATOR FEDERAL
HIGHWAY ADMINISTRATION UNITED STATES
DEPARTMENT OF TRANSPORTATION
BEFORE THE SENATE FINANCE SCHEMES, SCAMS,
AND CONS: FUEL TAX FRAUD
JULY 17, 2002
Mr. Chairman and Members
of the Committee, thank you for scheduling this hearing to focus attention on
the continuing problem of fuel tax evasion. My predecessors have come before you
on a number of occasions over the past two decades to report on the extent of
this problem and discuss ways to improve compliance with Federal motor fuel
excise tax laws. With your assistance, we have made significant progress in
addressing fuel tax evasion. Today, I would like to provide an overview of the
Federal
Highway Administration's (FHWA) fuel tax evasion
program, including measures taken to reduce the incidence of fraud and some
significant problems that remain. As you well know, the
Highway
Trust Fund (HTF) finances virtually the entire Federal investment in our
Nation's
highways, as well as a major portion of Federal
transit programs. The HTF itself is supported by the users of the
highway system through payment of Federal excise taxes on
gasoline, gasohol, and diesel fuels, on sales of large trucks, trailers, and
truck tires, and the special
highway use tax on heavy trucks.
By far the most significant portion of revenues is derived from fuel
taxes--projected at roughly 88 percent of revenues into the HTF over the next 10
years. Evasion of fuel taxes represents a significant loss of
funding to every State, not just to those States in which the
evasion occurs, since each State receives a share of every Federal-aid
highway dollar. Loss of motor fuel taxes poses a serious threat
to both Federal and State programs. The impact of such losses is even greater
coming at a time when we have experienced a reduction in growth of HTF revenues,
while demands on
highway capacity reach unprecedented levels
and replacement and rehabilitation costs for aging infrastructure increase.
Background
Fuel tax evasion exists because illicit profits on
sales of untaxed fuel can dwarf profits made on legitimate sales. To illustrate,
profit on a gallon of fuel is usually just a few cents but, if taxes can be
evaded, profit can be as much as 45 cents per gallon higher (24.4 cents Federal
diesel tax per gallon plus 20 cents average State tax). Thus, one truckload of
fuel could potentially yield about $
3600 in additional profits
if both Federal and State diesel taxes are evaded (45 cents x 8000 gallons).
Furthermore, the fuel tax compliance problem is exacerbated by the complexity of
motor fuel distribution processes.
Substantial revenue losses caused by
motor fuel tax fraud, involving organized crime, were first discovered in the
New York metropolitan area in the mid-1980s. Ray Barnhart, then Administrator of
the Federal
Highway Administration, was alerted to the problem
when fuel tax revenues did not increase as expected following gasoline and
diesel tax increases after 1982. Subsequent investigations revealed a nationwide
problem, which threatened the integrity of both the Federal HTF and State
highway and transportation funds.
The Internal Revenue
Service (IRS) and FHWA began working together to combat fuel tax evasion by
supporting changes in tax collection procedures and promoting enforcement
activities. Examination of the problem indicated that imposing a tax at a higher
point in the distribution chain offered the greatest potential for eliminating
fraud, mainly by reducing the number of taxpayers. The highest point in the
distribution chain is the refinery, but the fuel use is not determined at this
level. An overwhelming number of refund requests for exempt uses would be filed
if the point of taxation was at the refinery level.
Exhibit 1 (See
Attachment 1, Fuel Distribution System) illustrates the basic fuel distribution
process. Although there can be variations in the process (See Attachment 3,
Model of the Fuel Distribution System showing variations), in the basic system
fuel moves from the oil refinery in bulk shipment, by pipeline, ship, or barge,
to a terminal. A terminal is a storage and distribution facility. The terminal
"rack" refers to the mechanism used to dispense motor fuel products from the
terminal into tank trucks or rail cars. The expression "above the rack" is
sometimes used to refer to the bulk transfer system that is made up of all of
the facilities for the movement and storage of gasoline and diesel fuel from
refinery to terminal. The bulk transfer system includes terminals, pipelines,
barges, ships, and domestic refineries. Under current law, generally motor fuel
is not subject to Federal
highway taxes at the bulk shipment
level. However, State fuel taxes may be imposed at the bulk level, or at any
level in the distribution system.
