According to European recommendations, a combination of differentiated rail charges, environmental legal restrictions and voluntary commitment is generally required to achieve an effective reduction of rail environmental costs. This paper aims at contributing to define the requirements of a proper internalization scheme for rail transport. Environmental rail charges are analyzed both from a theoretical and a practical perspective. The state-of-the-art noise and pollution costs internalization schemes throughout Europe are extensively reviewed. Special emphasis is placed on the effects of the internalization scheme on rail business in terms of technology, operation performance and profitability. It is analyzed if current rail charges give correct incentives to provide a significant reduction in external costs considering financial and technical constrains of railway undertakings and the complexity of the rail market structure, particularly the freight market.