Spring Begins And State Tax Rates Continue To Fall

When the Washington State Supreme Court issued its March 24 ruling authorizing collection of the capital gains tax signed into law by Governor Jay Insley (D) two years ago, it made Washington the only jurisdiction on the planet to classify a capital gains tax as an excise tax. The decision also took Washington off the list of no-income-tax states.

Washington State’s departure from the club of no-income-tax states comes a little more than four months after Massachusetts was pulled off the list of flat tax states with Bay State voters’ approval of Question 1. Question 1, which garnered 52% of the vote, is a constitutional amendment that moved Massachusetts this year from a flat 5% state income tax to a progressive income tax with a top rate of 9%. Though these developments in Washington and Massachusetts are big wins for progressives, they’re outliers in the overall trend.

Progressive Democrats have won recent income tax battles, major ones, but there is still plenty of evidence they’re losing the overall tax policy debate in state capitals. “At least 24 states are weighing cuts to personal income tax rates this session,” Institute for Taxation and Economic Policy (ITEP) analysts wrote in a January blog post lamenting what they referred to as “tax cut fever” in state capitals, along with the “recent flurry of interest in flat taxes” that ITEP researchers criticized as “misguided and often reckless.”

In fact, more states moved from a progressive to a flat income tax in the last five years than in all previous years combined. Five years ago there were nine flat tax states. Today there are 13. While that number is down from 14 last year, even when factoring in the loss of Massachusetts, the number of flat tax states has increased by more than 44% in just the past five years.

When looking at the size of the no-income-tax club, even with Washington State’s departure, the list of no-income-tax states is up one on net in recent years. That’s because Tennessee lawmakers passed legislation phasing out their investment income tax, which was completed in 2021, bringing the number of no-income-tax states up from seven to eight. New Hampshire is scheduled to follow suit thanks to the budget signed into law by Governor Chris Sununu (R) in 2021, which will phaseout the Granite State’s investment income tax by 2027. As was the case in Tennessee when Volunteer State lawmakers repealed their investment income tax, New Hampshire already avoids taxing wage income. With so many rate-reducing tax reform plans advancing in state capitals right now, the number of no-income-tax and flat tax states is poised to grow even further in the coming years.

Along with a number of great basketball games, March 2023 also featured the passage of many state income tax cuts. In Montana, Governor Greg Gianforte (R) signed into law the largest tax cut in state history on March 13, taking the top rate from 6.75% down to 5.9%. The income tax relief enacted by Governor Gianforte and Montana legislators is all the more noteworthy since the state is one of only five without a state sales tax.

Two weeks after enactment of the Montana income tax cut, the Missouri House of Representatives passed House Bill 816, legislation that will reduce the state’s top income tax from 4.95% to 4.5%. HB 816 also cuts the state corporate income tax rate in half, taking it from 4% to 2%.

With this reform, Missouri legislators are seeking to build up on the tax relief enacted last year, which took the state’s top income tax rate from 5.2% down to the current rate of 4.95%. HB 816 now heads to the Missouri Senate for consideration. Legislative Democrats criticized the proposal, but proponents say the tax cut will help millions of Missouri households and make the state more economically competitive.

“We haven’t even seen the impacts of the historic tax cut that you all passed just a few months ago,” argued Representative Peter Merideth (D), who voted against the bill. “And you’re already here talking about another billion-dollar tax cut, all while cutting services or refusing to increase them with inflation.”

“This legislation will provide relief to all working Missourians,” Representative Dirk Deaton (R) said after HB 816’s passage. “It will provide for a brighter tomorrow for all Missourians, and a stronger Missouri for all.”

The income tax cut passed by the Missouri House is contingent upon certain revenue triggers being hit in the coming years. Revenue triggers have proven to be a popular method for implementing rate-reducing tax reform over the past decade, providing a mechanism to safeguard against unanticipated revenue shortfalls.

Arizona lawmakers used revenue triggers to cut their income tax rate from 4.5% to 2.5%. The 2.5% rate that took effect on the first day of 2023 is now the nation’s lowest flat income tax rate. Not resting on their laurels, Arizona legislators are now advancing legislation that would phase out the state income tax overtime based on revenue triggers that ensure state spending grows at what many consider to be a sustainable clip.

