Flat Tax Revolution: State Income Tax Reform

In the first century of state income taxation, only four states transitioned from a graduated-rate to a single-rate, or 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.
structure. But the past few years have brought significant focus on 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.
relief, and with that, something of a flat tax revolution.

In the 15 months from July 2021 to September 2022, five states enacted laws to transform their graduated-rate income taxes into single-rate tax structures: Arizona enacted 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.
legislation in July 2021, followed by Iowa in March 2022, Mississippi and Georgia in April 2022, and Idaho in September 2022.

While no additional flat taxes were enacted in 2023, legislators in several additional states have had serious deliberations on this issue and could be on the cusp of making a similar transition over the next few years. In Kansas, a bill to convert to a single-rate tax structure passed the House and Senate but was vetoed by the governor in both 2023 and 2024. While the legislature’s veto override attempt did not pass in 2023, an override attempt is expected again this legislative session and may have a greater chance of succeeding. Similarly, in Missouri and Oklahoma—two states with nearly flat bracket structures—lawmakers have also recently discussed the possibility of moving to a single-rate system.

Currently, 12 states have a flat individual income tax structure, while nine states do not levy an individual income tax on wage or salary income at all. Twenty-nine states and the District of Columbia have a graduated-rate tax structure, but one of these states (Iowa) is currently in the process of phasing in a flat tax.

A Brief History of State Income Tax Structure

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, followed by Kentucky, which implemented a single rate in 2019. They joined five other states that already had flat taxes: Illinois, Indiana, Massachusetts, Michigan, and Pennsylvania. (It is important to note, however, that Massachusetts’ flat tax has since been dismantled, with voters’ adoption in November 2022 of a constitutional amendment imposing a four percentage point surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services.
on income exceeding $1 million as of January 1, 2023.)

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 a graduated- to a single-rate structure. It took more than a century for the first three states—Colorado, North Carolina, and Kentucky—to make the transition from a graduated- to a single-rate structure, making it all the more notable that five states—Arizona, Iowa, Mississippi, Georgia, and Idaho—enacted laws to make that same transition within a matter of only 15 months in 2021 and 2022.

In 2021 and 2022, Five States Enacted Flat Taxes in a Span of 15 Months

In July 2021, Arizona lawmakers enacted legislation to phase in a flat tax rate of 2.5 percent using tax triggers that made the timing of such a transition subject to revenue availability. This law was temporarily held up in litigation but received court clearance in 2022 to move forward, and, upon the tax triggers being met, a flat rate of 2.5 percent was implemented in January 2023.

Under comprehensive tax reform legislation enacted in March 2022, Iowa is phasing in a 3.9 percent flat rate by 2026, moving further and further away from the graduated-rate tax that not long ago topped out at 8.98 percent. Given the state’s strong continued fiscal condition, Gov. Kim Reynolds (R) has proposed substantially accelerating the implementation of the flat tax by two years, such that a flat rate of 3.65 percent would apply retroactively to the 2024 tax year. Meanwhile, the House and Senate tax-writing committee chairs have introduced their own legislation to phase down—and eventually eliminate—the individual income tax, as well as a separate proposal that would enshrine the flat tax structure in the state’s constitution.

Mississippi’s flat tax, which took effect in 2023, was initially set at a rate of 5 percent, but that rate was reduced to 4.7 percent in 2024 and is scheduled to decrease to 4.4 percent in 2025 and 4.0 percent in 2026.

Georgia’s flat tax legislation, which was also adopted in 2022, was the most recent to take effect, with the transition to a flat rate of 5.49 percent occurring on January 1, 2024. Subject to tax triggers, this rate could be reduced by 0.1 percentage points each year until it reaches 4.99 percent, although lawmakers have signaled a willingness to consider accelerating these rate reductions.

Finally, in a 2022 special session, Idaho adopted a 5.8 percent flat tax, replacing the four-bracket tax system that was previously in effect. This change was effective starting with the 2023 tax year.

Benefits of Moving to a Flat Tax Structure

Supporters of flat taxes often identify their 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, that 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. State revenue forecasting—as well as projecting the revenue effects of potential tax changes—is far more easily accomplished under a flat tax structure. Flat taxes also make it easier for taxpayers to estimate their tax liability and how it would change under different income scenarios, enhancing tax transparency and potentially improving some taxpayers’ economic decision-making.

Flat taxes also accord better with taxpayers’ impressions of tax burdens based on headline rates. Individuals and small businesses may be more attracted to a state with a relatively lower flat rate than one with a graduated-rate system, even if the two systems yield similar liabilities. Flat taxes also simplify 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 they tend to be harder to raise in the future, whereas highly graduated taxes are more susceptible to targeted, but often economically inefficient, tax hikes. Notably, all four states that transitioned from a graduated-rate to a single-rate individual income tax before 2023 now have flat rates that are all between 0.5 and 1.05 percentage points lower than they were when the transition to a flat tax first occurred.

Taxpayers seem to sense this intuitively: in Illinois, for instance, voters in November 2020 lopsidedly rejected a constitutional amendment that would have permitted a graduated-rate structure even though the initially proposed tax increase would not have increased tax liability for the vast majority of voters. Illinoisans seemed to recognize that, once the principle of a graduated-rate structure is established, it would become far easier to raise income tax rates on more and more taxpayers—even setting aside the negative implications moving away from a flat tax would have had for the state’s economic competitiveness.

This is one reason why states with nearly flat income taxes should consider finishing the job, as Georgia, Idaho, and Mississippi have recently done. In Alabama, for instance, the current three-bracket system, with the top rate kicking in at $3,000 of income for single filers, 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 (TCJA) 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. Three other states likewise have top rates that kick in at or below $10,000 for single filers, including Arkansas, Missouri, and Oklahoma, all states in which continued income tax reform and relief remains a priority.

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 approximately $67,500 in 2024, 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.

Of the 12 states that already have flat taxes, four enshrine that status in their state constitutions, 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 businesses subject to individual, not corporate, income taxes, and the vast majority of 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.
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), 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.

States that currently have flat taxes but that have not yet constitutionally protected their single-rate tax structures should consider doing so. The following table shows states that currently have, or are on track to implement, a flat tax; their date of implementation (past or future); and whether a single rate tax is constitutionally mandated. Of the four states that have had flat taxes from the start, three enshrine this status in their constitution. Of the eight that transitioned, only one does.

In 2021 and 2022 alone, within the span of 15 months, more states enacted laws converting graduated-rate individual income tax structures into single-rate income tax structures than did so in the whole 108-year history of state income taxation up until that point. In several additional states, lawmakers are working to see that this momentum continues. For states that want to remove barriers to upward mobility and business investment while promoting long-term economic growth and enhancing their competitive standing, moving from a graduated-rate to a single-rate individual income tax structure while reducing the top marginal rate is among the most valuable tax reforms lawmakers could adopt.

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