Sales tax exemption isn’t a subsidy but a common shield against increasing consumers’ prices with hidden levies
Wisconsin’s sales tax exemption for data center equipment is increasingly controversial, with many policymakers wanting to eliminate what they assume is a subsidy. In a state with a long and fraught history of large tax incentives, they have good reason to be wary.
But data centers do not receive special favors under the sales tax. They actually receive slightly worse treatment than other industries.
A properly designed sales tax applies to final consumer purchases while exempting intermediate transactions. Imposing the sales tax at multiple stages of production turns the sales tax into a tax on in-state production, and can lead to “tax pyramiding,” where the final price of a good or service embeds multiple layers of hidden sales tax.
Because cloud-based digital services are used at virtually every stage of production for nearly everything we buy, when states impose sales tax on data processing (or its inputs), the result is higher prices across the board. Sales tax belongs on the final sales of a taxable good or service. If it is imposed on data center equipment, and then potentially again on data processing used by businesses as they produce goods and services that are ultimately sold for retail (with sales tax imposed), the result is multiple layers of tax on the same good or service.
No state exempts all intermediate transactions, even though public finance scholars almost unanimously urge them to do so. But most states at least avoid taxing raw materials, machinery and equipment used in production, and other “purer” business inputs.
Wisconsin’s sales tax exempts machinery and equipment used in manufacturing, agriculture, and energy generation, because none of these represent final consumption. Taxing the equipment makes it more expensive to do business in Wisconsin, putting Wisconsin companies at a competitive disadvantage against peers—including those that sell into Wisconsin but produce their goods and services out-of-state.
Data center equipment, such as servers, chillers and electrical equipment, receives similar, but not identical, treatment. When many companies operated their own servers, the computer equipment generally benefited from equipment exemptions applying to the industry in question. But with the shift from in-house data processing to cloud-based data centers, states realized that data centers didn’t fit cleanly into existing exemptions, and lawmakers worked to remedy the situation.
Instead of extending by-right exemptions to data center equipment to match those offered to other industries, however, lawmakers across the country structured data center sales tax exemptions as incentives. This was popular with economic development authorities and local government officials, who got to hold ribbon cuttings and advertise that their incentives had attracted data center investment.
Now the incentive framing cuts the other way, and many policymakers mistakenly, but understandably, believe that data centers are getting a special deal, when they’re really just jumping through additional hoops to get the same treatment as other industries.
Wisconsin was a data center latecomer, adopting its exemption in 2023, but when it did so, it followed the incentive model other states had pioneered. Notably, pre-exemption data center investment in Wisconsin was negligible. With equipment subject to sales tax, Wisconsin was not an attractive state for data center investment. Three years later, $46 billion in data center operations have been announced in Wisconsin, with $36 billion operating or committed.
When a cheese factory in Plymouth buys pasteurization systems, coagulation vats, and mechanical curd cutters, such equipment is exempt by right from the sales tax. The same is true when a potato grower in the Central Sands purchases harvesters, irrigation systems, and climate-controlled storage. This equipment all enjoys by-right exemptions. No one needs to secure an agreement with the Wisconsin Economic Development Corporation, invest a certain amount of capital, or create a given number of jobs.
But when a data center purchases servers, cooling units, electrical equipment, or backup generators, these purchases are exempt only if the operator receives WEDC certification and commits to a minimum qualified investment ($50 million to $150 million depending on county population). They must also invest despite knowing that their certification can be revoked, and that the exemption isn’t guaranteed when the time comes to replace the existing servers.
If states stop exempting data center equipment from the sales tax, that will increase the cost of digital automated services running on data centers. Ironically, even though those potato growers in the Central Sands avoid paying sales tax on their own equipment, they could easily wind up paying a hidden sales tax on many of their operational expenses.
Nearly every step of their production process involves digital services. Industrial potato planters run on GPS guidance, using equipment-control software, applying automatic adjustments for planting depth and spacing, and adjusting fertilizer to specific soil conditions. Crop monitoring is increasingly digital as well, and modern harvesters continuously monitor crop yields and moisture during harvesting to collect data for subsequent plantings. Storage, sales and logistics all rely heavily on cloud-based services. Every stage of production can be rendered more costly as states increase tax burdens on data centers.
Lawmakers sometimes speak of forgone revenue from the data center sales tax exemption, but that involves two assumptions: first, that the revenue ever belonged in the tax base, and second, that the investment would have been made in-state had tax been imposed. Data centers have extraordinarily high capital costs, and because servers must be replaced frequently, a sales tax on data center equipment is punitive enough to render many data center investments unviable.
Meanwhile, communities hosting data centers reap the benefit of sizable property tax revenues that can pay for additional local spending or reduce homeowners’ property tax burdens. Microsoft’s tax bill for its facility in Mount Pleasant is now about $20 million per year, making it Racine County’s largest taxpayer. Data centers are also good business for construction workers, engineers and electricians, and Wisconsin is home to manufacturers such as Regal Rexnord, Generac and Modine that supply data centers across the country.
Data centers should receive the same sales tax treatment afforded to other industries. Under current law, they receive slightly worse treatment. Eliminating the equipment exemption altogether would be a policy blunder. It is inconsistent with basic sales tax principles, and it would harm Wisconsin’s economy and undercut local revenue streams.
Jared Walczak is president of Walczak Policy Consulting and a Senior Fellow at the Tax Foundation, where he spent five years as Vice President of State Projects.
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