Senator Moreno’s 100% Federal Tax on Data Center Incentives Would Usurp Sound State Sales Tax Policies

Sen. Bernie Moreno’s (R-OH) RECLAIM Act (S. 5689) would impose a 100 percent federal taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on any state or local “incentive” received by a large AI data center. By our reading, the proposal would “top up” the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.  on data center servers and chips in the states that exempt them by imposing a federal tax equal to the exemption amount. We expect that, generally, the state would respond by imposing the tax itself, thereby collecting the revenue the federal government otherwise would collect (the “top up” logic is thus very similar to global minimum taxation).

This “top up” tax on exemptions usurps sound state sales tax policies. State sales tax exemptions for data center inputs are not subsidies or incentives: a sales tax is meant to fall on final consumption, and thus provisions that remove business inputs like servers from the base are integral to a well-designed sales tax. We estimate at least 31 states would be affected by the proposal. (Some states, like Ohio, have paused new exemptions; we therefore count them as already taxing these investments, though exemptions already granted would still be affected by the proposal.)

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What Would the Proposed RECLAIM Act Do?

The proposal would impose a tax “equal to 100 percent of the amount of any prohibited State or local incentive received by the data center operator.” The tax would apply only to “covered data centers,” which are certain large AI-focused facilities. The bill also has a federal component, which would affect data centers’ federal tax treatment.

A face-value reading of the bill suggests its effects may reach far beyond state sales tax exemptions. Indeed, as written, the bill could turn the income tax on a covered data center into something closer to a tax on gross receipts. Prohibited state or local incentives include “any state or local grant, loan, loan guarantee, cooperative agreement, tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income rather than the taxpayer’s tax bill directly. or deduction, exclusion, exemption, abatement” in addition to other state or local incentives.  This broad language could include denying deductions for business inputs, such as the usual deductions for wages and capital depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and disco. If this is not the policy intent, the proposal should make clear which types of deductions or exemptions are not covered by the policy.

In public statements, the bill’s sponsor appears clear about his intent. “Taxpayers will not subsidize data centers, period,” Sen. Moreno said in the press release announcing the bill, which further says the bill would tax “any state or local grant or tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax.” that hyperscalers use for data centers. Before introducing the bill, Sen. Moreno had singled out a sales tax exemption on equipment, calling the exemption a “$4.5 million subsidy.”

The bill thus counts exempting business equipment from the sales tax as a special incentive, and if enacted, it would top up the sales tax in many states that provide these exemptions.

Which States Would Be Topped Up?

Our analysis relies on a recent state-by-state survey for the National Taxpayers Union by Tax Foundation’s Jared Walczak, whose classification shows 31 states exempt data center equipment only through conditional or discretionary programs. These are the clearest cases, since these policies are clearly an “exemption . . . for the development or commercial operations of a covered data center,” as described in the proposal.

Two states we assess as less certain, because their policies are structured closer to a by-right exemption, which makes it unclear whether they would be interpreted as incentives under the proposed law.

The remaining 18 jurisdictions would face no top-up (at least on new projects). California, New Jersey, and 11 others (including the District of Columbia) already tax data center equipment at full rates, so there is no exemption to tax. Oregon and four other states have no sales tax at all.

Exempting Business Inputs from State Sales Tax Is Not a Subsidy

A retail sales tax is meant to fall on final consumption once. A well-designed sales tax exempts all intermediate business inputs. If the sales tax is instead imposed on business inputs, the tax is built into the price of whatever those inputs produce and then taxed again at the next sale, which economists call tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action.. Tax neutrality is lost, as the total sales tax rate depends on the structure of the supply chain. Tax transparency is lost, as the tax the consumer ultimately pays varies across goods in unobservable ways.

Data center equipment is a business input just like any other. Most states already accept the principle for factories, with 41 exempting manufacturing machinery and equipment by right. What makes data center exemptions look like favors is their legal form only: in most states, data center equipment escapes the sales tax only through special policies. That legal form is irrelevant to the economic point that these exemptions should be applied broadly on business inputs.

Indeed, Tax Foundation’s latest State Tax Competitiveness Index scores states more highly when they exempt data center equipment from sales tax, calling such purchases “a business-to-business transaction that should rightly be exempted along with other business inputs.” By focusing on legal form, the RECLAIM proposal would counteract states’ attempts to adopt sound sales tax treatment for these business inputs.

A Sales Tax on Equipment Is a Negative Investment Tax Credit, Translating into a Very High Tax Rate on Fast-Depreciating Chips

As an elegant economic analogy, a sales tax on equipment is a uniform negative investment tax credit: while an investment tax credit at rate  cuts the price of a machine by  percent, a sales tax at rate  raises it by  percent. In 1976, the economist Emil Sunley showed that a uniform investment tax credit is not neutral across asset lives: it favors short-lived assets, which get the credit much more frequently—every time they are repurchased after wearing out or becoming obsolete—than long-lived assets. A uniform sales tax is the mirror image. Consequently, the sales tax can translate into a very high effective tax burden on short-lived assets.

This is especially relevant for data centers. The chips used in data centers wear out or become obsolete very quickly. A 7.5 percent sales tax might sound like a modest tax rate, but when it’s paid again every few years, it translates into a very high effective rate.

In 1978, the economist David Bradford, extending Sunley’s work, derived the pre-tax return (net of depreciation) an asset must earn when it receives an investment tax credit. We apply his formula (page 291, equation 9) to study the sales tax by treating it as a negative investment tax credit and convert the estimate into a marginal effective tax rate.

To illustrate, at a typical sales tax rate of 7.5 percent, a 5 percent real required return, and a short asset life (an annual depreciation rate of one-third, corresponding to replacement every 3 to 6 years assuming that a third to a seventh of the asset value remains at retirement, respectively), the sales tax alone amounts to a marginal effective tax rate of about 37 percent on the return on a chip. For comparison, CBO estimates that federal taxes impose a marginal effective tax rate of about 4 percent on new investment in equipment in 2026, now that the 2025 One Big Beautiful Bill Act allows full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.; under prior law, with 20 percent bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs., the rate would have been about 16 percent.

Tax Neutrality and Federalism

The RECLAIM proposal is broader than a top-up tax for state sales tax exemptions. For example, it also tops up data center property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. abatements, which are in many cases non-neutral tax subsidies that are difficult to justify. Whether the federal government should intervene in such cases of non-neutral special treatment is a question of fiscal federalism. The state sales tax exemptions on data center equipment inputs are, however, not special tax incentives, and usurping them would be overturning sound tax policy.

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