In a notable shift that could reshape the financial landscape of the United States, two states—Mississippi and Kentucky—are making significant moves towards eliminating their income taxes on wages and salaries. It's been around 45 years since a U.S. state last took such a step, but the recent legislative actions in these states could pave the way for a new trend, contingent upon continued economic growth.

The drive to abolish income tax is a part of a broader movement aimed at cutting taxes across various states. This movement gained momentum as states experienced a resurgence in revenues following the economic turmoil caused by the COVID-19 pandemic. Many states have reported historic surpluses, prompting a reevaluation of tax structures.

However, this push comes amidst an atmosphere of uncertainty, as states brace for potential changes in federal funding. The economic policies of the Trump administration, characterized by cost-cutting measures and tariffs, may lead to a decrease in federal support for state budgets, raising concerns about the sustainability of such tax cuts.

Fiscal analysts caution that while eliminating income taxes might seem appealing, it could result in a disproportionate burden on low-income residents. States may turn to other forms of taxation, such as sales taxes, which are typically regressive and hit the impoverished harder.

The power to impose income taxes was granted to Congress by the 16th Amendment to the U.S. Constitution, ratified in 1913. Most states subsequently adopted personal income taxes, although some have opted out.

Currently, eight states do not impose any personal income tax: Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, and Wyoming. Washington state presents an interesting case; it does not tax wages and salaries but does impose taxes on capital gains exceeding $270,000. This trend of abolition is rare; for instance, Alaska eliminated its income tax in 1980, buoyed by a prosperous oil revenue influx.

Katherine Loughead, a senior analyst with the Tax Foundation, noted that eliminating an income tax is more feasible for states that have never imposed one. Once a state becomes reliant on income tax revenue, the path towards phasing it out becomes significantly more complicated.

In Mississippi, Republican Governor Tate Reeves recently enacted a law that will gradually decrease the state’s income tax rate from 4% to 3% by the year 2030. Furthermore, the legislation includes revenue growth benchmarks that could facilitate further tax cuts until the income tax is completely eradicated. Alongside the income tax reduction, the law lowers the sales tax on groceries and raises the gas tax to help balance the fiscal landscape.

If Mississippi successfully meets its revenue targets and adequately funds its cash reserves, the state could potentially eliminate the income tax altogether by 2040. Proponents of this initiative believe that decreasing income taxes will attract businesses and new residents, thereby stimulating economic growth. The rationale is that with lower taxes, residents will have more disposable income to spend, consequently enhancing sales tax revenues.

Governor Reeves expressed optimism about the potential benefits of this tax repeal, stating, “Mississippi has the potential to be a magnet for opportunity, investment, talent, and families looking to build a better life.” However, critics, particularly among Democratic lawmakers, caution that such sweeping tax cuts could leave the state vulnerable to financial crises, especially as Mississippi is one of the poorest states and heavily reliant on federal funding.

In Kentucky, a law passed in 2022 has similarly sought to reduce the income tax rate, establishing a framework for gradual reductions based on revenue triggers. However, unlike Mississippi's automatic measures, Kentucky's triggers require approval from the General Assembly for each tax cut. This legislative process has generated a series of tax-cutting initiatives, including two new laws this year that will reduce the tax rate from 4% to 3.5% starting in 2026. Additionally, another law makes it easier to implement further reductions, allowing smaller cuts in the tax rate if revenue growth does not meet the higher benchmarks.

Democratic Governor Andy Beshear, who signed off on the future tax cut, expressed his reservations about the other legislative measure, labeling it a “bait-and-switch” tactic. He argued that legislators had previously assured that safeguards for income tax reductions would remain intact while advocating for the upcoming 2026 tax cut, only to later amend the triggers for subsequent years.

Other states are also exploring the possibility of eliminating income taxes. New Hampshire and Tennessee have long been without a tax on wages, although they previously taxed certain types of income. In 2021, Tennessee abolished its tax on interest from bonds and stock dividends, a tax that had been in place since 1929, while New Hampshire ended its tax on interest and dividends at the beginning of this year.

Moreover, in Oklahoma, the House approved legislation in March aimed at gradually reducing the personal income tax rate to zero, contingent on meeting specific revenue growth benchmarks. In Missouri, newly elected Governor Mike Kehoe, a Republican, has also expressed his desire to phase out the income tax altogether. Recently, both the House and Senate advanced legislation that would take the initial step of exempting capital gains income from taxation.