Slow and steady

Winning the Arkansas tax race

Arkansas has made strides over the last decade to improve its income-tax structure. But if the Natural State wants to remain competitive against no-income-tax states like Texas and Tennessee, along with rate-cutting peers like Mississippi, lawmakers must continue to build on the momentum of these reforms.

Arkansas has room for responsible, pro-growth income-tax rate reductions, ideally paired with reforms that also make the state a destination for business investment.

Over the last three years, a wave of tax reform has swept across much of the country, with income-tax rate reductions adopted in 25 states. Arkansas was ahead of the curve, starting to overhaul its tax code in 2015. While there is no doubt this effort was in part necessitated by Arkansas’ exorbitantly high income-tax rates—which were nearly 7 percent that year while most of its bordering states were a full 1 to 2 percentage points lower (and some at zero)—the legislators who first embarked on the 2015 reforms deserve credit for starting the reform process.

Lawmakers in Little Rock continued the tax-reform journey over the next several years, reducing the state’s income tax as gradually as responsible fiscal policy would permit. While in some instances this meant that reductions only occurred once certain revenue targets were achieved, the cumulative effect has been a substantial boom for Arkansas’ revamped economy.

In fact, Arkansas will have the individual income-tax top rate down to 4.4 percent in 2024—a drastic shift from where it stood just nine years earlier. The state has also undoubtedly reaped the benefits of its economic overhaul, with a net inbound migration rate in the top third of states in 2022, according to the U.S. Census Bureau.

However, the rapidly shifting economic landscape has created an increased demand for reform. In our now highly mobile economy, where workers and businesses can easily work anywhere, all of Arkansas’ neighboring states have cut income-tax rates to either 5 percent or below, with further reductions set to phase in over the next few years. Mississippi will have a flat 4 percent rate in 2026, and Texas and Tennessee continue to forgo an individual income tax.

For Arkansas to continue to attract workers, families, and businesses, it must remain competitive on the tax front. Many policymakers in the state have expressed interest in alternative, accelerated roads to reform. Gov. Sarah Huckabee Sanders (R) even began her term stating she wanted to see the state’s income tax phase out entirely.

Ideally, income-tax rate reductions would be paired with business-tax reforms designed to boost investment and create additional jobs in the state—policies like repealing the franchise tax, an archaic business tax that falls on companies regardless of their profitability, or implementing a provision that allows businesses to write off the cost of new investment immediately rather than having to wait years or decades to take the full deduction.

These policies should not be seen as in competition with income-tax reductions, but rather as multipliers which make those cuts more economically powerful. We examine these reforms and several others, including responsible ways to reduce income-tax rates, in our new publication, “The Future of Arkansas Tax Reform.”

While full repeal of the individual income tax may be legislators’ destination, maintaining long-term economic competitiveness must be the engine that drives them there. If income-tax elimination is funded by adapting economically distortive taxes or by curtailing valuable services, Arkansans will not reap the benefits.

The fiscal prudence that has been a hallmark of Arkansas’ growth until now should continue. In fact, with the state’s 2024 spending projected to reach only $6.2 billion while tax revenues are positioned to raise $6.6 billion, there is ample opportunity in the immediate future to pay for the implementation of gradual reforms. And Arkansas’ $1.5 billion “rainy day fund” provides additional security for any economic downturn.

In the current economy, characterized by high mobility for individuals and businesses, maintaining tax competitiveness is undoubtedly crucial. Tax reform, however, is only worthwhile if it achieves long-term fiscal sustainability. Accelerating reform is desirable, but rate cuts are a means to an end (a more competitive economy), not an end in themselves, making it important to phase in rate reductions responsibly and sustainably.

Arkansas is doing well—and it will continue to by moving at a fiscally responsible pace to optimize its chances for future economic success.