When fuel leaves the terminal by truck
or rail, it must pass through the rack and at this time the use of the fuel is
determined and the Federal taxes are imposed, unless the fuel use is determined
to be tax exempt. Some exempt uses for diesel fuel and kerosene include school
buses, construction equipment used off-road, farming, and home heating. At this
point in the distribution system, tax-exempt diesel fuel and kerosene are dyed
red. However, aviation-grade kerosene may be removed from the terminal without
taxes being imposed and without being dyed, if certain conditions are met. All
removals of gasoline at a terminal rack are taxable.
From the terminal,
the fuel goes to the wholesale distributor, sometimes to intermediate storage,
then to the retailer, and finally the consumer. Fuel may also go directly to the
retailer from the terminal.
Tax Reform Act (TRA) of 1986 (P.L. 99-509,
100 Stat. 1951). Progress was made in gasoline tax enforcement under the TRA of
1986 which moved the point of gasoline tax collection from the wholesale level
to the rack level at the point of removal from the terminal, refinery, or point
of import, and also strengthened licensing and bonding requirements on
registrants for activities involving excise taxes. The point of taxation change
reduced the number of gasoline taxpayers from about 8,000 to 1,000, considerably
simplifying payment tracking. However, the point of taxation for diesel fuel was
not moved to the rack and diesel fuel tax evasion remained a continuing and
growing problem. By the early 1990s, FHWA estimated that the combined Federal
and State fuel tax evasion losses approached $
3 billion
annually.
Intermodal Surface Transportation Efficiency Act of 1991
(ISTEA) (P.L. 102- 240, 105 Stat. 1914). To address the ongoing evasion problem,
Congress, in fiscal year (FY) 1990, approved initial HTF
funding for the Joint Federal/State Motor Fuel Tax Compliance
Project (the Joint Project). However, it was
funding provided
in ISTEA, $
5 million annually through 1997, which allowed the
nationwide expansion of the fuel tax evasion program. Under section 1040 of
ISTEA, $
3 million were allocated to the States for
participation in regional motor fuel tax enforcement task forces and
$
2 million were provided to the IRS to supplement its fuel tax
enforcement efforts. The mission of the Joint Project was to ensure that
collection of motor fuel taxes was a priority for Federal and State tax
enforcement agencies. From the Joint Project's inception, FHWA promoted a
return-on-investment approach, through intergovernmental action, including
investments in the operations of other agencies. Success was measured in part by
increases in HTF revenues. Enforcement activities, such as audits and criminal
prosecutions, are estimated to produce assessments for violations of State and
Federal taxes in the range of $
10 to $
20 for
each dollar spent on these programs. However, not every assessed dollar is
actually collected, especially in the case of criminal assessments.
The
Joint Project is directed by a Steering Committee, chaired jointly by the FHWA
and IRS, and composed of representatives from the lead States of the nine task
forces, and numerous ad hoc participants, including the U.S. Department of
Justice, American Association of State
Highway and
Transportation Officials (AASHTO), American Petroleum Institute, Federation of
Tax Administrators and others. With
funding administered by
FHWA, the Joint Project supports fuel tax enforcement activities of the IRS and
States and facilitates the exchange of information among enforcement agencies.
Forty nine States and the District of Columbia now participate in one or more of
the Joint Project's nine task forces.
