Kentucky’s income tax rate will not drop to 3.5% in 2025 as planned.

In 2022, the General Assembly began a march toward elimination of Kentucky’s income tax. Republican state legislators have argued that a lower income tax will make the state more competitive with its bordering states’ economies.

Democrats have said that Kentucky cannot afford to lose income tax revenue, and that it will lead to cutbacks on key state services.

On Jan. 1, 2023, the income tax rate made its first drop, from 5% to 4.5%.

The 2023 General Assembly passed a law to continue this incremental half-percentage point drop with a decrease to 4% income tax rate beginning Jan. 1, 2024.

The legislation enacted a trigger mechanism that would decrease the income tax rate another half percentage point each year until reached zero, as long as two budgetary conditions were met.

However, one of those conditions has not been met for FY23, according to a recent letter from the State Budget Director John Hicks.

The first condition of the income tax drop is that the amount of money in the Budget Reserve Trust Fund—commonly called the rainy day fund—has to be at least 10% of General Fund moneys, or the state’s revenue in a given fiscal year.

That condition was met, with a rainy day fund that is 24.5% of the General Fund revenue for FY23.

The second condition is a bit more complicated.

It involves General Fund appropriations, the amount of money the state is spending in a given fiscal year, and the individual income tax equivalent, the cost of a one percentage point reduction in the income tax rate.

If the sum of the General Fund appropriations and the individual income tax equivalent is less than General Fund revenues in a given fiscal year, then the tax rate is allowed to drop.

But if not, the General Assembly must wait another year to try again.

In FY23, the General Fund revenue totals to $15.14 billion.

But the General Fund appropriations are $14.35 billion and the cost of a one percentage point reduction in the income tax would be $1.23 billion, adding to $15.58 billion.

Therefore, a gap of $434 million stands in the General Assembly’s planned tax reduction from 4% to 3.5% beginning in 2025.

Kentucky Center for Economy Policy said that this news is a bad sign for the majority Republican legislature’s plans to eliminate the income tax.

In a statement, KyPolicy said that the income tax used to be Kentucky’s largest revenue source, funding 41% of the budget.

“Failing to meet the trigger at a time when it’s easiest to do so because of national economic conditions should send a clear message,” said Jason Bailey, KyPolicy Executive Director.

“It’s time to put a halt to further cuts and focus on the education, health and infrastructure investments communities must have in order to thrive.”

Senate Budget Chair Chris McDaniel, R-Ryland Heights, said in a statement that the legislation was working as intended, and that by December 2024, the 2023 and 2024 income tax reductions will have saved Kentucky taxpayers $1.8 billion. 

“Naysayers have often criticized comprehensive tax reform and the Kentucky General Assembly’s responsible lowering of working Kentuckians’ income taxes,” McDaniel said. “However, this development is evidence we appropriately weighed the importance of lowering taxes with the need for critical government functions such as education, corrections, and more.”

Gov. Andy Beshear also responded to the news at his weekly presser Thursday.

He said that the legislature created a “responsible framework” for reducing the income tax, and that his administration’s job is simply to report the budgetary numbers.

Beshear said that completely eliminating the income tax would require a “massive” increase in Kentucky’s sales tax, which would likely include food and medicine.

“You cannot go to zero percent income tax like Daniel Cameron has pushed without having a massive sales tax increase, which is what he would do, or the gutting of K-12 education, higher education and health care coverage for millions of Kentuckians,” he said.

Beshear was referring to Cameron’s economic plan, debuted Wednesday, that included a continued push to eliminate the income tax.