State proposals to tax digital services and data processing may seem aimed at big tech companies, but they actually raise prices on everyday items like groceries, according to a new analysis from the Tax Foundation. The report traces how digital services are embedded throughout the entire supply chain of a simple box of cereal—from seed development through checkout—showing that taxes on business digital services or data center equipment get passed along to consumers at every stage. Even products exempt from sales tax, like groceries in most states, can carry heavy hidden tax burdens when digital infrastructure is taxed.
The report walks through the digital supply chain of cereal production to illustrate how pervasive data processing has become in modern commerce. Seed companies rely on statistical modeling, satellite imagery, climate models, and cloud-based systems to compare crop varieties and provide customized recommendations. Farmers use farm management software that analyzes commodity prices, seed costs, and field performance to estimate profitability, while modern tractors and combine harvesters use GPS guidance, yield monitors, moisture sensors, and automated controls that sync to the cloud for processing. Crop monitoring involves digital platforms tracking rainfall, soil moisture, pests, and temperature to recommend irrigation and pesticide application, while commodity-pricing platforms help farmers decide when to sell. Grain processing plants use software to schedule runs, manage batches, and coordinate deliveries, with sensors generating operational data. Cereal manufacturers employ enterprise purchasing systems, production software, automated controls, and machine-vision systems for quality control, while digital systems track which ingredients are used in each batch for tracing purposes. Warehouse management software tracks pallets and directs inventory rotation, and grocery chains use software analyzing point-of-sale data, inventory, and sales patterns to decide which cereals to stock and at what price, with loyalty programs and digital coupons adding another layer of cloud-based data processing.
According to the report's author, Jared Walczak, "every time a sales, excise, or gross receipts tax is applied to business digital services, and every time the equipment used for those services is taxed, those taxes are embedded up and down the supply chain." The analysis finds that consumers pay more for their cereal even though no tax shows up on the receipt. The report warns that "a product that is nominally untaxed in most states—groceries are usually exempt from the sales tax—can easily embed a heavy tax burden because of taxes conceptualized as falling on 'big tech.'" Policymakers across the country are considering proposals that include extending sales tax to business digital services, imposing excise taxes on data collection, levying per-user or receipts-based taxes on digital activity, or denying data centers ordinary sales tax exemptions for production equipment.
The report explains that these tax proposals stem from skepticism of "big tech" and data processing, which lawmakers often contrast with "traditional" businesses. But when states tax data processing or levy new taxes on the inputs of data processing, "they aren't just taxing big tech companies; they're taxing virtually everything, because digital services are so embedded in how we live and how businesses operate." The analysis demonstrates this through the cereal example, showing digital automated services power not just internet services or AI, but farm equipment, grain elevators, trucking logistics, factory sensors, warehouse robotics, and checkout scanners. Each layer of taxation on these digital services creates what economists call "tax pyramiding"—taxes stacking on top of taxes at each stage of production—which ultimately gets passed to consumers as higher prices.
The report's bottom line is clear: if lawmakers fail to consider how deeply digital services are woven into supply chains when they contemplate new taxes on data processing or data center equipment, they'll end up taxing groceries and just about everything else from production to purchase. What looks like a targeted tax on tech giants becomes a hidden consumption tax on families buying cereal.