After years of low rankings, Kentucky’s tax code continues to receive high marks in a national business tax climate index. In the Tax Foundation’s 2023 State Business Tax Climate Index, Kentucky ranks 18th among the 50 states. Kentucky has been among the top 20 states for the competitiveness of its tax code since 2019, following the passage of pro-growth tax reform legislation by the General Assembly in 2017 and 2018. Before 2019, Kentucky generally ranked among some of the least competitive tax codes in the nation.
Three states in Kentucky’s broader region scored among the most competitive state tax codes. Indiana ranks 9th best. North Carolina is 10th. Florida is 4th. While not in the top 10, Tennessee ranks 14th, and Missouri ranks 11th.
Kentucky scores highest for its corporate income tax structure – which was significantly reformed in 2017 and 2018 – and for its sales tax structure, which has also undergone major changes in recent years. The state performs modestly for its individual income tax, thanks particularly because the General Assembly instituted a flat tax structure in 2017. As discussed in more detail below, recent changes to the individual income tax in Kentucky are not yet included in the index. Kentucky receives poor rankings for property taxes and unemployment insurance taxes.
The Tax Foundation is a nonpartisan research organization based in Washington, D.C. Their index scores states based on more than 120 variables within five major categories: individual income taxes, corporate income taxes, sales taxes, property taxes, and unemployment insurance taxes. According to the Tax Foundation’s analysis, competitive tax codes are the ones that most effectively support economic growth and help states attract and retain business activity. In 2021, the Kentucky Chamber partnered with the Tax Foundation to study Kentucky’s tax code and recommend reforms. In November 2021, the Tax Foundation released “Aligning Kentucky’s Tax Code for Growth,” which outlined a menu of options to improve the Commonwealth’s tax competitiveness.
It is important to note that the 2023 index analyzes states based on their tax codes as of July 1, 2022 (the start of the Fiscal Year 2023 for most states). This means that the impact of legislation such as House Bill 8 from the 2022 legislative session is not included in the new rankings. House Bill 8 implemented a long-term plan to gradually phase out Kentucky’s individual income tax, starting with a rate drop from 5 percent to 4.5 percent in January 2023. The bill also included numerous changes to the state’s sales tax base, which could affect Kentucky’s ranking next year. Another bill not included in the index is House Bill 4, which enacted changes to how the state calculates unemployment insurance taxes.
At the same time, it is equally important to note that many major changes enacted by other states are also not included in the 2023 index. 2021 and 2022 marked a sea change in state taxation, with numerous states enacting significant reforms to individual income, corporate income, and sales taxes. Indiana, for example, is scheduled to reduce its individual income tax rate in January 2023. Georgia is replacing its graduated income tax structure with a flat tax in January 2024.
“Reform efforts in other states and indices like the Tax Foundation’s are good reminders that state tax reform does not occur in a vacuum,” said Charles Aull, Executive Director of the Kentucky Chamber Center for Policy and Research. “Competition for workers, businesses, and new economic opportunities has rarely been more intense than it is today. While Kentucky has been actively reforming its tax code to facilitate growth, so too have other states, including key competitor states like Indiana, North Carolina, Missouri, and Tennessee. In future rankings – after state reforms from 2021 and 2022 have gone into effect – there is a good chance that Kentucky’s tax competitiveness among the states will change.”
Whether Kentucky moves up in future rankings, moves down, or holds steady will ultimately be in the hands of state policymakers. Both the Chamber and the Tax Foundation have recommended numerous key reforms to continue moving Kentucky up the rankings and growing the state’s economy.
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