Cities Useful Idiots in LILO Tax Dodge

So, remember those lease-in/lease-out (LILO) transaction thingies? Probably not. I’ve mentioned them here a few times. They’re a corporate tax dodge that works like this:

Say you’re a city government and you’ve got a big something-or-other like a bridge or a metro system. Over the years it’s depreciating in value, but as a city government, you’re not able to get much tax advantage out of this depreciation. So here’s what you do: you sell (or lease) your metro system to a big profitable company for a hunk of cash, then you lease your metro system back from the big profitable company for a somewhat smaller hunk of cash. The big profitable company can then take advantage of the depreciation expenses to lower its taxes, in exchange for offering you a good deal on the lease so you both come out ahead.

If that strikes you as somewhat shady, you’re not alone. The IRS thought so, too, and tried to shut down the practice. But because the leases had been cleverly written so that if they were ever invalidated in this way, the cities (and not the companies) would end up on the hook for everything, including the price of the expected tax benefits to the companies, the political cost of enforcing this was too high, and so the IRS grandfathered in the existing LILOs but banned any future ones.

The next fun twist in the saga happened during all the recent bank / credit-swap / et cetera collapses. Many of these schemes were insured by the now-assploded insurance company AIG — and in the wake of its collapse, the companies who partnered with cities in these plans were entitled to demand huge fees from the cities. So naturally, Congress saw this as a chance for the government to step in and use taxpayer money to bail out an illegal corporate tax shelter!

Okay… that brings us up to today. Plenty of insane behavior all around, all made quasi-rational courtesy of the tax code. Now you’ll learn how these LILO schemes may have killed nine people this week:

Taxes raise revenue, of course, but they also induce behavior. Sometimes these behavioral responses are intended by lawmakers (for example, when lawmakers raise taxes on an activity they deem undesirable, such as smoking), but often they are not.

The deadliness of [Monday]’s Metro crash in Washington, DC… may be, at least in part, one of these unintended consequences.

As you have doubtless seen elsewhere, two Metro trains collided when one train ran into the back of a stopped train, killing at least nine and injuring over 75 others. The first car of the moving train was, the Washington City Paper reports, the oldest type of Metro car in the system, a 1000-series Rohr car.

The City Paper reports that the National Transportation Safety Board repeatedly recommended that Metro (more formally known as the Washington Metropolitan Area Transit Authority, or WMATA) retrofit or replace these older cars, but Metro refused. Why? Because “WMATA is constrained by tax advantage leases, which require that WMATA keep the 1000 Series cars in service at least until the end of 2014.”

What are these “tax advantage leases”? They appear to be standard sale-leaseback transactions, in which WMATA sold equipment, including train cars, to another party and now leases it back. The other party gets various tax advantages (depreciation, credits, and so forth) associated with owning the equipment, and WMATA, which as a tax-exempt organization cannot use these advantages, gets cash. But apparently the leases did not include language that permits WMATA to break the leases if newer, safer equipment comes along.