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Protecting Interstate Taxpayers from Discriminatory State Taxation: CSX Transportation v. Alabama Department of Revenue

3 min readBy: Joseph Bishop-Henchman

State and local governments are frequently tempted to apply different taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rules to individuals and businesses less able to resist them. One area of this is interstate railroads, where local governments historically imposed excessive property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. levies compared with other similarly situated property. In some cases, a railroad track going through a town paid most of the local property taxes collected for the whole town. These local tax practices contributed to the bankruptcy of a large part of the U.S. railroad industry in the 1960s and 1970s. The federal 4-R Act, passed in 1976, prohibits discriminatory taxes on railroads, and is a model for defining discriminatory tax burdens and fair property tax practices for individuals and other businesses.

In this case, Alabama imposes a 4 percent sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. on purchases of diesel fuel by interstate railroads, the proceeds of which are used for general state government such as education, criminal justice, and health programs. Motor carriers’ purchase of diesel fuel is exempt from the sales tax, but is subject to a 19 cent per gallon tax, the proceeds of which are used to fund construction and maintenance of roads. Water carriers are exempt from both taxes. In strict dollar terms, railroad and road users will pay about the same in taxes. But road users directly benefit from those taxes as the funds paid are used to improve the roads they use, while the funds from the taxes paid by the railroads are diverted to other governmental purposes. This differential amounts to discriminatory taxation.

The trial and appellate courts ruled for the state by concluding that sales tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s are not subject to the 4-R Act, but the U.S. Supreme Court reversed in 2011 and ruled that they are, because the 4-R Act was meant to stop discriminatory state taxation of any kind. (The Tax Foundation filed an amicus brief in that case, making that argument.) Remanded back to the trial court, the issue then became against whom you compared the railroads for discriminatory taxation purposes: all state taxpayers, or competitors in the transportation industry (road and water carriers). Ultimately the issue reached the U.S. Supreme Court again in 2015, where they ruled that the comparison class should be similarly situated to the railroad, so the transportation competitors was a valid comparison. The Court did not decide the Alabama tax system’s validity and directed the lower courts to consider the matter, noting that if a state imposes “an alternative, roughly equivalent tax,” a tax on railroads may not be discriminatory. In deciding that matter, the trial court concluded that the two taxes are roughly equivalent and upheld it.

The Tax Foundation has filed an amicus brief with the Eleventh Circuit Court of Appeals now considering the case, coauthored by eminent Professor Walter Hellerstein, the author of a respected law review article on complementary taxation. We argue that the trial court erred by not looking at the use of the revenue. In Bacchus Imports, Inc. v. Diaz (1984), the U.S. Supreme Court struck down a tax-and-subsidy scheme whereby interstate businesses paid a tax, and intrastate businesses paid the same tax but got it effectively refunded to them. The same situation is occurring here, as road users pay a tax that is effectively refunded to them in the form of road maintenance and construction while interstate railroad users pay a tax that is used for non-transportation purposes. This practice was one of the reasons the 4-R Act was enacted in the first place. We hope the appellate court understands the use of the revenue is important for assessing discrimination, and we hope that the precedent will guide future tax decisions.

The case is CSX Transportation v. Alabama Department of Revenue, No. 17-11705.