Taxpayer group: Some state tax policies disadvantage data centers

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(The Center Square) – The buildings that house thousands of computer servers powering cloud computing and artificial intelligence have increasingly caught heat over environmental and energy concerns.

Another common criticism is that state and local governments offer data centers sweetheart deals to attract them, including tax breaks and other incentives, potentially leaving ordinary residents to shoulder some of the costs associated with their development. But the National Taxpayers Union has released a pair of studies in a series arguing that at least two common state tax policies treat data centers less favorably than other industries.

Most states allow a tangible personal property tax on data centers, a tax the group contends is not only antiquated and generally harmful but disproportionately disadvantages data centers. The NTU also calls the tax an “international anomaly,” noting that “only seven of the 38 Organisation for Economic Co-operation and Development countries tax tangible personal property at all, and among them, only Japan imposes them as broadly as the U.S.”

A tangible personal property tax is a tax exacted on property “that can be moved or touched, such as business equipment, machinery, inventory and furniture,” as defined by the Tax Foundation. It’s paid annually and, like real estate property taxes, is calculated based on the assessed value of the property.

For example, in some states, residents pay an annual property tax on their vehicles, often referred to as a car tax, based on the vehicle’s assessed value and the applicable tax rate. 

Data centers can pay tangible personal property taxes on their servers, networking equipment and other computer hardware, depending on state and local tax laws. Only, like with the car tax, the assessed value can be inaccurate.

“Suppose the government thinks, ‘Well, your car is only two years old. It’s this make and model. You pay this much tax.’ But then you say, ‘Well, wait a minute! I drive this thing into the ground, and I’ve had to replace part of the suspension on it. It’s not in as good of shape as you think,’” NTU President Pete Sepp told The Center Square.

Similarly, the assessed value of technology used in data centers can differ drastically from its market value — to the point that NTU argues state tangible personal property tax laws actually “discriminate against technology.”

“The complex depreciation schedules required to value property are designed around manufacturing machinery that often performs at the same level after a decade or more of use,” NTU writes. “Applying the same standards to companies like data centers can significantly overvalue equipment like computer servers, which are often obsolete after three years.”

And those depreciation schedules can also vary widely by state. In Florida, a three-year-old server is valued at 56% of its original cost according to its TPP tax law, while a handful of states would value that same server at 40% of its original cost.

To avoid “discriminating” against technology-heavy industries like data centers, NTU recommends that states refrain from introducing new tangible personal property taxes but also avoid replacing existing ones with higher taxes elsewhere. And Sepp recommends going a step further.

“State lawmakers should reform personal property laws so they’re uniform, neutral, simple and stable,” Sepp said in a statement. “Data centers are the manufacturing plants of the information age, and our laws should reflect that reality with equal treatment.”

NTU also examined sales-and-use-tax exemptions in the first report of its series, addressing a more widely debated tax policy that has recently drawn criticism for its application to data centers.

Thirty-three states offer a conditional form of the exemption to data centers (two offer it by right), but between May and August, eight states took steps to suspend or eliminate the exemptions “or benefit programs” for data centers, according to an analysis by S&P Global Market Intelligence.

In the two states that offer sales-and-use-tax exemptions to data centers without having to meet special investment or employment requirements, the exemptions allow data centers to purchase computer servers, networking equipment and other hardware without paying applicable state and local sales taxes. Such exemptions are often perceived as unique to the industry, but that is a misconception, according to NTU Senior Fellow Jared Walczak, and “betrays a misunderstanding of how sales taxes are supposed to work.”

There is a general consensus in tax policy that sales taxes should apply to final consumption rather than the inputs used to produce goods and services so as to avoid tax pyramiding, which occurs when a good or service is taxed multiple times at different stages of the production and supply chain, inflating the final consumer price.

For example, if a data center pays sales tax on its computer servers, it may pass that expense along to businesses that use its computing services. Those businesses may then pass the added cost along to their customers through higher prices, which are taxed again when consumers make purchases. 

“No state’s perfect on exempting business inputs, but there are a few bright lines that basically all states adhere to,” Walczak told The Center Square. “They don't tax raw materials, and they almost always exempt machinery and equipment.”

The vast majority of states offer sales tax exemptions for machinery and equipment used in manufacturing, while exemptions are also available for equipment used in industries such as agriculture, mining and energy production.

“The problem is, where do data centers fit in that? Are they manufacturing? You know, what are they?” Walczak said.  “A lot of states didn’t have a ready-made category for that.”

Many states created similar exemptions years ago for data centers through incentive programs to help attract data centers, but unlike in manufacturing, in 33 states, data centers’ equipment hasn’t been exempted outright. Data centers have to meet different investment or employment targets to qualify. And now, amid growing opposition, a number of states are looking at repealing those exemptions.

“Lawmakers have shifted, and now they look at the word 'incentive' and say, ‘Why are we giving special handouts?’ But the thing is, they're not,” Walczak said. “They're providing — under a slightly worse system because you have to qualify — the same exemption that every other industry gets by right because the sales tax is not supposed to tax equipment.”

“Most incentives are a special treatment, and this is an incentive that gets you ordinary treatment,” Walczak told The Center Square.