Data center taxation should be guided by sound policy, not short-term gains

Public political pushback against data centers has state lawmakers rethinking tax breaks they passed with little controversy only a few years ago. Between 2008 and 2025, 38 states passed legislation offering tax exemptions and incentives to these centers in hopes of attracting more of what they saw as a new and booming type of business. 

Now, amid a backlash over data centers that has reached near fever pitch in recent months, the mood in state capitols has undergone a sudden change. In the spring and summer of 2026 alone, lawmakers in at least eight states have introduced bills that would repeal data center tax exemptions, with several more pausing or reducing tax breaks that appeared safe only a couple of years ago.

During the initial legislative boom, proponents argued these tax exemptions would attract more data centers to their states. Amid increasingly stiff competition from dozens of other states passing similar packages, legislators sought to bring a larger share of data center construction within their borders. To assure residents of the benefits of increased data center activity, each state attached requirements to data centers receiving tax breaks, such as overall capital investment dollars in the project and new jobs created. But when it became clear in the last two years that the boom in question was, in reality, far larger than anyone expected, states began to rightfully question whether tax breaks were really necessary to reap the benefits.

When reconsidering the tax breaks they recently passed, states should not repeat the mistake of singling out data centers for short-term political benefits but instead look to sound long-term tax policy. Some of the exemptions offered by states to data centers are the same as those long provided to other types of businesses like manufacturers, and that experts have long argued should be extended to all firms. States should keep exemptions for data centers on the books when they are justified based on fair and efficient taxation, and repeal them when they are not.

Sales and property tax exemptions

While the state tax packages vary in their technical details, they are mostly similar in the type of exemptions they offer and the benchmarks they require in return. In 37 of 38 states, an exemption on sales tax for machinery and equipment (M&E) is the principal break offered, which covers chips, servers, cooling and electrical equipment, and networking gear. Some states extend this sales tax exemption to also cover utilities. (Montana, which does not have a sales tax, passed legislation with a property tax exemption.)

Property taxes fill the other category of exemptions found in some states’ packages. Property tax incentives offered to data centers are both less frequent and more idiosyncratic than the sales tax exemptions at the core of almost every state bill. A few states, such as Iowa and Montana, passed statewide property tax abatements covering either land or previously purchased equipment. Others like Indiana and Mississippi passed legislation authorizing cities and counties to offer data centers special property tax breaks during their negotiations. 

Virtually all of the data center tax breaks offered by states are conditional on the recipients meeting “economic development” benchmarks. While benchmarks vary from state to state, they most commonly take the form of requirements on capital investment and jobs. To qualify for sales tax breaks in Virginia, data centers must make $150 million in new capital investment and hire 50 workers at wages at least 150% of the local average (with these hurdles lowered in “distressed areas”). In Illinois, qualifying data centers must make $250 million in capital investment and create 20 jobs within 60 months. Other states such as Michigan add “green” building requirements to the list of necessary qualifications.

The economic case for M&E exemptions

While the combination of exemptions and incentives makes the tax treatment of data centers unlike any other business, the practice of single-stage sales taxes that exempt B2B transactions and apply once only at the point of final consumption is both time-tested and economically sound. In fact, the wave of legislation from 2008 to 2025 brought data centers more closely in line with how states tax traditional manufacturers. Forty states exempt factories from paying sales tax on M&E, with a smaller subset again extending the break to electricity. In this regard, states’ treatment of data centers and manufacturers now tracks very closely.

Sales taxes are a critical part of how most state governments operate, accounting for approximately one-third of revenue in the 43 states that impose them. A well-designed sales tax applies only to the final stage of consumption. Most of what we buy in a modern economy goes through many steps in a supply chain. If businesses and manufacturers must pay the sales tax in full at each step in that chain, goods and services that pass through several steps will be taxed several times. This is called “tax pyramiding.” Tax pyramiding penalizes manufacturers that produce goods that require many stages of production and can disadvantage smaller firms by incentivizing vertical integration. Capital investment is similarly penalized when sales tax falls on B2B transactions. Finally, repeated taxation at each stage of the value chain can obscure the essential signals that market prices send to buyers and sellers, a problem only compounded when goods or services move across the borders of states with different rules.

For these reasons, economists and tax experts widely agree that all businesses should receive M&E sales tax exemptions of this kind. Karl A. Frieden and Fredrick J. Nicely, authors of a 2024 study examining sales tax history, note that historically services and wholesale did not typically receive such robust exemptions, and observed that sound taxation principles like neutrality (treating all types of business as similarly as possible) and avoiding tax pyramiding were less prominent in more recent debates. They recommend all states with manufacturing exemptions on the books extend them to digital products as a matter of “good tax policy.” Jared Walczack of the Tax Foundation found that eliminating the sales taxation of intermediate goods for all types of business, while raising rates on final consumption goods in a revenue-neutral manner, would increase capital accumulation and ultimately output in state economies by billions of dollars. Data center M&E sales tax exemptions represent progress toward the goal of a single-stage sales tax for all types of businesses. 

Looking forward

Unfortunately, proponents of the data center tax bills focused on the flimsier prospect of short-term economic and political benefits rather than on sound longer-term tax policy. Lawmakers told their constituents they would out-compete other states for a larger piece of a construction boom destined to bring investment and jobs in the short-term. What happened next shows why targeting handpicked industries and firms for special treatment is misguided.

Predictions of a boom proved wildly underestimated. States did not need to out-compete each other because it turned out there would be enough projects to go around. This is an unavoidable problem when designing policy around handpicked businesses and predictions about cutting-edge new technology. Businesses and governments alike are bound to make false assumptions. But while businesses must face self-correcting market mechanisms, governments risk keeping policies in place long after these assumptions are proven wrong. 

States are therefore better off crafting tax policy that is efficient, neutral in its treatment of different businesses, and built for long-term prosperity rather than short-term gains. To the extent that states gave data centers tax breaks that other businesses do not have and that lack justification, repeal them. 

The 37 states that passed M&E sales tax exemptions should keep them in place. Were it politically feasible, states would best proceed by extending these exemptions to all businesses. But if such a proposal is too politically messy, it nevertheless makes sense to leave these specific exemptions in place for data centers. Repealing them would amount to placing short-term political gains ahead of sound tax policy.

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Source: https://reason.org/commentary/data-center-taxation-should-be-guided-by-sound-policy-not-short-term-gains/