Forget H.R. 25, the Fair Tax Act. 45G Is What Counts

Written by David Nahass, Financial Editor
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FINANCIAL EDGE, RAILWAY AGE, MARCH 2023 ISSUE: Oftentimes, “Financial Edge” gets an earful from readers—sometimes congratulatory like a Home Depotesque slogan: “You nailed it.” Other times there’s criticism, like being too much in the railroads’ pockets in supporting the industry’s safety record.

Recently, a reader asked (twice!) for a discussion of the potential impact of a tax bill, the Fair Tax Act, H.R. 25, on short line railroads, specifically on Internal Revenue Code section 45G. H.R. 25 proposes a revision to the U.S. tax code that would eliminate all government tax credits, deductions and the IRS. Instead, tax collection would pivot to a consumption tax.

Consumption tax may seem enticing (not to mention regressive), but theory is often poor in execution. The evidence is clear, as globally there is no consumption tax in use as a system satisfying the tax needs in any country. Value-added taxes (VAT) are the closest simulacrum. 

But that is a digression. 

Government is often not about being sensible. Frequently, most of what counts as governing is pathetic pandering dressed up in what were once known as “Sunday Clothes.” The rail industry has been witness to difficult events in East Palestine, Ohio. It is tragic. However, anyone who has watched politicians grandstand about rail’s lack of commitment to safety has to be incensed watching the political flies feed on the manure pile that the hyperbole around that derailment has created. 

Another digression. 

In investigating the impact and value of 45G, there is no better resource than the American Short Line and Regional Railroad Association (ASLRRA), the go-to for all short line railroad questions. First off, let’s ensure there’s no confusion: ASLRRA confirmed and stated categorically there is no chance that H.R. 25 gets passed. “Financial Edge” unequivocally agrees that H.R. 25 will not be passed, and that as a piece of legislation, it is most useful as a door stop.

“Government is often not about being sensible. Most of what counts as governing is pathetic pandering dressed up in what were once known as ‘Sunday Clothes.’”

In discussions with ASLRRA, what did become clear is how important 45G has become to the U.S. rail system since its passage in 2004. ASLRRA President Chuck Baker, a regular Railway Age columnist, noted the following: 

“The 45G tax credit for infrastructure rehabilitation and maintenance is an effective and successful tool to help short lines serve thousands of agricultural, energy, and manufacturing customers throughout small town and rural America. 45G was extraordinarily popular with elected officials of all stripes, and is widely seen as an unmitigated success story. It has been proven to work and remains of crucial importance to hundreds of short lines.”

The statistics (provided by ASLRRA from a Price Waterhouse 2018 study) of 45G improvements are phenomenal: More than a 50% reduction in short line railroad derailments; a 6,000% increase in railway tie acquisitions; a 63% reduction in capital cost; and a 47% increase in investments in infrastructure.

ASLRRA was instrumental in the passage of 45G and in making 45G a permanent part of the tax code in 2020. 

But here is what makes 45G such an important part of maintaining capital investment in short line railroads: 45G allows for the tax credits generated by a short line railroad to be assigned/sold to a third party. This mix—providing the credit to the railroads and then allowing them to be monetized—turns an attractive concession into a financial tool of perpetual motion that generates continued investment in short line railroads.

Barbara Wilson, a former short line railroad CEO whose railroads effectively used 45G, provided more clarity. “A critical clause in the 45G tax credit is the credit transferability provision,” she said. “Many short line railroads are structured as pass-through tax entities and/or do not have enough taxable income to utilize the credit. All short lines can transfer (sell) the tax credit to a railroad customer or railroad vendor. This enables short lines to utilize the credit to fund important track improvements.”

David Nahass, Railway Age Financial Editor

Wilson further noted that some states have coat-tailed similar 45G style provisions in their own tax code: “Several states have structured tax credit programs for their short line railroads. In 2021, I worked, on behalf of the eight owners of short line railroads operating 2,040 track-miles in Florida, with Michelson & Company’s Ryan Piddle to pass the Florida Short Line Modernization Tax Credit. We spent significant time educating the legislature on the importance of the tax credit transferability provision.” 

So as big government moves to get in the way of railroad safety in the wake of the derailment in East Palestine, it helps to be reminded that government can do good. Even in spite of efforts to the contrary (e.g., H.R. 25), something well done can continue to provide benefits. Hold onto that over the coming months.

Got questions? Set them free at [email protected].  

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