The Republican supermajority of the Kentucky General Assembly passed a landmark bill in 2022 to incrementally cut the state’s individual income tax rate until it is eventually eliminated.
The method of cutting this tax rate is quite complicated, as it set up a trigger mechanism that would allow the rate to be lowered by half a percentage point each year, so long as the state’s revenue, spending and budget reserve trust fund were at certain levels.
The state hit both triggers in the 2022 fiscal year concluding at the end of June, missed one of the triggers in mid-2023, then hit both triggers again at the conclusion of the 2024 fiscal year this summer.
Because the budget triggers were hit this summer, legislators in the 2025 session are expected to quickly approve the newest incremental reduction from 4% to 3.5%, which will go into effect in the 2026 calendar year.
Here’s a closer look at how this tax cut trigger mechanism works, and how it has been implemented so far.
Two trigger formulas on revenue, spending and rainy day fund
The tax cut mechanism of House Bill 8 in 2022 allowed the individual income tax rate to be lowered by half a percentage point in a future calendar year if General Fund revenues, General Fund spending and the budget reserve trust fund are at certain amounts at the end of a fiscal year, which concludes June 30.
For example, Kentucky hit the budget triggers in the 2024 fiscal year ending this summer, so legislators in the 2025 session are clear to approve the decrease in the tax rate to 3.5% starting in January 2026.
Under the law, the tax rate can be lowered if both of the following budget conditions are met:
- the budget reserve trust fund at the end of the fiscal year is at least 10% of the General Fund revenue;
- if the tax rate had been one percentage point lower in that fiscal year, the General Fund revenue would have been more than the General Fund spending.
Here’s how these trigger mechanism formulas would work in a hypothetical example.
Let’s say that in fiscal year 1, General Fund revenue is $15 billion. So long as the budget reserve trust fund — often referred to as the state’s rainy day fund — is greater than $1.5 billion (10% of these revenues), the first budget trigger will have been met.
Let’s also say that in fiscal year 1, the current individual income tax rate is 4%. With General Fund revenue at $15 billion, let’s say the amount of that coming in from the individual income tax is $6 billion. If the tax rate would have been 3% — 25% lower than 4% — this would have meant $1.5 billion less in revenue from the income tax, putting total General Fund revenue at $13.5 billion. So long as total General Fund spending in that fiscal year was less than $13.5 billion, the second trigger would be met. If greater, the second trigger would not be met and the tax rate would not be decreased by half a percentage point in a future calendar year.
This second trigger was not met in the 2023 fiscal year, when General Fund spending was $435 million more than what General Fund revenue would have been if the income tax rate was a percentage point lower.
Certain spending can be exempt from trigger mechanism
One caveat to this second trigger mechanism is that under House Bill 8, spending to pay down the debt of the public pension system beyond what is actuarially required does not count towards the spending trigger. For example, if there is $15 billion in General Fund spending in a fiscal year, but $2 billion of that are public pension contributions above what is required by law, the spending trigger total would be $13 billion.
Yet another caveat to the second trigger mechanism is the language that Republicans included in a large spending bill during the 2024 session to exempt other spending from counting towards this trigger.
House Bill 1 directed $2.7 billion of spending from the state’s budget reserve trust fund to various projects, but added “notwithstanding” language to disregard the existing trigger law and say its non-pension appropriations — $2.5 billion — did not count as General Fund spending under this trigger mechanism.
Such a maneuver clearly improved the odds of hitting the tax cut triggers in the summer of 2024, which left-leaning think tank Kentucky Center for Economic Policy characterized as “moving the goalposts” of the trigger law in order to force through a tax cut.
Rationale of trigger system is to not cut taxes too fast
Passing the tax cut bill in 2022, Republicans said their desire to get the individual income tax rate down to zero was part of their goal to move toward taxing consumption instead of production. They were largely inspired by the tax policy in Tennessee, whose lack of an individual income tax they credited for the state’s relative economic success and population growth.
The mechanism they put in place to make these cuts incrementally and only if certain budget conditions were met was also partly inspired by another state — but not their success.
Kansas enacted large tax cuts in 2012 and 2013, but did not experience the economic growth they were hoping for in the following years. State revenues dramatically decreased, causing emergency cuts to public education and other government services, as well as downgrades to their bond ratings. In 2017, the Kansas legislature repealed and rolled back the tax cuts.
Republicans in Frankfort said the tax cut trigger mechanism of HB 8 would prevent Kentucky from following in the footsteps of Kansas — making the cuts gradually and only when budget conditions were favorable to them.
Sen. Chris McDaniel, the GOP chairman of the budget committee from Ryland Heights, said in December the trigger system is working as the deliberate and long term project they intended to be, citing the 2023 failure to hit the trigger and alluding to Kansas.
“We've seen examples of other states where they were overly aggressive with what they did, and it not only forced them to make some very difficult mid-cycle decisions, but it also really derailed a lot of their efforts in reducing the income tax because they lost public opinion,” McDaniel said.
Tax cut trigger critics and outlook
Critics of the tax cut mechanism say that it still cuts the income tax too quickly, which is likely to jeopardize vital government services or be made up for in future years by the regressive strategy of increasing sales taxes.
The Kentucky Center for Economic Policy is among the groups arguing that the system’s income tax cuts are permanent, while the flush revenue, budget surpluses and rainy day funds of the past few years — largely made possible by the massive federal spending of the COVID-19 era — are only temporary.
While Republican lawmakers still say they want the tax rate to hit 0%, some acknowledge that the economic and budget forecast ahead shows the chances of hitting tax cuts triggers in the next couple of years is low, barring dramatic changes.
“Until we do a few more things, it will be more difficult to reach further points of time that we can hit those triggers,” said GOP Senate President Robert Stivers in December. “But I do believe it is attainable (to hit a 0% tax rate).”
GOP House Speaker David Osborne shared that viewpoint, singling out state Medicaid spending as “the number one obstacle” to hitting the tax cut triggers in future years. He said Kentucky’s expanding Medicaid enrollment will have a “dramatic” impact on the state budget going forward “unless we figure out a way to get it under control.”
State government and politics reporting is supported in part by the Corporation for Public Broadcasting.
