Fuel Tax Hijacking: How State Governments Are Responding.

• Author: Hagquist, Ron

In 1982, Congress more than doubled the federal gasoline tax and quadrupled the diesel tax to fund the Federal Highway Trust Fund, the source of monies that are distributed to the states for their federal road improvements. But despite the dramatic tax increases, in January of 1985, Ray Barnhart, the administrator of the Federal Highway Administration (FHWA), discovered that fuel tax revenues had not increased as expected.

Discussions with Treasury authorities and Internal Revenue Service officials failed to reveal any legitimate explanation. Visits were made to various states in an effort to correlate their data with the federal results, but the reason for the magnitude of the differential between projected revenue and actual collections remained unexplained. Weeks of investigation led Barnhart to but one conclusion: theft of federal fuel taxes--and undoubtedly state taxes as well--was occurring on a nationwide scale, as much as $1.7 billion annually.

As part of an agreement with prosecutors, a man indicted for fraud confirmed Barnhart's suspicions in 1986. He described in detail how organized crime in the New York area had been stealing fuel taxes at the rate of as much as $8 million a month for years. It was the classic formula for crime, the combination of motive and opportunity: the opportunity was control of fuel distribution businesses; the motive was the increased fuel tax rate--as one defendant described it to the IRS, "every time you raise taxes, we get a raise."

Combined state and federal taxes now total as much as half the price the consumer pays for fuel at the gas pump. From the criminal's point of view, the beauty of the situation is that enormous amounts of money can be made by hijacking the taxes, rather than the fuel itself--and with much less effort, coupled with a lower risk of apprehension.

Tax authorities at the state level began to hear about the federal findings and realized that their state fuel taxes were prey to all the fraud that the feds were uncovering. Upon further investigation, they discovered that they were open to even more such schemes because states had greatly differing tax rates, opening rich bootlegging opportunities across state boundaries. They also learned that large volumes of fuel crossed state borders untaxed on the "honor system," with the taxes supposed to be paid to the destination states--but ripe for stealing by the unscrupulous.

The Business of Fuel Tax Fraud

As federal and state tax authorities continued their investigations, they learned that the spectacular cases initially discovered were only the tip of the fuel tax fraud iceberg. A wide variety of fraudulent practices was supporting tax hijacking very democratically. It was occurring at all magnitudes of scale and at all levels of the fuel marketing chain--from mom-and-pop retailing through major crime organizations. Even the final consumers of fuel had avenues for fraud, by using or reselling legally tax-exempt fuel for non-tax-exempt uses.

Some case examples illustrate this variety.

The Case of the Big Little Delivery. A fuel distributor purchases 2,500 gallons of diesel for tax-free use, only 500 gallons of which is delivered to a farmer for off-road use. However, documents are falsified to show that all 2,500 gallons were delivered tax-free to the farmer. Then the remaining 2,000 gallons are actually delivered to the local truck stop tax-paid, and the distributor pockets $400 in state tax.

The Case of the Color Cover-up. A commercial motor carrier trying to get an economic edge on the competition buys 200 gallons of used motor oil and lubricant waste product. He then purchases red dyed diesel for delivery to an off-road user but retains 100 gallons of the red dyed diesel and puts it into his rig's fuel supply tank along with a...