September 6, 2017

Protecting Interstate Taxpayers from Discriminatory State Taxation: Illinois Central Railroad Company v. Tennessee Department of Revenue

State and local governments are frequently tempted to apply different tax rules to individuals and businesses less able to resist them. One area of this is interstate railroads, where local governments historically imposed excessive property tax 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, Tennessee imposes a 7 percent sales tax on purchases of diesel fuel by interstate railroads, the proceeds of which are used for state education funding (1.5 percent) and noninterstate local railroad bridge and track repair grants to local communities (5.5 percent). Motor carriers’ purchase of diesel fuel is exempt from the sales tax, but is subject to an 18.4 cent per gallon tax, the proceeds of which are used to fund construction and maintenance of roads. In strict dollar terms, road users generally will pay more in taxes. But they 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 court ruled for the railroads challenging the state’s taxation scheme. While under appeal to the Sixth Circuit Court of Appeals, the U.S. Supreme Court ruled in Alabama Department of Revenue v. CSX (2015) that if a state imposes “an alternative, roughly equivalent tax,” a tax on railroads may not be discriminatory. The Court cited Gregg Dyeing Co. v. Query (1932), where a South Carolina law was upheld as nondiscriminatory, which involved one tax on interstate companies and another tax at an identical rate on intrastate companies. The Sixth Circuit directed the trial court to determine whether the motor fuel tax in this case was such “an alternative, roughly equivalent tax.” Focusing on the rough dollar amount rather than the use of the revenue, the trial court concluded that the two taxes are roughly equivalent and upheld it.

The Tax Foundation has filed an amicus brief with the Sixth 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 Illinois Central Railroad Company v. Tennessee Department of Revenue, No. 17-5553.

Was this page helpful to you?


Thank You!

The Tax Foundation works hard to provide insightful tax policy analysis. Our work depends on support from members of the public like you. Would you consider contributing to our work?

Contribute to the Tax Foundation