National Report Highlights Importance of Continued Focus on Tax Reform in Kentucky

Kentucky ranks 25^th in the nation for the economic competitiveness of its tax policies, according to a new study by the nonpartisan Tax Foundation. The Commonwealth received high marks for its work to reduce individual income taxes and ensure a pro-business tax environment. However, aggressive actions by competitor states and long-standing challenges with certain antiquated tax provisions have caused Kentucky’s ranking to fall six places since 2021. These rankings underscore the importance of continued focus on improving Kentucky’s tax competitiveness through pro-growth policy reforms.

The Tax Foundation is a nonpartisan research organization focused on tax policy. Since 2003, it has produced an annual report ranking the states based on the economic competitiveness of their tax codes. The report was previously known as the State Business Tax Climate Index. In 2024, the Tax Foundation changed its methodology and rebranded the report as the State Tax Competitiveness Index.

The report looks at more than 150 tax variables within five areas: corporate taxes, individual income taxes, sales and excise taxes, property taxes, and unemployment insurance taxes. The Tax Foundation views tax structures that are “simple, neutral, transparent, and pro-growth” as beneficial to states and taxpayers. States with such tax policies on the books rank highest in the study, while states with the opposite—policies that are complex, cause economic distortions, or reduce growth and investment—rank the lowest.

Kentucky’s Recent Progress

The report applauds recent tax reform measures by the Kentucky General Assembly in 2018 and 2022. “Kentucky’s tax competitiveness has improved substantially in recent years due to several rounds of reforms that broadened the sales tax base to additional categories of mostly final personal consumption while moving to a single-rate individual income tax at a substantially lower rate,” the report states. The state also performs well under corporate taxes, ranking 19^th in this category, thanks largely to its flat corporate income tax rate of 5 percent.

In the Tax Foundation’s State Business Tax Climate Index, Kentucky’s tax code was frequently ranked as one of the worst in the nation prior to state tax reform efforts in 2018. Thanks to these reforms, Kentucky rapidly reversed course and climbed as high as 18^th. 

Notably, Kentucky’s forthcoming income tax cut is not reflected in the analysis. On January 1, 2026, the state’s individual income tax rate will fall from 4.0 percent to 3.5 percent. The study based its analysis on a snapshot of state tax codes as of July 1. Reform measures scheduled to be implemented by other states after the snapshot date are also not included in the study.

Where Improvement Is Needed

The Tax Foundation points out several key weak points in Kentucky’s tax landscape. For example, the state’s tax treatment of business investments in machinery and equipment—especially for small businesses—is harsher than most other states and the federal government. The report is especially critical of the state’s Limited Liability Entity Tax, noting that Kentucky is one of only four states with such a tax, alongside California, Minnesota, and New Hampshire. Another area that the report recommends reforming are local occupational licensing taxes and net profits taxes. Kentucky is one of only a small handful of states that allow for these types of taxes, which function to dilute the benefits of recent efforts to reduce the state’s individual income tax rate.

Competing with Other States

Another challenge facing Kentucky is the fact that the Commonwealth is situated among several states with highly competitive tax codes. Kentucky is bordered by two of the top 10 states in the nation—10^th ranked Indiana and 8^th ranked Tennessee. Zooming further out, Missouri is ranked 12^th, and North Carolina is ranked 13^th. In addition, Georgia has improved its ranking from 28^th in 2020 to 18^th, thanks to recent reductions to its individual income tax rate and having one of the top 10 most competitive corporate tax codes in the nation. Another nearby state on the move is Iowa, rising from 43^rd in 2020 to 17^th. The state receives high marks for its individual income and sales tax structures. Iowa has also announced plans to reform its corporate tax provisions.

This ever-shifting state tax landscape serves as a reminder to policymakers and business leaders that Kentucky’s tax policies do not exist in a vacuum. Other states are actively working to ensure that their policies are optimally structured and more favorable to businesses, workers, and entrepreneurs than their competitor states. While Kentucky has made progress on tax reform in recent years, it is critical that stakeholders remain focused on constant improvement and continue pursuing measured reforms.

Priorities to Maintain Momentum

To support this ongoing work, the Kentucky Chamber Center for Policy and Research has released several tax reform guides outlining key focus areas. In addition, the Chamber released partnership reports with the Tax Foundation in 2021 and 2024. Key reform principles recommended by the Chamber include:

• Continue reducing the individual income tax rate in a responsible manner as outlined in House Bill 8 from 2022 (along with changes to the reduction formula passed in 2025);
• Ensure that sales tax base broadening does NOT include business inputs;
• Repeal, or at minimum, significantly reform the Limited Liability Entity Tax; and
• Improve Kentucky’s treatment of business investments—for example, by increasing Kentucky’s Section 179 expensing limit to align with federal law and most other states.

Tax reform reports by the Kentucky Chamber Center for Policy and Research can be found here. Read the Tax Foundation’s full report here.