State revenue is forecast to decline as Kentucky lawmakers prepare another income tax cut

A projected dip in state tax collections appears not to have dimmed Republican leaders’ eagerness to again cut Kentucky’s income tax.

Kentucky Senate President Robert Stivers on Saturday said continuing to reduce the individual income tax rate — this time from  4% to 3.5% — remains the Republican supermajority’s No. 1 priority in the upcoming legislative session, reports WHAS11 News in Louisville, where Stivers spoke to the Kentucky Farm Bureau’s annual meeting.

Kentucky Senate President Robert Stivers (LRC Public Information)

Recently revised forecasts predict that Kentucky’s general fund revenue will decline by $213 million or 1.4% in fiscal year 2025. The projections were released Nov. 21 by the state budget director’s office in its quarterly report to state officials.

This would be only the fourth time in 50 years that general fund revenue has declined year over year, said Jason Bailey,  executive director of the Kentucky Center for Economic Policy. The other times were in 2001 and twice during the post-2008 Great Recession.

The turnaround follows several years of booming state revenues across the country fueled by the federal government’s pandemic aid. Kentucky is among many states that have cut taxes or are experiencing declines in revenue as the stimulus spending ends.

The surge in state revenues began to reverse a couple of years ago, according to a Pew research brief.“Annual inflation-adjusted state tax revenue fell in fiscal year 2023 from the prior year — the only time in at least 40 years that real revenue has declined outside of a recession. More than three dozen states saw their revenue shrink, including a steep decline in California that drove the breaking of the (revenue) wave, and in fiscal 2024, at least five states reported shortfalls.”

Policymakers prepared for the coming revenue declines by “prioritizing non-recurring expenditures and one-time tax cuts over long-term commitments,” says the issues brief from The Pew Charitable Trusts.

In Kentucky, however, lawmakers enacted permanent cuts in the individual income tax, first in 2022 and again in 2023.

The state budget director’s report attributes the largest reduction in the revenue forecast to tax credits due in 2025 that are part of a new pass-through tax that was paid in 2024. “This asynchronized timing inflated FY24 collections in the individual income tax and will reduce expected FY25 receipts,” the report says. 

Kentucky in fiscal year 2024 collected  $15.571 billion in general fund revenue and is projected to collect  $15.358 billion in the current fiscal year. Revenue now expected in 2025 is also below the estimates on which the state budget is built.

“General Fund revenue collections grew 1.3 percent in first quarter,” says the Kentucky budget director’s report. “Of the $49.3 million increase in revenues, the majority came from the corporation income tax, which rose by $266.6 million. A nearly equal decline in individual income tax revenue erased almost all of those gains. In the case of the individual income tax, all four of the major components of the tax receipts: withholding, net returns, estimated payments and the pass-through entity tax (PTET); declined by a combined $266.4 million.”

The corporate income tax is volatile, and the gains in revenue from it are not projected to continue at the first-quarter rate.

Meanwhile, revenue from the state sales tax grew 1.3% to $1.5 billion in the first quarter of fiscal 2025. The legislature in 2022 expanded the sales tax to cover more services in order to partially offset the income tax cut.

Sen. Chris McDaniel (LRC Public Information)

Kentucky Senate budget committee Chair Chris McDaniel R-Ryland Heights, last week said he’s keeping an eye on the projected revenue decline and called it manageable. He said the legislature remains “fully committed” to enabling “Kentuckians to retain more of their hard-earned income” by approving a bill early in the 2025 session lowering the individual income tax rate to 3.5%.

“We will closely monitor the latest revenue projections, but the figure is manageable within our current budget, even with the planned income tax reduction factored in,” McDaniel said in a statement. “We crafted a conservative budget to prepare for scenarios like this. The enacted budget includes a significant buffer for the reduction, which would take effect in January 2026, ensuring it does not impact FY 2025 or the first half of FY 2026.”

McDaniel also said, “Guided by 2022’s House Bill 8, we are dedicated to a cautious, responsible income tax reduction and disciplined long-term budgeting.”

Stivers in an interview with WHAS11 News also cited the “guardrails” in the 2022 law that established two fiscal benchmarks that the state must meet before the legislature can enact another half percent cut in the income tax.

Jason Bailey

In the current state budget, Bailey says, the legislature got around the guardrails by changing the rules to exclude billions of dollars in one-time spending from the calculation of whether the state had met the fiscal benchmarks. 

Bailey’s nonprofit organization has opposed cutting Kentucky’s income tax, a change it describes as skewed to benefit the affluent while reducing money to pay for education, health care, public worker salaries and benefits among other services.

“When you reduce the largest most productive revenue source, you’re going to have less money,” Bailey said of the expected decline in general fund revenue.

“No one has explained how they’re going to make up for the decline in revenue,” Bailey said.

Rep. Jason Petrie (LRC Public Information)

House budget Chair Jason Petrie, R-Elkton, on Monday issued a statement saying Kentucky can still afford to lower taxes and noted that the quarterly reports “are just that, data points and projections that are updated quarterly.”

He said “figures from November already show an uptick in revenue. Frankly, this reinforces why it is important to build a budget based on meeting the needs of Kentuckians rather than Frankfort spending every potential dollar of revenue. When we budget to our needs rather than our wants, we have an opportunity to invest surplus revenue while still lowering taxes for working Kentuckians. The budget we approved in the 2024 Regular Session includes an estimated $600 million more in revenue than spending, which then allows for deposits into the reserve account where it serves Kentuckians by both preparing the state for variations in revenue and allowing us to make further investments in priority areas like water infrastructure, roads, and pension liabilities.”

The Kentucky Chamber of Commerce and some Republicans have said the goal should be to gradually eliminate the state individual income tax but earlier this year Republican House Speaker David Osborne said  doing away with the income tax altogether is not a realistic goal. Osborne told the Lexington Herald-Leader that reducing the individual income tax rate below 3% would require dramatic increases in the state sales tax. 

Democratic Gov. Andy Beshear vetoed the bill cutting the income tax in 2022.  In 2023, campaigning for reelection, Beshear signed the measure although he said the legislature could have helped more Kentuckians by instead lowering the sales tax.

This story has been updated with comments from Rep. Jason Petrie, chair of the House budget committee.