Some KY schools and local governments eye a data center tax windfall. A think tank sees loopholes.

In some Kentucky communities where hyperscale data centers are being proposed, leaders in local governments and school districts are eyeing a potential tax windfall that they hope could lead to transformative investments back in their communities. 

In the small Mercer County city of Burgin, a school board member for the city’s school district argued a proposed data center there could bring in hundreds of millions of dollars in local taxes over 15 years. 

In Hancock County, the local judge-executive believes a planned data center could bring “material local tax revenues” estimated by the developer to be over $22 million during the first year of operation. Broadly, advocates for data centers point to communities across the country that have reaped local tax benefits, through property taxes and otherwise, because of having these power-intensive operations. 

But one progressive think tank worries there could be long-existing tax breaks in Kentucky law that data center developers could exploit to avoid paying those local taxes.

“I think there’s a huge risk that communities will take what they’re being told about the local tax benefits, but that those benefits end up being mostly taken away by a court,” said Jason Bailey, the executive director of the Berea-based Kentucky Center for Economic Policy. 

In an early August analysis, Bailey and the think tank’s senior policy director Pam Thomas point to a recent series of blog posts by Louisville tax attorney Mark Sommer, who writes that data center developers could argue the operations qualify as “manufacturing” or “industrial processing” under state law. Sommer has represented a company proposing a data center campus in seeking a legal opinion from Kentucky Attorney General Russell Coleman.

In a text message Tuesday, Sommer said he was not available to respond to a Lantern request seeking commentary about the think tank’s concerns. 

Bailey said if a developer is able to successfully gain that classification under state law, then the developer could “dramatically reduce the taxes that a data center pays.” He said whether a data center developer can successfully argue that classification may end up in court, a legal question that the state legislature could grapple with in the future.

The local taxes in question are primarily two-fold: the utility excise tax on electricity sales that goes to almost all school districts, usually levied at 3% of electricity sales of an operation, and property taxes that go toward the school district and the local government. 

For example, under state law, if a person is “engaged in manufacturing or industrial processing”, then energy for that operation is not included among the revenue collected for the utility tax going toward school districts. Also under state law, manufacturing “machinery” is also exempt from local property taxes. 

In a July blog post, Sommer wrote data centers could qualify for tax breaks as a manufacturer. He pointed to laws passed by the state legislature providing tax breaks for cryptocurrency mining operations and the legal opinion he sought from the attorney general to argue that data centers make a “product” and “process” data and digital property. Therefore, data centers should also qualify for the tax breaks that manufacturers receive.  

Bailey and Thomas also worry that industrial revenue bonds granted by local governments could also be an avenue for data center developers to avoid paying local property taxes. Bailey and Thomas wrote that local governments, often counties, buy the property of a developer with such bonds and lease it back to the developer, thereby eliminating property taxes because the property is technically owned by the government. 

Bipartisan backlash

But Bailey said the political realities of local governments giving bonds for data centers amid a bipartisan backlash against data center construction make it unlikely that it’ll happen. At least one data center developer in Kentucky TeraWulf says it is also committing to paying its “fair share” of state and local taxes following an executive order by Gov. Andy Beshear that directed data center developers to do so.

An interview request sent Tuesday to TeraWulf through their website was not returned. 

The executive director of an association representing school superintendents told the Lantern his group would support lawmakers clarifying whether data centers qualify for tax breaks allowed for manufacturers. 

“We do think those need to be clarified so that everyone has kind of a transparent understanding of what those are moving forward so that there’s no surprises,” said Jim Flynn, executive director of the Kentucky Association of School Superintendents. “Most of us that have been involved in this have seen various economic development projects come into a community, have seen situations where what was promised might not be delivered. And you want these things to be you know as clear as possible.” 

Some Kentucky lawmakers have also suggested rolling back a specific sales tax break for data centers passed in recent years by the state legislature. Late last month, Beshear said he didn’t believe data centers needed incentives and would support “rolling back any of that.”

Despite the political opposition surrounding data centers, Bailey said the manufacturing and industrial processing exemptions is a local tax “loophole that you could drive a Mack truck through.” 

“As long as it remains unclosed, there’s a huge question about the local tax benefits of data centers,” Bailey said. “Any momentum among elected officials toward rolling back the tax incentives for data centers should also, and must also include, closing this loophole to prevent even more tax breaks.”