Year of Publication

2021

College

Martin School of Public Policy and Administration

Degree Name

Master of Public Financial Management

Committee Chair

Dr. Merl Hackbart

Executive Summary

There are competing theories on the impact of tax policy on the economy. Many policymakers believe that cutting income taxes stimulates the economy, while others believe that tax cuts adversely affect the economy. Income taxes face the most opposition from governors and legislators, despite generating huge amounts of revenue. However, whether policymakers decide on cutting or raising personal income taxes, this can significantly affect state government revenues—either negatively or positively, most especially states whose primary source of revenue is personal income tax. Recently, Tennessee and Kentucky passed major tax reforms in 2017 and 2018 respectively, with broadly different policy goals. Tennessee’s Hall income tax1 was phased out and Kentucky’s personal income tax was lowered, while reforming policies towards income tax deductions, credits, and exemptions. Theory suggests that some of these policies could have a significant effect on revenue and taxpayers. This claim is examined using a case study approach for both states to determine the effect these reforms had on the state revenues and taxpayers in Kentucky and Tennessee. This study examines the impact of personal income tax on state government revenues and analyzes the impact of tax cuts by comparing the economies of two states: Kentucky and Tennessee. They are geographically within the same region. Kentucky is a state in the Upland South region of the United states, bordered by Tennessee to the south, and thus share the same demographics and other social economic characteristics. The literature review focuses on studies on personal income tax, government revenue, and economic growth. The paper also reviews the theoretical framework to include supply-side theory and benefit theory. In addition, the paper reviews empirical studies relevant to the subject. 1 Hall income tax is a tax imposed only on individuals and other entities receiving interest from bonds and notes and dividends from stock. 3 The research design details the goals and methodology of the analysis utilizing secondary data from the Kentucky Office of the State Budget Director, Kentucky Department of Revenue, Tennessee Department of Revenue, US Bureau of Labor Statistics, and the US Census Bureau for the data analysis. The study finds that tax cuts have significant influence on government revenue, but strong gains in sales and gross receipts were offset by declines in income and property taxes. The study also finds that tax cuts shift the tax burden onto low-and-middle income families. Additionally, Kentucky’s revenue system—though in need of revenue to keep up with the economy—has a more balanced and reliable mix of revenue sources compared to Tennessee’s revenue system. The findings also showed that the economy of Tennessee fairs better than Kentucky’s in terms of population and employment. In conclusion, personal income tax cuts impact government revenues, but further research is needed to understand more reasons for the results shown.

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