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• The fact that original equipment manufacturers (OEMs) make Federal Retail Excise Tax (FRET) payments on vehicles that they sell to the U.S. Department of Defense (DoD) is counterintuitive. This is a right-pocket-to-left-pocket transfer within the government, except it encumbers OEMs, increasing costs.
• There may be scope for DoD to reduce its FRET bill through management changes. OEMs should be informed when a FRET-eligible vehicle's first usage is outside of the country, rendering that vehicle tax-exempt. Subject-matter experts expressed concern that FRET has been paid unnecessarily on exported vehicles, though we have not found evidence of this phenomenon being widespread.
• If DoD wishes to pursue reform options, the most direct way to do so would be through the legislative process, i.e., convincing Congress to include such a reform in annual defense-related legislation. Indeed, DoD could only pursue options involving direct payments to the Highway Trust Fund through legislation.
• A second, non-legislative path to pursuing DoD exemption from FRET payments would be to seek relief from the Department of the Treasury. The Secretary of the Treasury has the authority to exempt items purchased from taxes if those taxes become a substantial burden. Indirect costs of FRET are real, but there is no objective test on whether the current costs are "substantial."

Certain types of medium and heavy tactical wheeled vehicles purchased or refurbished by the U.S. Department of Defense (DoD) are subject to a 12-percent Federal Retail Excise Tax (FRET) on the retail price or refurbishment cost of the vehicle. Original equipment manufacturers (OEMs) pay FRET, but are reimbursed for these payments by DoD. FRET proceeds are provided to the Highway Trust Fund (HTF).

FRET imposes two types of costs on DoD and its OEMs.First, there is a direct cost of DoD reimbursements to OEMs for FRET payments. DoD vehicle FRET payments were especially sizable (more than $200 million annually) from fiscal years 2007 to 2011. Second, FRET imposes indirect costs in the form of increased administrative costs, both within DoD and on its OEMs, as they strive to comply with FRET regulations. FRET also increases OEM working capital costs, as OEMs must pay FRET before they are reimbursed for it. The indirect costs of FRET are social costs of the mechanism, losses not offset by gains to the HTF.

We consider three prospective FRET reform options that could reduce its indirect or social costs; (1) DoD receives a blanket exemption from vehicle FRET; (2) DoD provides a direct financial offset on vehicles purchased or substantially refurbished to the HTF and OEMs make no FRET payments on DoD vehicles; and (3) DoD makes an annual payment, perhaps indexed for inflation, to the HTF unrelated to annual DoD vehicle purchases or refurbishments.

• Chapter One

  Introduction and Background

• Chapter Two

  Direct Costs of the FRET

• Chapter Three

  Indirect Costs of the FRET

• Chapter Four

  Options for Reform

• Chapter Five

  Conclusions

• Appendix A

  An Indifference Curve–Based Portrayal of U.S. Department of Defense Vehicle Choice

• Appendix B

  Challenges in Collection and Tabulation of FRET's Direct Costs to the U.S. Department of Defense

• Appendix C

  Finances of the Highway Trust Fund