Which states are pausing data center tax incentives—and why

Arizona has become one of the latest states to pull back from tax breaks for data centers, freezing new state tax incentives for three years as lawmakers reassess whether subsidies created more than a decade ago still make sense in the age of AI.

The three-year suspension, included in the state budget that took effect July 1, applies to new applications and renewals for Arizona’s data center tax exemption program.

Governor Katie Hobbs said the pause is intended to give the state time to craft a new policy for an industry that has grown rapidly while raising concerns about groundwater use, utility strain and whether residents should be asked to help subsidize large technology companies.

“Nobody’s talking about a moratorium on data centers themselves,” Hobbs told ABC15. “There are places where they make sense, where they provide economic opportunity and where they’re not sucking the groundwater and overtaxing the utilities.”

Arizona Freezes New Tax Breaks

Arizona first adopted its data center tax incentives in 2013, when the state was trying to attract more technology investment. Hobbs, then a state senator, voted for the program, but has since argued that the market has changed substantially, saying, during her state-of-the-state address in January, that “Now, Arizona is a national leader in this sector. We must ask ourselves: Should taxpayers continue subsidizing the data center industry?“

According to a 2026 report published by the Pew Research Center, Arizona ranks among the top 10 states for data centers, with nearly 98 facilities operating and 86 planned or under construction.

The governor had initially sought to repeal the incentives entirely, but the three-year freeze emerged as a compromise in budget negotiations. ABC15 reported that Hobbs’ office estimated the pause would save about $57 million, while Democratic lawmakers argued that money could be better used for priorities such as childcare support.

The switch comes after locals pushed back on major projects, including Project Baccara, a proposed data center complex in Maricopa County that would include two data centers and a gas power plant.

Residents, quoted by ABC15, raised concerns about water use, environmental impacts, and whether local communities would bear infrastructure costs tied to the development, with one saying, “We’re going to end up helping pay for it, and I don’t think that the community should.”

Other States Are Reconsidering Incentives

Arizona is part of a broader shift. The National Conference of State Legislatures (NCSL) said that 38 states currently offer dedicated data center incentives. In 2026 legislative sessions, the NCSL reported that lawmakers in at least 28 of those states introduced proposals to substantially amend existing tax breaks, often by adding “guardrails” intended to control costs or manage energy demand.

According to NCSL, at least nine states have considered fully repealing their data center tax incentives. In its April summary, it specifically named Arizona, Connecticut, Georgia, Maryland, Michigan, Pennsylvania, and Virginia among states that considered measures to end the tax breaks.

Other states have taken different approaches:

• Georgia: Lawmakers and regulators faced growing questions about the state’s data center incentive program after updated projections showed data center sales-tax exemptions could cost $2.5 billion in fiscal year 2026, 664 percent more than previous estimates.

• Connecticut, Georgia and Washington: NCSL said lawmakers advanced “off-ramp” proposals that would restrict future eligibility for data center incentives rather than immediately terminate the programs.

• Pennsylvania and New Jersey: Lawmakers have considered adding prevailing-wage requirements for data center construction, meaning projects could lose tax benefits if contractors fail to meet wage standards, according to NCSL.

• Minnesota: NCSL reported that, in June, the state removed the sales-tax exemption previously available to large data centers and created a new annual fee based on energy use.

• New York: Senate Bill S8546 proposed requiring large data centers to pay a fee based on their electricity consumption, with the revenue used to fund upgrades aimed at improving the reliability of the power grid.

Why States Are Pulling Back

The backlash seems to be largely driven by three main concerns:

• Infrastructure costs, particularly the impact on electricity grids and utility bills
• Environmental strain, including water use and energy consumption
• The fiscal cost of incentives, or the tax revenue states forgo through subsidies and tax breaks for data centers

Data centers can require enormous amounts of electricity, particularly as AI workloads increase demand for computing power. NCSL reported that data centers are viewed as a major driver of rising energy demand, and said that just one large facility can use as much energy as 10,000 homes.

Water is another worry, especially in states such as Arizona, where long-term drought and Colorado River supply concerns are already dominating policy debates. Hobbs has specifically said that Arizona needs policies to make sure data centers use water efficiently and sustainably without taking resources away from other critical uses. In an interview with local radio station KTAR News, she said: “We have to make sure that data centers are utilizing water efficiently and sustainably and not taking it away from the other uses that are as critical.”

There is also growing skepticism over whether tax breaks deliver enough public benefit.

Supporters argue that data centers bring investment, construction work, and local tax revenue. Critics counter that facilities often create relatively few permanent jobs compared with the size of the subsidy, while shifting power, water, and infrastructure costs onto nearby residents and ratepayers.

What Could Happen Next

The next phase is unlikely to be a nationwide rejection of data centers.

Demand for AI, cloud computing and digital infrastructure is still rising, and many states continue to view these projects as economic development opportunities.

But the policy model appears to be changing. Instead of open-ended tax exemptions, states may increasingly require data centers to meet stricter conditions, such as paying for grid upgrades, providing access to clean energy, disclosing water usage, meeting wage standards, limiting noise and emissions, or contributing fees to offset public costs.

Arizona’s three-year pause gives lawmakers time to decide whether to permanently narrow, restructure or stop the state’s incentive altogether.

Other states may watch how this goes closely. If the freeze doesn’t stop projects from moving forward, it could strengthen arguments that data center subsidies are no longer needed.

If investment slows or shifts to competing states, industry groups may use Arizona as a warning about the risks of policy uncertainty.

For now, Arizona’s decision signals a broader political shift: States are no longer just asking how to attract data centers. They are asking who pays for them.

Contact Newsweek editors on this story: Ben Kelly and James Debens