Data Center Sales Tax Exemptions are Sound Policy, Not Subsidies

My new paper, with a 50-state survey

Last week, Nebraska became the latest state to announce a moratorium on sales tax exemptions for data center equipment, joining Arizona, Illinois, and Ohio. In each state, the exemptions have been framed as subsidies, with policymakers questioning why data centers enjoy a tax preference. But this framing is an inversion: far from receiving special treatment, data centers must meet eligibility requirements to qualify for exemptions that virtually any other industry would receive by right.

An ideal sales tax falls on final consumption, avoiding the taxation of intermediate transactions (business inputs) to prevent tax pyramiding, and so that what is intended as a destination-based consumption tax is not turned into an origin-based production tax. No state achieves this ideal, but most draw a few clear lines. Among these: exempting raw materials as well as machinery and equipment used in production.

States almost invariably exempt manufacturing, agricultural, mining, and energy machinery and equipment from the sales tax, and they do so by right. Most states also exempt data center equipment, but on less favorable terms—and these exemptions are increasingly precarious.

In a new paper for the National Taxpayers Union (the first of a series of three papers on data center tax issues), I (1) examine how this came about, (2) explain the policy rationale for exempting machinery and equipment from the sales tax, and (3) document how states’ treatment of data center equipment differs from their treatment of virtually all other equipment used in production.

As of this writing, 38 states exempt new data center equipment purchases or forgo a general sales tax, but only two provide a by-right exemption to all data centers. By contrast, 46 states exempt manufacturing machinery by right or forgo a sales tax.

Two decades ago, policymakers structured sales tax exemptions for data center equipment as incentives. This suited the purposes of local governments and economic development agencies, enabling them to take credit for “attracting” data centers. Awarding an incentive permitted governments to enumerate and promote their successes in a way that operations moving in and claiming a by-right exemption did not.

Now the incentive framing yields the opposite result, with policymakers increasingly questioning whether they should be “incentivizing” the industry, sometimes unaware that equipment exemptions aren’t incentives at all, but merely ordinary non-discriminatory treatment under the sales tax.

As I contend in the paper, data centers should receive the same sales tax treatment as other industries. Current law in most states already falls short of that aim. But states should avoid policies that impose unique and highly consequential penalties on a single industry.

For the full argument, and details about all 50 states, you can read my new paper here.

See You at NCSL?

I am at the National Conference of State Legislatures (NCSL) annual summit this week. If you’re around, please come say hello, or shoot me a note to let me know you’re here!

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