Omnibus Budget Reconciliation Act
of 1993 (P.L. 103-66, 107 Stat. 312). Two provisions in the Omnibus Budget
Reconciliation Act strengthened enforcement of diesel fuel taxes and resulted in
substantial revenue gains. The Federal point of taxation for diesel fuel was
moved up to the terminal rack level consistent with gasoline, and any untaxed
(exempt) diesel removed from the terminal was required to be dyed red. Using the
terminal rack point of taxation substantially reduces the number of entities
responsible for collecting and remitting diesel fuel taxes, making enforcement
simpler and less costly. Dyeing makes it more difficult to use exempt diesel
on-road. Those caught with red- dyed fuel in
highway vehicles
are subject to a minimum $
1,000 fine. In the first year under
the new law, Federal diesel fuel tax revenues increased over $
1
billion, with about $
700 million of the increase attributed to
improved compliance. States that have adopted legislation conforming point of
taxation and dyed fuel provisions with Federal requirements have also seen
substantial improvements, in some cases double-digit percentage increases in
diesel fuel tax revenue.
Transportation Equity Act for the 21st Century
(TEA-21) (P.L. 105- 178, 112 Stat. 107). TEA-21 continued support for fuel tax
compliance projects and also gave States the option of using up to 1/4 of 1
percent of their Surface Transportation Program (STP) funds for such projects.
However, under TEA-21, the focus of the fuel tax compliance program under the
Joint Project shifted from encouraging cooperation among the States and the
Federal government in addressing tax evasion issues, to developing and
maintaining a Federal automated fuel tracking system.
Under section 1114
of TEA-21, the IRS was directed to develop a Federal and State motor fuel
information reporting system that could track the movement of fuel and determine
if the proper tax is paid. The majority of TEA-21 tax compliance funds were
dedicated to IRS development and implementation of the Excise Files Information
Retrieval System (ExFIRS), with the IRS receiving $
31 million
and States sharing $
4 million, over the six year period of the
Act. The ExFIRS system is made up of a number of subsystems that will support
the collection of motor fuel industry operational information; support automated
analysis of this information; and aid in identification of the areas with
highest risk for non-payment of excise tax liabilities (therefore offering
higher potential for return on investigative and enforcement activities).
Perhaps the most important of the subsystems is the Excise Summary Terminal
Activity Reporting System (ExSTARS), which is designed to track all petroleum
movements, in and out, through approved terminals, and to capture destination
State information when the product is removed through the terminal rack. The IRS
reports that the ExFIRS system is nearing completion.
As a result of the
change in priorities,
funding to the States for tax compliance
projects has been reduced each year to the point where, in FY 2002, States
received $
8,146 ($
16,292 for task force lead
States), approximately an 84 percent reduction from the $
50,000
($
100,000 for task force lead States) they received each year
under ISTEA. And not every State is receiving funds. However, the method of
distribution ensures that the limited funds are going to those States whose
unobligated balance of tax evasion funds has dropped below a minimum threshold.
Unfortunately, the reduction in HTF
funding for State
compliance projects has taken place at the same time that many State agencies
are experiencing erosion of other tax enforcement resources as part of broader
budget cutting efforts.
Furthermore, the TEA-21 option for States to use
STP funds for motor fuel tax compliance projects has had limited success.
Between FY 1998 and FY 2002, close to $
85 million in STP funds
potentially could have been used for fuel tax evasion projects, but only
$
8.8 million have been used for such purposes by 18 States. The
majority of States have not obligated STP funds for fuel tax evasion because the
State DOTs have set priorities for these funds years before receiving them. Tax
compliance projects, which normally are administered by State revenue or
enforcement agencies rather than State DOTs, must compete with other eligible
State DOT projects for use of the STP dollars. While this
funding option has given some State revenue and enforcement
agencies the opportunity to invest in more costly items, such as State automated
fuel tracking systems, and hardware and software for program support, most have
been unable to benefit from the option.
FHWA continues to support and
promote the Joint Project and State tax compliance initiatives by acting as a
clearinghouse for enforcement information at both Federal and State levels; by
supporting Federation of Tax Administrators training for motor fuel auditors in
basic and advanced audit techniques; by contributing to the development of a
training course on enforcement/criminal investigations techniques for State
motor fuel tax enforcement agents; and by investigating areas with potential for
new evasion schemes such as imported finished motor fuel products. Recently, we
provided a Spanish-language version of the brochure "Attention Truckers: No Dyed
Fuel on the
Highway," so that truck drivers from Mexico sharing
our transportation system will know about our laws and penalties for using
untaxed diesel fuel on-road.
