The U.S. electricity sector is at a turning point where after nearly two decades of flat demand, electricity use is projected to surge over the next several years. A major reason is the growth of data centers for artificial intelligence (AI) and cloud computing. The country is on the road to build data centers quickly and at enormous scale. AI is a highly critical technology that will shape the future U.S. economy and its place in the world.

State and local government policies to attract data centers seem at odds with many locales opposing the building of new data centers. These policies are offering tax breaks and other inducements to lure data centers, while vocal groups are slamming data centers for various reasons, including their intensive use of land, electricity and water.

In my home state of New Mexico, there is an active and growing opposition to data center projects. For one proposed facility, Oracle’s Project Jupiter, opponents of the project raised concerns about electricity consumption and air pollution (especially since it will rely on natural-gas-fired microgrids), scarce water resources for cooling and inadequate public input.

There also is a political undercurrent from both the left and the right that raises questions on AI and the need for data centers, if only because they are owned by Silicon Valley billionaires. As stated in one article, “just like some Democrats are worried they’re ceding the anti-AI development lane to Republicans, the same is true on the other side.”

We see NIMBYism and corporate welfare at play simultaneously. Each action is misguided by either obstructing the building of new data centers or compelling taxpayers to subsidize them. One challenge is to facilitate the building of new data centers to accommodate AI. NIMBYism can either delay their construction and operation or, worst, terminate their construction. Corporate welfare, besides encouraging wasteful rent-seeking, redistributes wealth from taxpayers to owners of highly profitable data centers.

NIMBYism

Three general problems underlie the NIMBY syndrome. NIMBY projects are facilities that increase overall social welfare but inflict net costs (or at least perceived as such) on the citizens living in the host locality. Data centers seem to fall in this category.

First, the risk perceptions of local citizens may be distorted because of faulty information. Better education of citizens can mitigate this problem. While data centers may increase the price of electricity — which is a major concern of policymakers and activists opposed to data centers — this is not a sure outcome.

Proposals to address this potential problem are numerous and seem plausible if policymakers are willing to implement them. They include:

• • allowing data centers to purchase or produce electricity, free of regulation, from facilities off the grid;
  • requiring data centers to sign long-term contracts with utilities that include exit fees and minimum billing requirements;
  • reforming electricity tariffs to protect existing customers; and
  • requiring curtailments or time-of-use pricing of power for data centers during peak periods.

The second problem is that the siting/political process may not mirror a locality’s consensus. An active minority of opponents to a facility can dominate the preference of a more passive majority at town meetings or in referenda. This intervention can lead to a decision not representative of the majority preference in the community. The vocal group may be most affected by a facility or have ideological or self-interest reasons for opposing it. The group may perceive no benefits, for example, but only environmental, economic or safety threats from the facility.

The third problem is that the local benefits of a facility may fall short of the local costs. For example, the local area may suffer environmental costs and higher energy costs, while most of the benefits from cloud computing or AI accrue to other areas; a parallel example is the production of shale gas (that emits methane and threatens the local water quality) that benefits out-of-state consumers. Overall, a decision based on faulty information, a defective political process or disregard for out-of-area effects is likely to cause a NIMBY problem.

Corporate Welfare

Corporate welfare (sometimes pejoratively labeled “crony capitalism”) refers to government handouts and special protections granted to certain businesses to locate in a specific jurisdiction. Tax breaks, or as some observers call them tax incentives, have in particular become a popular device for state and local governments. Politicians, whether Democrats or Republicans, have relied on tax breaks to attract new businesses. Several states and locales have taxpayer-funded inducements for data centers.

Proponents argue that tax breaks are necessary to attract businesses and that their costs are offset by the additional tax revenue from increased economic activity. They claim that to compete with other jurisdictions, they need to offer tax breaks or businesses will go elsewhere.

Politicians see themselves entangled in a vicious cycle where they are competing with other jurisdictions to attract new businesses. They don’t want to appear indifferent to attracting businesses that can bring new jobs and other economic benefits.

What we have seen, with Amazon as a prime example (no pun intended), is jurisdictions driving up the tax breaks they are willing to pay to exorbitant levels. Analysts refer to this as the “race to the bottom.”

Studies have shown that these giveaways to businesses most times have little effect on their decision on where to locate. Recipients who receive tax breaks often use their political and economic clout to gain favors at the expense of their competitors and taxpayers. It is a classic example of special interests benefiting at the expense of the general public.

At first thought, it seems audacious for government officials to expect poor households and small, struggling businesses to apportion some of the taxes they pay to large, profitable businesses headquartered outside their state or locality (like Meta, Amazon, Microsoft and Goggle). But their behavior shows that they would rather chance a groundless handout than being perceived as anti-job and anti-business.

While governments offer handouts with the hope of realizing greater economic returns, companies often make promises to create jobs they fail to keep. Handouts often are no more than a zero-sum game where one jurisdiction benefits at the expense of another.

For many of them, the added revenue from the recipient business falls short of the tax break. While data centers employ many people during construction, relatively few employees operate the facilities. Their effect on local economic development arguably is minor.

Tax breaks are just as likely to result in perverse behavior and unintended consequences. They can shrink the tax base, shift tax burdens to other taxpayers or reduce public goods valued by the local citizenry.

Tax breaks also open the door to rent-seeking and corruption: Large companies threaten to locate elsewhere unless they receive special treatment and even “bribe” officials with campaign funds in exchange for favoritism.

Of course, one can imagine situations where a tax break could contribute to the economic well-being of the local or state citizenry net of the subsidy cost. But government officials should make that determination before offering tax breaks to any company.

What we frequently observe is the failure of government officials to provide the public with a transparent accounting of the actual costs of the tax breaks offered to businesses. Most states and localities neglect to fully disclose all the details of their “tax break” packages. A good argument can be made that they should either stamp out tax breaks to businesses or make government officials more accountable for their decisions. Their taxpayers deserve no less.

Redressing the Conflict

Real-world experiences have shown the importance of local participation in every aspect of the siting process (for example, economic, safety, environmental). Not only should local individuals or groups have the opportunity to participate, but government and industry should encourage them to do so.

Industry acts as a good citizen when responsive to the concerns of local people over a facility that can, or is perceived to, cause substantial harm. Education and public understanding are critical in subsiding opposition and fear and gaining support for a facility. Frequently, the fears are irrational; but the political reality remains that if the public is wary of a new facility in their locality, the owner will need to address those fears or face strong opposition.

One often-suggested remedy to the NIMBY syndrome is to shift jurisdiction to a less local authority, such as the state and federal government. Of course, that may have its own problems and should be used only as a last resort.

Instead of tax breaks, governments should create a good business climate with reasonable tax rates and regulations, and pro-growth public expenditures like for infrastructure development. States and locales can better satisfy this goal by broad-based tax cuts than by discriminatory and wasteful tax breaks where they play the role of picking winners and losers.

If governments continue to offer handouts to businesses, they should at least do a cost-benefit analysis. Experience has shown that public officials often understate the true costs of tax breaks and overstate the benefits, which should be no surprise.

For data centers, the two wrongs of NIMBYism and corporate welfare don’t make a right: They drive up the costs of data centers, delay or even terminate their construction, dampen the benefits to the economy from AI and cloud computing, and unfairly burden taxpayers. All of these outcomes will harm society, and for what purpose?

Kenneth W. Costello is a regulatory economist and independent consultant who resides in Santa Fe, N.M.