Arizona Lured Data Centers With Tax Breaks and Cheap Water—Now, It’s Payback Time

Arizona wants to make the “cloud” pay for life in the desert. 

In her latest budget push, Gov. Katie Hobbs is proposing to charge data centers more for the water they use while eliminating the state’s data center tax exemptions, arguing that Arizona can’t keep subsidizing a booming industry while residents face rising bills and tighter water limits.

Hobbs’ argument hinges on a stark comparison: The average Arizona household effectively pays about 1 cent per gallon for water used at home. If data centers paid the same amount, she says, the state could make a multimillion-dollar deposit every year into a new Colorado River Protection Fund meant to “supercharge” conservation and protect the state’s long-term water supply.

The timing is pointed. Hobbs is expected to meet with President Donald Trump tomorrow as Arizona and the other Colorado River Basin states race to reshape the rules that govern the river in negotiations that could determine how much water fast-growing metro areas like Phoenix can reliably count on in the years ahead.

That could have huge implications for the future of affordability in a state that has effectively sold itself as the cheaper, just-as-nice-minus-the-ocean, alternative to California. Earlier this week, Brett Fleck, a water resources adviser for the city of Peoria, told Realtor.com® that he expects “water and wastewater bills to go up faster than the rate of inflation for the foreseeable future.”

And now, Hobbs, who is up for reelection in November, is reading the room.

Once the darling of economic development officials, data centers are increasingly drawing local backlash over water use and sustainability. In December, the Chandler City Council unanimously rejected a rezoning request for a proposed data center that would have used more than 17.75 million gallons of water a year—roughly the equivalent of 160 homes.

‘The Arizona promise’

Hobbs framed her pitch as a question of what Arizona owes its next century of residents. In her State of the State address, she invoked the late Sen. Barry Goldwater’s vision of Arizona as a place where “initiative” is rewarded and hard work has an upside.

From there, she tied that “Arizona promise” to a practical reality: Growth only works if the basics keep working, too. The state, she argued, is trying to thread a needle—build more homes, keep the economy expanding, and protect a water supply that hangs in limbo.

But the price tag for that stability is rising.

“It’s time we make the booming data center industry work for the people of our state, rather than the other way around. ... We must ask ourselves: Should taxpayers continue subsidizing the data center industry?" she said.

“I know my answer,” she continued. “My executive budget will eliminate the Data Center Tax Exemption, putting an end to a $38 million corporate handout.”

Behind the ‘$38 million corporate handout’

If Hobbs’ “fair share” pitch is about who pays to protect Arizona’s water future, the next question is why one of the state’s fastest-growing industries has been treated like it shouldn’t pay much at all.

Nationally, data centers have become one of the most heavily subsidized sectors in state tax codes. At least 10 states already forgo more than $100 million a year in revenue because of data center–specific sales and use tax exemptions, according to research from Good Jobs First, a national policy resource center. In Arizona, they estimate that the cost of these subsidies has grown by 1,000% in recent years.

In a pitch to potential clients, Aligned Data Centers highlights Arizona’s tax advantages as a core reason to build in metro Phoenix, including a 20-year sales tax exemption on equipment purchases, which it says can translate into millions in savings over the life of a data center contract.

The marketing campaign has yielded staggering results. Phoenix has become a major data center hub, with Data Center Map listing 167 data centers in Phoenix—a proxy for the sheer concentration of facilities and the momentum behind the boom.

But as those facilities multiplied around the valley, so too has their water footprint. The Goodyear Microsoft Data Center alone is estimated to use as much water as 670 of the town’s households.

It’s a tension that Hobbs is trying to sharpen: How can Arizona argue for shared sacrifice if one of its biggest growth industries has been structured not to share the bill?

Industry pushback

Not everyone is on board with Hobbs’ pivot. 

This week, a coalition of 65 Arizona business and industry leaders released an open letter pushing back on her “corporate handout” framing, warning lawmakers against moves that could make Arizona less competitive for an industry they argue is now deeply embedded in the state’s growth engine.

For one, they argue, data centers are a valuable commercial property sector, and—unlike some boom-and-bust industries—can provide cities and counties with a large, predictable tax base over time.

That’s an important draw in a state wrestling with affordability. Predictable revenue is one of the few levers local governments can pull without waiting on federal programs or one-off grants. And there’s already a playbook for leveraging that predictable tax revenue into more affordable housing, another one of Hobbs’ main focus areas. 

Henrico County, VA, seeded an Affordable Housing Trust Fund with data center-driven tax revenues and uses the money to directly reduce the purchase price of newly built homes. The fund is projected to bring 150 new homes to market per year for moderate-income buyers earning between 60% and 120% of the area's median income.

One of the letter’s co-authors, Anita Verma-Lallian, told Realtor.com earlier this week that affordability like that is one of Arizona’s biggest draws.

“People are chasing affordability,” she said. “In Arizona, you can get a newer home, more space, and a lower overall cost than in most California markets. Taxes and day-to-day living costs matter, too. Even when salaries are similar, households just feel less stretched financially, which makes a big difference.”

Verma-Lallian and her cosigners don’t see data centers in competition with that affordability, but rather an important piece of it. They argue that data centers often use land on underutilized parcels and help finance major utility and infrastructure upgrades.

They also have a simple political reality on their side: Once incentives are in place, they’re hard to unwind. In Arizona, even critics acknowledge repeal is an uphill climb (it requires a two-thirds supermajority), and other states’ attempts to rein in data-center perks have often run into fierce lobbying pressure.

Hobbs' proposal and industry pushback still leaves an important question unanswered: If data centers are going to be a permanent part of Arizona’s growth story, what are they contributing in return?