Fuel Tax Evasion Today
While
legislative changes have made substantial inroads in the motor fuel tax evasion
problem, fuel tax evasion persists nationwide. There are still a variety of ways
in which fuel taxes may be evaded or underpaid, and fraud schemes have quickly
adapted to take advantage of the remaining loopholes.
Daisy Chain. An
operation of this sort was more popular before the dyeing of diesel fuel and the
change to a terminal rack point of taxation. It involves multiple paper
transfers of fuel among fictitious companies to conceal the party liable for
remitting the tax, which is in fact never remitted. By the time auditors unravel
the transactions, the company that allegedly paid the tax will have disappeared
without leaving assets. A Daisy Chain could often siphon off millions of tax
dollars in a few weeks of operation. Schemes involving false information filing
continue to operate today and, as discussed below, are believed to be ongoing in
the jet fuel distribution system. Bootlegging. Fuel is smuggled across State,
Tribal, or international borders without paying the taxes due, meaning losses in
Federal or State taxes, or both. Bootlegging is particularly a threat to State
fuel tax collections, usually occurring where a high-tax State borders a low-tax
State.
One type of bootleg operation may be accomplished using fuel
barges that move untaxed fuel through inland waterways or along the coast. The
barges will tie up where a portable pump can be used to pump fuel into trucks.
The terminal rack, the point of taxation, may be bypassed completely or a
portion of the revenue that should have been collected may be lost. In the
latter case, because barges are not completely pumped dry at the terminal,
diversion of a part of the fuel shipment to be offloaded may not be detected by
the terminal.
Noncompliance Involving Imports of Foreign Finished
Product. According to the U.S. Department of Energy's Energy Information
Administration 1998 import data, 437.5 million barrels of finished petroleum
products are imported into the U.S. annually. This number is projected to grow
each year. Increased reliance on foreign products is a result of increased
demand and the reduced number of working domestic refineries (from 315 in 1980
to 151 in 2000).
The importation of finished motor fuel products is an
area of potential motor fuel tax evasion concern that, to date, has not been
adequately addressed. Ideally, shipments of imported fuel should be capable of
being tracked from their entry into the U.S. waters to their destination
terminal. Domestic source barges also require oversight to prevent purported
exports from re-entering the U.S. unreported. A variety of agencies collect data
from entities importing motor fuel into the U.S. While each agency requires
specific forms to be completed, coordination of the data from each of the forms
does not occur.
This lack of data coordination, and the lack of
coordinated agency efforts, may allow fuel to enter the U.S. unreported. In
addition, this permits loopholes that may allow high- sulfur fuel shipments to
proceed undetected to points within the U.S. where the fuel may be off-loaded
illegally.
In conjunction with the Joint Project, FHWA is currently
studying the finished motor fuel importation process. Our focus is on truck and
rail shipments across the Canadian and Mexican borders; barge movements;
seaports; and fuel moving through foreign trade zones. Washington State
officials, for example, believe that cheating is increasing on gasoline brought
in from Canada. Exported fuel does not have to pay Canadian gasoline tax.
Companies may be bringing in tax-free fuel for retail sale without paying
Federal or State fuel taxes and without proper import licensing.
Complex
processes and overlapping responsibilities for tracking foreign fuel shipments
suggest that closer scrutiny may be warranted to address homeland security
concerns as well as tax evasion potential. For instance, the maneuver known as
"lightering" can complicate tracking of fuel shipments and could create
vulnerabilities. "Lightering" refers to the off- loading of fuel, in many cases
of foreign origin, from a seagoing vessel into barges, to lighten the vessel
sufficiently to allow its passage into a shallow seaport.
Below the Rack
Schemes/Jet Fuel Tax Fraud . So called "Cocktailing" refers to the blending of
tax-paid fuel with untaxed products to extend the supply, resulting in loss of
State and Federal taxes on the extended gallons. Additives can include jet fuel,
petroleum waste products, and even hazardous waste materials, leading to
potentially dangerous emissions and damage to motor vehicle engines in addition
to the revenue losses.
