Approximately 45 years have elapsed since any U.S. state completely abolished its income tax on wages and salaries. However, recent legislative moves in Mississippi and Kentucky have placed these states on a trajectory towards eliminating income taxes, contingent upon their continued economic growth.
These endeavors signify the most assertive phase of a wider tax reduction trend that has emerged across numerous states. This trend gained momentum as states recovered from the economic repercussions of the COVID-19 pandemic, witnessing a surge in revenues that led to historic budget surpluses.
However, the drive toward lowering income taxes is occurring amid increased uncertainty for states. Factors such as potential reductions in federal funding due to potential policy changes and the overall economic climate have contributed to this sense of unpredictability.
Fiscal analysts warn that abolishing income taxes might increase states’ dependency on alternative taxes, such as sales taxes, which can disproportionately impact lower-income individuals.
**Which states impose income tax?**
Most states in the U.S. have established their own income taxes since the ratification of the 16th Amendment to the U.S. Constitution in 1913, which bestowed Congress with the authority to levy income taxes. Currently, eight states do not impose a personal income tax, namely: Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, and Wyoming. Washington state also does not tax personal income on wages but does tax certain investment income beyond a specific threshold.
Alaska repealed its personal income tax back in 1980, taking advantage of substantial revenues generated from oil profits. Other states have considered similar measures but have not succeeded in implementing them.
Katherine Loughead from the Tax Foundation highlights the challenge states face in eliminating long-standing income taxes, noting that it is much more feasible never to impose an income tax than to rely on one and later attempt to remove it.
**Mississippi’s Approach**
Mississippi’s Republican Governor, Tate Reeves, has recently enacted a law designed to gradually reduce the state’s income tax rate over the next decade. Under this legislation, the tax rate will fall from 4% to 3% by 2030, with state revenue growth milestones potentially instigating further reductions until the tax is completely abolished. Additionally, the law reduces sales tax on groceries and increases the gas tax.
Should Mississippi’s financial benchmarks and revenue triggers remain on track, the state’s income tax could be entirely absent by 2040. Proponents of the repeal argue that it could draw businesses and individuals, bolstering Mississippi’s economy to be comparable to that of states like Florida and Texas. They propose that with less income tax, consumer spending would surge, thereby increasing sales tax revenue.
Governor Reeves expressed enthusiasm, stating the potential for Mississippi to become a hub of opportunity and economic growth. However, given its reliance on federal funding, some Democrats caution against potential fiscal crises if federal funding decreases align with state tax cuts. Neva Butkus, from the Institute on Taxation and Economic Policy, emphasized the role of income tax in financing essential state services like education and healthcare.
**Kentucky’s Strategy**
In Kentucky, a 2022 law decreased the income tax rate, with further cuts contingent on meeting certain fiscal benchmarks. Unlike Mississippi, Kentucky requires legislative approval for each new tax cut.
Kentucky’s lawmakers have already approved additional reductions, with a law scheduled to lower the tax rate to 3.5% by 2026. Another new measure allows for more minor rate reductions if growth doesn’t meet full thresholds, though Democratic Governor Andy Beshear has criticized this as a potential tactic to erode the agreed safeguards for income tax reductions subsequently.
**Actions by Other States**
Tennessee and New Hampshire did not tax wages but had taxed specific types of income until recently deciding to remove those taxes. In 2021, Tennessee ended its tax on investment income, a practice dating back to 1929. Likewise, New Hampshire eliminated its tax on interest and dividends at the onset of this year.
Some states have taken cues from these developments, with the Oklahoma House advancing legislation to phase out the state’s personal income tax if revenue meets specified growth. In Missouri, Republican Governor Mike Kehoe has also expressed ambitions to phase out income tax, taking steps to reduce taxes on capital gains income.