Kentucky Competitor State Further Reduces Income Taxes

The Indiana General Assembly gave final approval to legislation to further reduce state income taxes earlier this week. Hoosier lawmakers voted to reduce Indiana’s already-low individual income tax rate from 3.23 percent to 2.99 over a period of several years. Effective in January 2023, the rate will drop to 3.15 percent and then gradually phase down to 2.99 percent based on revenue growth. 

This means Kentucky will soon be sandwiched in between Tennessee, a state with no individual income tax, and Indiana, a state with the lowest flat income tax in the nation. The Tax Foundation already ranks the tax codes of Tennessee and Indiana as two of the best in the nation. 

Indiana is one of dozens of states that have taken concrete steps to reduce income taxes in 2021 and 2022. This is a trend driven by widespread recognition of the economic benefits of reducing income taxes as well as the fact that many states are experiencing record budget surpluses and seeking to compete for businesses and workers in an increasingly mobile world.  

Kentucky, which has a flat 5 percent individual income tax rate, runs the risk of becoming a regional outlier with a higher income tax rate unless it acts in the 2022 legislative session. In addition to the competitive tax codes in Tennessee and Indiana, Ohio dropped its individual income tax rate to 3.99 percent in January 2022. 

The Kentucky House of Representatives passed House Bill 8 last week, which proposes a bold plan to reduce and phase out Kentucky’s individual income tax. House Bill 8 awaits action by the State Senate. 

As the Chamber illustrated in a recent report, reducing the Commonwealth’s reliance on individual income taxes can help drive population growth and economic growth. For example, we know that the combined population of no-income tax states grew at twice the national rate in the 2020 Census. Similarly,  the economies of no-income tax states grew 56 percent faster than states with income taxes between 2010 and 2020. 

“With Indiana continuing to improve their tax code, it has never been more critical for Kentucky to do the same to truly be able to compete and grow our economy,” said Kentucky Chamber President and CEO Ashli Watts. “The Kentucky business community encourages the legislature to make the bold changes needed to our tax code to be ensure we can give our citizens relief and compete with our neighboring states.”

The Tax Foundation further analyzed the economic and competitive benefits of reducing individual income taxes and implementing other tax reforms in a major study of Kentucky’s tax code last year. 

Press reports on Indiana’s income tax reduction show that the legislation had bipartisan support. The Indiana State Senate, which has 39 Republicans and 11 Democrats, voted unanimously in support of the bill. The Indiana House, with 71 Republicans and 29 Democrats, voted 82-17. According to U.S. News, some House Democrats criticized the plan for phasing in the income tax cut too slowly. “We’re looking at those dollars that we can get back to the community because we don’t want to have any more missed opportunities for working men and women,” Rep. Greg Porter of Indianapolis, the top Democrat on the tax-writing House Ways and Means Committee, is reported to have stated.