The first of two tax cuts that took effect in January lowered the income tax from 5% to 4.5%. Lawmakers then voted to drop the rate again, to 4%, effective Jan. 1 of next year.
The cuts are part of a process put in place by the GOP-led legislature in 2022 that would eventually eliminate the state’s income tax if certain conditions are met. But according to the review process put in place by the legislature the state didn’t meet the economic conditions necessary to trigger another cut during next year’s legislative session.
Sen. Chris McDaniel, a Republican who chairs the state Senate’s budget committee, said he is not surprised the state didn’t meet the benchmark this year.
“We set some pretty stringent conditions on making the reduction, because we were working very diligently to try to reduce the tax burden on all Kentuckians while at the same time, recognizing the ongoing need for delivery of essential services,” he said.
It’s the third fiscal year that the Office of State Budget Director, led by Director John T. Hicks, has had to evaluate whether the state’s finances can withstand another tax cut, but it’s the first time Kentucky didn’t meet one of the two required conditions. It’s also the first evaluation since a tax cut was actually put into effect.
The state met the first condition, which requires the state’s so-called rainy day fund to have the equivalent of 10% of the annual budget. But the state didn’t meet the other stipulation, which requires the state to look at whether spending would have been less than or equal to the amount of revenues brought in if an additional 1% income tax cut had been in place.
If Kentucky had decreased income taxes by an additional 1% in the last fiscal year, as the second condition lays out, the legislature would have had to cut the budget by an additional $435 million.
Even if Kentucky had met the prescribed conditions, the state legislature would still have to approve another cut for it to take effect.
Cutting, and eventually eliminating, the income tax has become a major priority for Kentucky’s Republican-dominated legislature in recent years, and Democratic Gov. Andy Beshear signed the most recent tax cut bill. That’s even though some advocates point out that reducing the state’s income tax, and relying more on the sales tax,is a regressive policy that disproportionately burdens people who make less money.
In his weekly update Thursday, Beshear said he isn’t worried that Kentucky didn’t meet conditions necessary for another tax cut.
“What the legislature tried to do was set up a responsible method for determining when to take — they're not incremental steps. They're real steps in reducing income tax,” Beshear said. “But we have to make sure that we are also responsible.”
Republican Attorney General Daniel Cameron, who is running for governor against Beshear, announced Wednesday that he wants to completely eliminate income tax, if elected. He did not specify how or if he would endeavor to make up that revenue.
When asked if he still wanted to reduce Kentucky’s income tax despite not meeting the conditions this year, Cameron said in a statement, “I will be the Governor who eliminates the income tax. We will get it down to zero as soon as possible.”
According to Jason Bailey, executive director of the progressive-leaning Kentucky Center for Economic Policy, recent tax cuts have hampered the state’s ability to generate revenue.
With low unemployment and high inflation, Bailey said Kentucky’s tax revenues should be healthy. The fact that they aren’t is cause for future concern, Bailey said.
“Cutting the income tax, which is the largest source of revenue in the state, is incredibly expensive and the state’s budget needs are real,” Bailey said. “It’s hard to not fund things like disaster relief and schools and healthcare, and ultimately there weren’t enough cuts to make [more income tax cuts] possible.”
McDaniel, the Senate’s budget committee leader, said he would not support changing the conditions to approve a tax cut next year.He said he wants to hold parts of the budget constant so, as the economy grows, future tax cuts become more feasible. But he also said he doesn’t necessarily support expanding or increasing other taxes to make up the revenue from cutting income tax. In 2022, as part of the first income tax cut, legislators expanded sales tax to include more services.
“I don't know that I foresee us necessarily going much further than we have already with that, and certainly not a rate increase in that area,” McDaniel said.
Many states that have eliminated income tax, which McDaniel said is still his goal, have much higher sales tax than in Kentucky. Kentucky imposes a 6% sales tax, with no local sales taxes. According to the Tax Foundation, Tennessee collects a combined average of 9.55% combined local and state sales tax.
And the only other state that has eliminated its income tax is Alaska after the creation of the Trans-Alaska Pipeline created billions of dollars in new revenue.
Rep. Jason Petrie, a Republican who chairs the state House budget committee, said in a statement that the tax cut plan was created with “an abundance of caution” to fully eliminate the income tax.
“While several factors contributed to conditions not being met for a third consecutive cut in January 2025, the fiscal year-end report evidenced healthy revenue growth over prior years, moderated spending with the exception of addressing historical flooding in eastern Kentucky, a budget reserve at an historically high level and unprecedented high investment income from the reserve, which all point toward promising conditions for a next cut to the individual income tax in 2026,” Petrie said.
Bailey said he worries the cuts the legislature has already made to the income tax could put Kentucky in a bad position should the economy take a turn.
“Recessions come. Good times come and go,” Bailey said. “We know that at some point, we will need those revenues, and we will have a major source that is far less robust than it was before they began to cut it.”
