Cost of doing business

All of Minnesota’s businesses should be paying less sales tax.

One of the few things we know with reasonable certainty about the new state budget is that data centers will be required to pay sales tax on their electricity in the future, just like other Minnesota businesses. That isn’t the only fiscal change this growing industry faces in our state. Michelle Griffith reported on May 27 for the Minnesota Reformer:

Minnesota lawmakers are considering giving some of the country’s most profitable tech companies tax breaks on their data centers up to the year 2102 — when most of the legislators and lobbyists furiously negotiating the deal will be dead.

Minnesota currently has 42 data centers, with the majority spread across the metro. Nationwide, tech companies are rapidly building data centers — large warehouses with computer servers used to power the internet — to store and process data. The massive computing power required to develop nascent artificial intelligence breakthroughs are leading companies to seek more data centers.

Minnesota offers sales tax breaks for qualified data centers on purchases of computers, servers, software and cooling and energy equipment. This tax break, which comes in the form of a refund, is set to expire in 2042.

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Minnesota law currently allows qualified data centers a sales tax exemption on technology equipment for 20 years, up to the year 2042. But a proposal from Senate Democrats would extend the tax break to 40 years and sunset it at 2062. This means that a data center that makes its first purchase in 2062 could continue claiming the exemption until 2102.

Is it right to extend the break on the sales tax on purchases of “computers, servers, software, and cooling and energy equipment”? Is it wrong to end the exemption from sales tax of “the electricity that data centers consume”?

Sales tax 101

Economists generally prefer sales taxes to other methods of raising revenues. As Jared Walczak of the Tax Foundation writes in his 2024 paper, “Modernizing State Sales Taxes: A Policymakers’ Guide”:

Taxes on consumption are more economically efficient than taxes on income (though less efficient than taxes on real property), meaning they do less to distort economic decision-making; do less to reduce investment levels and labor force participation; and are less likely to adversely affect interstate migration. This holds true not just in the realm of an ideal consumption tax, but more importantly in the real-world case of the sales tax as it exists in US states, even though these taxes substantially depart from what public finance scholars would consider an “ideal” sales tax.

“[T]he ideal sales tax is a tax on final consumption,” Walczak continues:

Yet, to varying degrees, a substantial portion of the sales tax in each state falls on the factors of production instead. A tax on consumption is more pro-growth than an income tax, but a tax on production is worse than an income tax. In the real-world case of sales taxes that fall on both consumption and production, the analysis is dependent upon the preponderance of those burdens.

Listing “seven principles and observations [that] capture the broad consensus of public finance scholars who study sales taxation,” number two is, “An ideal sales tax exempts all intermediate transactions (business inputs) to avoid tax pyramiding and to avoid transforming it from a consumption tax to a tax on production or investment.”

Not only should we not be charging Minnesota’s data centers for their electricity, but we also shouldn’t be charging any of the state’s businesses for it. This bad decision is indicated by the fact that a self-employed person working from their home can deduct a portion of their electricity bill from their tax liability. And, beyond that, we shouldn’t be levying sales tax on business purchases of “computers, servers, software and cooling and energy equipment” either.

Walczak argues in favor of “sales tax base broadening to certain excluded goods and services (including newly arising digital products).” So do we, in theory. But we could not support Gov. Tim Walz’s recent proposal to shave 0.75 percent off the current state sales tax rate in exchange for a broader base because it represented a tax hike on already over-taxed Minnesotans. Cut the rate a bit more, and we’d be in business, which is more than can be said for some data centers.