Table of Contents
Kentucky’s move to replace its progressive income tax with a flat five percent rate in 2018 led the rising flat-tax revolution and spurred serious economic growth. That growth triggered further tax cuts that have reduced the state’s income tax to four percent, with another drop to 3.5 percent scheduled next year—all while raising the Budget Reserve Trust Fund to a record $3.76 billion.
But this is no time for state policymakers to rest on recent laurels. Kentucky must now keep up with the Joneses.
Neighboring states are aggressively reshaping their tax codes to attract businesses and workers. Kentucky will need to do the same if it wants to remain competitive. Neighboring Tennessee levies no state income tax. Indiana will charge just 2.95 percent in 2026. And Ohio adopted a flat rate of 2.75 percent earlier this year. Kentucky’s 3.5 percent rate in 2026 will still be higher than several regional competitors.
And competition for employers and employees in the 21st century economy is no longer regional, as workers and businesses move freely around the country looking to boost their bottom lines. That means good tax policy matters now more than ever. States reduced personal income taxes 56 times between 2019 and 2024. And between 2020 and 2023, high-tax states lost 2.8 million net residents to low-tax states, with remote workers, retirees, young professionals, and households across income levels seeking more financial flexibility.
But personal migration tells only part of the story. Companies looking to build manufacturing facilities, data centers, or AI research hubs, evaluate whether they can attract and retain skilled workers. States with lower personal income taxes offer a dual advantage: reduced labor costs for employers and higher take-home pay for workers. These advantages increase productivity, spurring more investment, more jobs, and faster wage growth.
States often rely on aggressive tax incentive packages to attract major manufacturing and technology projects, but these short-term deals are no substitute for structural tax policies that benefit all workers and businesses. Kentucky can dangle project-specific incentives for some would-be employers, but higher personal income tax rates keep the Commonwealth at a regional disadvantage when companies evaluate long-term operating environments. And smaller firms never even see special tax incentives, leaving them at a perpetual disadvantage despite the valuable role they play in economic growth and local labor markets.
To keep pace, Kentucky should continue lowering its tax rates for everyone, not just large firms. And lower tax rates are more affordable than some might think.
The Buckeye Institute used its dynamic scoring model—STELA (state tax and economic long-run analysis model) to analyze two scenarios of Kentucky tax reform: the scheduled tax rate reduction to 3.5 percent in 2026, and a hypothetical cut to three percent in 2027. The 2026 tax cut will trigger immediate economic effects, with a projected $510 million increase in Kentucky’s GDP in the first year, along with a $260 million rise in private investment and 2,000 new jobs. By 2034, the STELA estimates sustained annual GDP gains of $1.76 billion, an additional $750 million in investment, and another 6,000 new jobs.
But Kentucky can afford to move even faster. A reduction to three percent in 2027 would raise the GDP by $810 million and private investment by $370 million. By 2034, once fully phased in, the STELA projects annual GDP gains of $1.99 billion, $850 million in new private investment, and 7,000 jobs—all while generating new tax revenue of roughly 38 percent of the initial revenue loss, reducing the net impact to $1.55 billion by 2034.
Kentucky has a responsible fiscal framework for eliminating its income tax. And its record Budget Reserve Trust Fund, current economic conditions, and quantified dynamic modeling justify policymakers hitting the next revenue trigger to make the state more competitive sooner rather than later.
Rea. S Hederman Jr is vice president of policy and Sai C. Martha is an economic research analyst at The Buckeye Institute.