The potential for aviation fuel to find its way
onto the
highway system untaxed has recently become a
particular concern. Under the current IRS code, "H" registrants (importers or
producers (including wholesale distributors) of aviation fuel) can purchase
clear, tax-free jet fuel for resale. Because jet fuel can be used in diesel
engines "as is" or can be blended with diesel for use on-road in trucks, exempt
removal of clear jet fuel from the terminal rack provides evasion opportunities
that can result in the loss of both Federal and State
highway
diesel fuel tax revenues. The Leaking Underground Storage Tank (LUST) Trust Fund
may suffer a loss as well.
Jet fuel can enter the motor fuel
distribution system primarily in one of three ways: (1) Jet fuel is taxed at the
jet fuel rate but used as diesel fuel. The tax rate on jet fuel is either 4.4
cents/gallon (commercial) or 21.9 cents/gallon (general aviation). Purchasing
the fuel tax-paid at either of the aviation rates, and using the fuel on-road,
results in a loss of 24.3 cents/gallon to the Federal HTF. The Airport and
Airway Trust Fund receives a small windfall and the LUST trust fund is not
affected. (2) Jet fuel is not taxed and is used as diesel fuel. Purchase of
tax-free jet fuel and its subsequent use on the
highway results
in losses to the
Highway and LUST trust funds, while the
Airport and Airway Trust Fund receives no benefit. (3) Diesel fuel is sold as
exempt jet fuel (e.g. for military use) but does not meet jet fuel
specifications and is used on-road as diesel fuel. The HTF loses 24.3
cents/gallon; the LUST trust fund loses .01 cents/gallon. The Airport and Airway
Trust Fund is not affected.
Exhibit 2 (See Attachment 2,
Production/Consumption graph) provides a comparative illustration of trends in
jet fuel production and consumption from July of 2001 to March of this year, and
suggests there is a considerable quantity of jet fuel remaining after taxable
airline consumption. Some of the difference represents tax-free exports or use
in foreign commerce. Because jet fuel is currently the only major transportation
fuel not taxed at the terminal rack level, tracking fuel and revenues is
difficult. Florida, the only State to tax aviation fuels at the rack, reported a
21.4% increase in aviation fuel taxes collected in the first year under the new
system.
A study prepared in December 2001, by KPMG Consulting, using
data from the Energy Information Administration at the Department of Energy
(DOE), FHWA, the Federal Aviation Administration (FAA), and the IRS, estimated
that potential revenue loss from jet fuel diversion could range as high as
$
9.2 billion for the FY 2002 through FY 2011 period. This
estimate was arrived at in part because of the difference in volume of fuel
production and volume of airline consumption.
Conclusion
In
shaping the Administration's reauthorization bill, Secretary Mineta has
committed to maximizing the safety and security of surface transportation for
all Americans, even as the Department seeks to enhance mobility, reduce
congestion, and facilitate growth in the economy. If we are to realize these
goals, we must strive for the greatest return possible on each dollar invested
in transportation. Furthermore, we must ensure that the American people are not
cheated out of the dollars that, by law, they are entitled to have invested in
their surface transportation systems.
An ongoing commitment to motor
fuel tax enforcement is needed to continue the progress already made in
combating fuel tax evasion. Although it is difficult to precisely quantify the
revenue gains attributable to reduced evasion, reports from specific enforcement
actions indicate that we are getting a good return on the money that has been
invested to improve fuel tax compliance. Increased tax compliance means
increased revenues.
FHWA will continue, through the Joint Fuel Tax
Compliance Project, promoting enforcement activities and developing new
strategies to encourage compliance. We believe that working together with our
partners to ensure collection of the revenues that fund our programs is an
integral part of our role as stewards of Federal-Aid
Highway
Program investments.
Mr. Chairman and Members of the Committee, this
concludes my statement. I again thank you for the opportunity to testify today
and I will be pleased to answer any questions you may have.
LOAD-DATE: July 18, 2002