In more than a century of state income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es, only four states have ever transitioned from a graduated-rate income tax to a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. . Another four adopted legislation doing so this year, and a planned transition in a fifth state is now going forward under a recent court decision. In what is already a year of significant bipartisan focus on tax relief, 2022 is also launching something of a flat tax revolution.
In 1987, the 75th anniversary of state income taxation, Colorado replaced its half century-old graduated-rate income tax with a single-rate tax. It would take another 30 years for another state to follow suit, when Utah implemented a flat tax in 2007. Next came North Carolina in 2014, as part of that state’s comprehensive reforms, and most recently, Kentucky implemented a single rate of 5 percent in 2019. They joined five other states which already had flat taxes: Illinois, Indiana, Massachusetts, Michigan, and Pennsylvania.
The first state income tax, implemented in Wisconsin in 1912, had a two-rate structure. The first flat tax was Massachusetts’ tax, which went into effect in 1917. Five states had income taxes back then, with Massachusetts and Virginia both implementing them that January. Only five years passed between the first progressive income tax and the first flat income tax, but 75 years passed between the first progressive income tax and the first time one was transitioned from graduated to single rate. It took more than a century for three to do so—and four states have adopted legislation to make that transition just this year, with a fifth cleared for the transition by a court decision and a two more potentially in the wings.
Iowa is phasing in a 3.9 percent flat individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. by 2026, going from a graduated-rate tax that not long ago topped out at 8.98 percent. Mississippi will have a flat tax as of next year, with a 4 percent rate by 2026. Georgia’s income tax is now scheduled to convert to a flat rate of 5.49 percent, eventually phasing down to 4.99 percent. A court cleared the way for the implementation of Arizona’s transition to a 2.5 percent flat tax, which should happen, pending revenue availability, in 2024. In special session, Idaho adopted a 5.8 percent flat tax, replacing a four-bracket system. Missouri has been called into special session to adopt income tax rate cuts, but a flat tax could still be a consideration, soon if not this session, and a serious effort at adopting a flat tax is likely in Oklahoma next year.
Supporters of flat taxes often identify the simplicity as one of their salient features. This is true, but it’s important to stop and ask what is meant by this. It is not enough to merely state that a single rate is simpler than multiple rates, because, while trivially true, it tells us relatively little. It is not particularly difficult to use tax tables to ascertain one’s tax liability.
Flat taxes are meaningfully simple, however, in several ways. It is easier to forecast revenue under a flat tax, and to project the revenue effects of potential tax changes. It is easier for taxpayers to estimate their tax liability and how it would change under different income scenarios, which enhances tax transparency and potentially improves some economic decision-making. It accords better with impressions that taxpayers form of tax burdens based on headline rates, such that individuals and small businesses may be more attracted to a state with a relatively lower flat rate than one with a graduated-rate system that would yield similar liability. And it simplifies the function by which taxpayers decide whether to work or invest more on the margin, since all marginal returns to labor and investment are exposed to the same rate.
Of greater significance for taxpayers, however, is that flat-rate income taxes tend to function as a bulwark against unnecessary tax increases, and to provide greater certainty for individual and business taxpayers. Economic decisions are made on the margin; choices about investments, labor, or relocation will be made on the basis of the effect on the next dollar of income, not the prior ones. A competitive top marginal rate matters most for economic growth, and flat income taxes—given their “all-in” nature—not only mean a lower rate on that all-important margin, but tend to be harder to raise in the future, whereas highly graduated taxes are more susceptible to targeted, but often economically inefficient, tax hikes.
Taxpayers seem to sense this intuitively: it seems to have been persuasive in Illinois, for instance, where voters lopsidedly rejected a constitutional amendment permitting a graduated-rate structure even though the initially proposed tax increase would not increase tax liability for the vast majority of voters. They seemed to recognize that, once the principle was established, higher rates would be established for more and more taxpayers—even setting aside the implications for the state’s economic competitiveness.
This is one reason why states with nearly-flat taxes should consider finishing the job. In Alabama, for instance, the current three-bracket system, with the top rate kicking in at $3,000 of income, only provides $40 in tax savings compared to taxing all income at the top rate. Raising the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. would easily provide the same progressive benefits while embracing the simplicity and—more importantly—the certainty and stability of a single-rate tax. Five other states likewise have top rates that kick in at or below $10,000, including Idaho and Mississippi, which are now transitioning to a flat tax, and Oklahoma, where a flat tax is under active consideration.
|State||Brackets||Top Rate Kick-In||Maximum Savings|
|State statutes; Tax Foundation calculations|
These states now present an opportunity for reform culminating in a flat tax, but they also serve as a cautionary tale about the implications of not indexing a graduated-rate income tax. When Alabama adopted its graduated-rate income tax in 1935, the majority of taxpayers were fully exempt, and few taxpayers were subject to the top marginal rate of 5 percent on income above $3,000, which is equivalent to almost $63,500 in 2022, higher than today’s median household income in the state and a small fortune in Depression-era Alabama. Over time, the lack of inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. indexing has subjected the vast majority of taxpayers’ income to the top marginal rate. The same is true in Georgia, where policymakers have adopted a very gradual approach to a flat tax. Georgia’s top rate has kicked in at $7,000 since 1955, when it was equivalent to about $75,000 in today’s dollars.
Of the nine states that already have flat taxes, five enshrine that status in their state constitution, locking in the benefit and making it harder for lawmakers to raise taxes by switching to a progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. regime. This is a particularly important protection for small business owners, since about 95 percent of all businesses are pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es subject to individual, not corporate, income taxes, and the vast majority of pass-through business income is earned by companies exposed to states’ top marginal income tax rates. In Illinois, for instance, where lawmakers championed a failed constitutional amendment to permit a graduated-rate income tax, 93 percent of pass-through business income was on returns with more than $200,000 in adjusted gross income (AGI)Adjusted gross income (AGI) is a taxpayer’s total income minus certain “above-the-line” deductions. It is a broad measure that includes income from wages, salaries, interest, dividends, retirement income, Social Security benefits, capital gains, business, and other sources, and subtracts specific deductions. , and over half of all pass-through business income was reported on returns showing more than $1 million in AGI. Hiking the top marginal rate is not just about the wealthy; it is about the state’s small businesses too, and about providing a greater level of certainty for entrepreneurs making location decisions.
The states now transitioning to flat taxes, and those which have not yet constitutionally protected their current single-rate tax structures, should consider doing so. The following table shows states which currently have, or are on track to implement, a flat tax, with date of implementation (past or future) and whether a single rate tax is constitutionally mandated. Of the five states that have had flat taxes from the start, four enshrine this status in their constitution. Of the four that transitioned, only one does.
|State||PIT Adopted||Flat As Of||Constitutional|
Notes: Georgia, Idaho, Iowa, and Mississippi are implementing flat taxes in accordance with legislation enacted this year, while in Arizona, a court has cleared the implementation of a 2021 law. Implementation dates in Arizona and Georgia are contingent on revenue availability.
Sources: State statutes; Tax Foundation research.
States shifted from graduated to single-rate income taxes in 1987, 2007, 2014, and 2019. A recent court decision will allow a 2021 law in Arizona to move forward. With new laws beginning that transition in Arizona, Georgia, Iowa, and Mississippi, 2022 has already seen the enactment or legal clearance of as many new flat taxes as we’ve seen transition in the history of state income taxes to date, and that’s before any action is taken in Missouri and Oklahoma.
Note: Originally published on April 26th, this post has been updated on November 14th to reflect recent state tax policy developments.