Senate Bill 1577, which passed out of the Arizona Senate in February and is now being considered by the House, would gradually phase out the state income tax. The way the revenue triggers in SB 1577 work is that any time ongoing revenue collections exceed the rate of population growth plus inflation, half of that reoccurring surplus would be used to drive down the income tax rate. This would go on until the rate is zeroed out, something that proponents of the bill say would take a number of years, likely more than a decade.

The state that inspired and was the model for Arizona’s tax reform efforts, North Carolina, is now poised for another round of rate-reducing tax reform. The North Carolina House Republicans unveiled their budget proposal last week, which calls for an acceleration of already scheduled income tax rate reduction. North Carolina’s income tax rate, which is currently at 4.75%, is scheduled to fall every year until it reaches 3.99% at the end of 2026.

Many expect the North Carolina Senate to put forth a budget proposal that aims for greater rate reduction. Early in 2023, North Carolina Senate President Pro Tempore Phil Berger (R) indicated his caucus is interested in pursuing further income tax rate reduction this year, possibly bringing North Carolina’s flat income tax rate down to match Arizona’s 2.5% rate.

Meanwhile in Kansas, a state that is often portrayed in the media as the archetype for conservative tax reform, lawmakers are now seeking to follow the lead of North Carolina, the state that has actually been viewed by governors and legislators around the country as the model for conservative tax reform. On March 29, the Kansas House of Representatives passed legislation to move from a progressive income tax with a top rate of 5.7% to a flat 5.25% income tax. That bill also accelerates the repeal of the state sales tax, which is the top tax priority for Governor Laura Kelly (D), and cuts the state corporate tax from 7% to 6%.

“This bill has a lot of really good things in it and it’s not perfect,” said Representative Tom Sawyer (D), who called the proposal, which 10 Democrats voted for, “a compromise.” The tax reform debate now moves to the Kansas Senate, where lawmakers are looking to craft a new compromise that achieves greater rate reduction. “Hopefully we’ll get closer to the Senate position,” said Senator Caryn Tyson (R), whose caucus approved a flat tax of 4.75% back in February.

Next door to Kansas another state income tax cut was approved last week by legislators in Nebraska. In a 41-0 vote on March 30, the Nebraska Senate passed LB 754, legislation that will reduce the state’s personal and corporate income tax rates, which respectively impose top rates of 6.27% and 7.5%, down to 3.99% by 2027.

Nebraska lawmakers approved legislation last year to cut the personal income tax rate to 5.84% over time. But Senator Lou Ann Linehan (R), sponsor of LB 754, noted that rate would still leave Nebraska at a competitive disadvantage relative to other states.

“Bringing down our top income tax rate is critical for the future of the state of Nebraska,” Senator Linehan said on March 29 during the Senate floor debate on LB 754. “We are overtaxed in Nebraska.”

The same day the Nebraska Senate approved their income tax cut, Arkansas Governor Sarah Huckabee Sanders (R) unveiled her tax relief proposal at a press conference with state legislators. Governor Sanders’ proposal would cut the state’s top income tax rate from 4.9% to 4.75% for taxpayers earning between $23,600 to $84,500 and reduce the corporate tax rate from 5.3% to 5.1%.

“Arkansans need relief and they need it quickly,” Governor Sanders said at the March 30 press conference announcing her tax plan, which has been introduced as Senate Bill 549. “Whether it’s a single mom living in Warren, or working parents in Ozark, this bill is aimed directly at the hard-working Arkansans hurting most from inflation.”

On the campaign trail last year, Governor Sanders announced her long-term goal is full repeal of the state income tax. In the no-income-tax state bordering Arkansas, Tennessee, Governor Bill Lee (R) is now seeking to make his state’s tax climate even more competitive and hospitable than it already is.

Governor Lee put forth a tax package earlier this year that provides relief from each of the three taxes assessed on businesses in Tennessee. Governor Lee’s tax plan, which has been introduced as Senate Bill 275, will be considered in the Tennessee Senate Finance Committee this week, on April 4.

Tennessee is not the only no-income-tax state where the governor and lawmakers are pursuing further tax relief. Legislation to provide tax relief is also pending in Florida and Texas.

These recent income tax cutting and flattening developments in state capitals don’t take away from the progressive victories in Washington State and Massachusetts, which will have major consequences for millions of people, companies, and firms. They do, however, make it clear that those bicoastal progressive achievements have been outliers in the overall trend in state tax policy.