Vermont Income Tax Rate Increase Proposal

Chair Kornheiser and Members of the Ways and Means Committee:

My name is Janelle Fritts, and I am a policy analyst at the Tax Foundation. We are a nonprofit, nonpartisan tax policy research organization that focuses on issues at the state, federal, and international levels. While we do not take a position on legislation, I appreciate the opportunity to discuss Vermont’s proposal to add a fifth, higher 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 bracket aimed at high earners.

No state makes tax changes in a vacuum. Any substantive changes a state makes will improve or harm its competitiveness compared to other states, affecting population, jobs, and the economy. But tax codes are complex, making meaningful comparisons between states difficult.

To address this issue, the Tax Foundation publishes a study each year called the State Tax Competitiveness Index. In it, we rank all 50 state tax codes on how well they encourage economic growth. We give an overall competitiveness rank in addition to rankings for the subcategories of corporate income, individual income, sales, property, and unemployment insurance taxes. We examine both the rates and bases of each category, looking at around 170 variables to provide a reasonably complete picture of state tax codes. A rank of 1 is the best, and 50 is the worst.

As of July 1, 2025—our snapshot date for the most recent Index—Vermont ranks 42nd overall, with a rank of 39 on the individual income tax component.[1] This poor income tax ranking largely stems from a high top marginal rate of 8.75 percent, a relatively high number of tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. (four), and a high top rate kick-in ($249,700 as of tax year 2025). The income tax accounts for 31.8 percent of a state’s overall Index score.

If Vermont were to change its tax code today and create the proposed fifth tax bracket with a top rate of 13.3 percent, kicking in at $481,825 for single filers, then it would rank 44th overall, and 44th in the individual income tax category—a significant drop.

A tax increase of this size would substantially impact Vermont’s economic competitiveness, and this would be reflected in the state’s Index ranking. In the northeast region, Vermont is largely surrounded by high-income-tax states, excepting New Hampshire. While it does have a high top rate of 8.75 percent, Vermont still has a lower rate than New York (10.9 percent), New Jersey (10.75 percent), and Massachusetts (9.0 percent). If the proposed tax bracket were to be enacted, Vermont would see the highest top rate in the region and would tie with California for the highest top income tax rate in the country. However, Vermont’s top rate would be more aggressive than other high-earners taxes: California, New Jersey, New York, and the District of Columbia all see their high earners taxes kick in at $1 million, while Vermont’s would kick in at less than half of that amount.

Top income tax rates matter. Most economists consider the individual income tax to be the second-most economically damaging of the major taxes, after the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax., because income taxes fall on labor and investment. The strongest economic impact is at higher income levels, because of the outsized role of the economic decisions of high earners, their greater incentive (and ability) to adjust their activity to reduce tax liability, and their far greater mobility, which can include moving out of a state altogether to avoid excessively high taxes. It’s not just individuals who would be paying this tax—many small businesses, including LLCs and S corporations, pay taxes through the individual income tax, so an even higher top marginal rate would substantially burden small businesses.

Now, taxes are not the only factor that contributes to a state’s success. After all, a well-structured tax code won’t make the Wyoming Basin a metropolis, and poor tax structure won’t make Manhattan a ghost town. But tax structure does play a role in a state’s economic successes or failures, and even a state that is not likely to become a ghost town can still see ramifications from uncompetitive rate changes.

We can look at California, which levies the same 13.3 percent top rate that Vermont is considering. Economists Rauh and Shyu in 2024 analyzed Proposition 30 in California, which increased the top marginal income tax rate by three percentage points in 2012. They show that high earners reported between $321,000 and $436,000 less in taxable income in the first three years following the reform—about 10 percent of their baseline income of $4.15 million—in response to this major tax increase.[2] They also show that there was a meaningful outmigration effect, which increased with income and was concentrated among top earners. These responses together mean that the state lost about 61 percent of the potential extra tax revenue from Proposition 30 within two years of the reform.

Vermont would do well to learn from this portent. The Department of Taxes reports that taxpayers with incomes above $500,000 accounted for 30.41 percent of the state’s income tax revenue in tax year 2024. Giving these residents more motivation to move out of the state or adjust their taxable income could significantly cut into the revenue that this new tax bracket would raise.

A drastic rate increase like the one being discussed would have negative effects on Vermont’s economy, harming the state’s ability to attract and retain residents and small businesses, and potentially generating less revenue than lawmakers might hope.

A top rate of 13.3 percent would give Vermont the highest top income tax rate in the country, tied with California. This would set Vermont apart as a high-tax state, even among its neighboring high-tax states. The change would drop its overall Index ranking from 42nd to 44th and harm its competitiveness. Caring for those with lower incomes is extremely important, but trying to solve that issue through large rate increases can backfire by stifling the economic opportunity that would build up those who need it. When it comes to a tax code, the best thing you can do is have broad bases and low rates that encourage economic growth, creating and retaining good jobs.

Thank you again for the opportunity to testify. I would be happy to answer any questions.

References

[1] Janelle Fritts, Jared Walczak, Abir Mandal, and Katherine Loughead, 2026 State Tax Competitiveness Index, Tax Foundation, Oct. 30, 2025, https://taxfoundation.org/research/all/state/2026-state-tax-competitiveness-index/.

[2] Joshua Rauh and Ryan Shyu, “Behavioral Responses to State Income Taxation of High Earners: Evidence from California,” American Economic Journal: Economic Policy 16:1 (2024): 34-86.