Did Pritzker have the right to halt Illinois’ data center tax credit?
The governor halted the credit via press release after lawmakers declined to do so.
When the Illinois General Assembly returns, Gov. J.B. Pritzker wants lawmakers to grant new regulatory authority over data centers, though some proposed requirements match what most data center operators already do, like covering the cost of expanding the energy grid.
Pritzker presented the so-called POWER Act as building on his earlier decision to pause sales tax exemptions for data centers, which, he correctly notes, “means for a lot of them, that they’ve got to either slow down or stop.”
In early June, Pritzker unveiled a new instrument of governance: He modified the state sales tax by press release. The governor’s unilateral suspension of a statutory exemption, exposing future data centers (but no other industries) to sales tax on their equipment purchases, is both economically and legally dubious.
The sales tax is intended as a tax on final consumer purchases. Including intermediate transactions turns it into a tax on in-state production and can lead to tax pyramiding, where the same good or service is taxed multiple times before final sale. Given that digital automated services are embedded in virtually every stage of production for everything we buy, if states levy sales tax on the inputs to data processing, that can raise prices economywide.
No state’s sales tax completely exempts intermediate transactions, even though public finance scholars are almost unanimously in favor of doing so. But states almost always draw a couple of bright lines: They don’t tax raw materials, and they don’t tax machinery and equipment used in production. Sales tax isn’t imposed on machinery or equipment used in manufacturing, agriculture, energy generation, mining or other production activities. That extends to computer equipment used in these operations.
Data centers did not fit cleanly into any existing category, even though their equipment (servers, chillers, electrical equipment, etc.) is also used in production. States remedied this omission beginning about two decades ago, with the shift from self-hosted data processing to cloud-based data center usage.
Whereas sales tax exemptions for other classes of equipment were provided by right, most states structured their data center equipment exemptions as incentives. Economic development authorities were eager to attract data centers, and offering a perfectly ordinary sales tax exemption as an “incentive” allowed states to boast of their success at attracting data center investment. The incentive structure produced announcements and ribbon cuttings.
Today, however, channeling this ordinary and necessary exemption through an incentive structure makes it seem like preferential treatment, and policymakers in a growing number of states are beginning to treat it that way. Against this backdrop, Pritzker announced in June that he was directing the Department of Commerce and Economic Opportunity (DCEO) to stop processing agreements under the Data Center Investment Program as of July 1, effectively denying the sales tax exemption for new data center projects.
Pritzker’s directive, notably, is not an executive order or regulation. It is merely a press release.
In fact, Pritzker accomplished by press release what he failed to secure in his own budget. The governor had proposed a data center pause, but the legislature rejected it. Bills to pause the exemption also failed. House Speaker Chris Welch (D-Hillside) told Capitol News Illinois that pausing the data center credits didn’t have enough Democratic caucus support to pass, saying “not only did it struggle, it wasn’t even close.” Thwarted legislatively, the governor waited until session adjourned and then announced by fiat what the legislature rejected.
State law stipulates that the DCEO “shall issue certificates of exemption” to qualifying data centers. Eligibility is determined by objective criteria, including at least $250 million in capital investment, project labor agreements and green building requirements. The department has some limited procedural discretion in processing applications, but under state law, exemption issuance is mandatory for any qualified data center.
Illinois courts have affirmed a mandatory interpretation of “shall” when a business meets statutory eligibility standards. In 2003, the Illinois Appellate Court ruled that a law dictating that the state’s gaming board “shall grant” an application once conditions were met meant that the board lacked discretion and could not refuse an applicant that satisfied the statutory conditions.
The DCEO’s implementing rules for the data center program also make clear that applications for the sales tax exemption “will be accepted at any time during the year” and that applicants “shall be notified in writing” about the department’s review of their eligibility, with administrative hearing rights if the department concludes that the applicant did not meet the eligibility requirements. Neither the law nor the regulations provide any authority to deny the applications, or to achieve the same result by refusing to process them. The regulations have not been altered, and the underlying law has not been amended.
Illinois has no good answer to how a press release can suspend the execution of state law adopted by the legislature and agency regulations that went through a formal rulemaking process, and Illinois courts have looked unkindly on policymaking outside these channels even when it does not suspend existing law, which is what the governor has done here.
It is not enough to lean on executive authority over the processing of applications. The governor and the DCEO announced a categorical and indefinite suspension of the program. Couching this in language of (indefinite) changes in processing time is insufficient.
Illinois is not alone in pausing the issuance of exemption certificates for data centers. Arizona adopted a three-year moratorium on data center sales tax exemptions in this year’s budget. In Ohio, where grants of exemptions to data centers were always discretionary by law, the governor announced a pause similar to the one in Illinois, which violates the spirit of the law but less clearly violates its letter. Most recently, the governor of Nebraska issued an executive order framed as a pause. The order directs the issuing agency to take a skeptical approach in determining whether future exemptions are consistent with the incentive program’s purpose, which is an existing statutory condition for issuance.
Arizona’s pause, while economically shortsighted, was accomplished legislatively. In Nebraska and Ohio, governors at least arguably had the legal authority to implement the policies by executive order. Illinois law allows no such discretion.
The Illinois legislature objected eliminating the exemption but did support a July 1, 2029, sunset, allowing an opportunity to evaluate it further. This provision was in digital advertising tax legislation that Pritzker signed 11 days after announcing his moratorium. Sunsetting incentives to allow for evaluation is common, and most incentives are extended. While sunsets indicate that the legislature believes the issue deserves further debate, what’s particularly notable is that Pritzker signed legislation clearly reinforcing the “shall issue” requirement for at least three more years, while also establishing a pause that tries to run out the clock.
Because data centers are capital-intensive and their servers must be replaced regularly, imposing sales tax on their equipment can make it unprofitable for many to operate in Illinois. The governor was right to say that his unilateral sales tax action means many data centers must “either slow down or stop.”
Singling out a specific industry’s equipment for discriminatory treatment is bad policy. Taxing business inputs is poor economics. And subverting statutory requirements by press release is not just wrong on its merits but sends a signal to every business considering investing in Illinois that it’s always at risk of discriminatory treatment by gubernatorial decree.