California Needs AI. So Why Is It Making Data Centers Harder to Build?

The state depends on AI-driven tax revenue, jobs, and economic growth while lawmakers pile new regulations onto the data centers needed to power the industry.

In its analysis of the state budget late last year, the Legislative Analyst’s Office warned that California’s “income tax, fueled by exuberance over Artificial Intelligence (AI), remains [the] lone bright spot” in the California fiscal picture. Noting economic headwinds, along with a budget-balancing act that’s dependent on borrowing and fiscal reserves, the nonpartisan LAO found that tax collections here “are being driven by enthusiasm around AI.”

Our state, by the way, is home to 32 of the world’s top 50 AI companies — and our capital-gains-dependent tax system means their success is crucial to fund the California Legislature’s ever-expanding appetite for funding new social programs. “AI is already changing the world, and California will play a pivotal role in defining that future,” boasts a statement from Gov. Gavin Newsom’s office. In fairness, Newsom has taken a relatively light touch on AI regulations, sticking mainly to regulating deep fakes and setting guidelines on government procurement.

Yet the likely next governor, Democrat Xavier Becerra, recently complained at a Sacramento Politico summit that “we hardly have any” AI regulations, vowed to “enforce and strengthen” the rules we do have, and called for “real guardrails” on AI technology. We’ll see what that means in the next legislative session, but for now lawmakers are targeting AI companies where it hurts: at their ability to build data centers and tap into the electricity needed to power them.

California has avoided some of the big data-center battles that we’ve seen in, say, Wisconsin and Texas, but mainly because the tech firms have proposed a fewer number of them here. Nevertheless, one company has proposed plans for eight new data centers, including on some public sites, in the San Francisco Bay Area alone. Local officials reportedly are receptive to the idea given that region’s dependence on the AI economy.

But as the state Legislature sprints toward the finish line, lawmakers just can’t restrain themselves from meddling in the industry. Two major bills are advancing with strong support. Senate Bill 886 “requires the California Public Utilities Commission (CPUC) to establish tariffs that address costs associated with transmission, distribution, generation, and interconnection services for data centers.” Basically, lawmakers are claiming the expansion of such centers will cause other customers’ rates to rise — and the goal is make sure they pay their own way.

That sounds reasonable, of course. As the committee analysis explains, “[T]he clustering of data centers in specific regions (like the Bay Area) can strain local transmission capacity and necessitate costly upgrades for new service lines, raising broader questions of who pays for these upgrades and how to properly plan for these incoming loads.” A related bill, Senate Bill 887, would provide permitting streamlining — specifically, exemptions from the cumbersome California Environmental Quality Act (CEQA) process — for companies that rely totally on “clean energy” within five years.

The latter bill is inconsequential, as centers can presumably ignore those requirements by getting approvals in the usual, albeit time-consuming way. But SB 886 really could throw a wrench in the works of new data-center development by adding myriad regulatory requirements to achieve goals that, as the California Chamber of Commerce explains, already are being met: “The California Public Utilities Commission (CPUC), through its Energy Division, actively reviews and approves large-load interconnection requests to ensure that new customers bear the costs they cause.”

The biggest problem perhaps, per the Chamber, is the bill forces “data center customers to prefund long-term contracts of at least 15 years for new zero-carbon energy resources.… While intended to provide certainty for load-serving entities, these requirements introduce significant challenges for project development and financing. Many  data center customers operate in sectors where demand projections, technology needs, and business models evolve rapidly.”

The bill would create an even more bureaucratic rate structure — complete with input from “stakeholders” — that will impose “rigid statutory mandates that increase project cost and uncertainty, undermines regulatory flexibility, and sends a negative policy signal to large-load investments California must attract to help put downward pressure on utility rates and drive future  economic growth.” It typifies California’s government-heavy approach to any new industry, which is astounding when it applies to industries it relies upon to fund its massive budget.

Even stranger, California continues to push its businesses and residents to rely more on electricity as the state transitions, however clumsily, to a non-carbon future. It mainly needs to incentivize electricity generation so that it can meet its future electricity needs. The state continues to fall short and power bills continue to surge. California lawmakers had previously fretted about data-center water usage, but the solution is to permit more water projects. Likewise with electricity. (And the state needs to figure out how to better assess liability on utilities when their equipment sparks wildfires.)

Here’s the kicker on SB 886: The creation of data centers might actually reduce rates for consumers and businesses. The state’s regulated utility system has enormous fixed costs to pay for electricity generation. As more Californians have taken advantage of net-energy metering — a system that allows them to exit the grid and rely on rooftop solar panels — utilities have warned of a death spiral. The more people who leave the system, the higher the rates on remaining customers to pay for those stranded costs. That incentivizes even more people to go solar. Hence, the spiral.

But, per a Canary Media report, “PG&E says that load growth will create billions of dollars in tax revenue and — more important to its customers — lower electric bills by 10 percent or more ​“by spreading fixed costs across more energy usage.” A report last month from my R Street Institute colleague, energy expert Josiah Neeley, confirms that point:

While you might expect that an increase in demand for electricity from data centers would raise electricity prices, the relationship has been just the opposite. Increasing electricity demand has gone hand in hand with lower electricity prices, and a doubling of data center capacity has been estimated to reduce residential electric rates by 4 percent.

Other opponents note that it’s wrong to single out one source of electrical use given that data centers aren’t the only large users of electricity. But the fundamental questions remain: Does California want more data centers or not? Do we want to power the industry that is powering our economy and propping up our budget? Do we want the good-paying jobs that come along with the AI industry?

If California wants to keep its AI servers humming, state officials shouldn’t hobble the construction of data centers — even if it’s the latest social panic. But of course California lawmakers can’t seem to accept a world of trade-offs.