The General Assembly reduced future revenues substantially this session by passing House Bill (HB) 1, a law that will further shrink Kentucky’s largest revenue source by cutting the state income tax rate, continuing a process that endangers the future of vital public services in the commonwealth. The legislature also phased out a local tax on the booming bourbon industry, harming the budgets of counties, cities, fire departments, and school districts where bourbon is produced, and shifting more education spending to the state budget.
On the spending side, lawmakers appropriated funds in a few areas – primarily to the crisis-ridden juvenile detention system – but released only part of the funds appropriated last year for public employee raises and state parks renovation. In total, the legislature maintained a fairly austere budget despite the ample availability of surplus dollars and Kentucky’s many needs – from the teacher shortage to replacing major federal pandemic funds soon to end for child care.
These decisions set the stage for a possible push to reduce the income tax rate again next year, which would further increase the risk of serious budget problems down the road.
Here are the major ways in which the legislature impacted the current and future budgets this session:
Severe reduction in future revenue through HB 1
The passage of HB 1 was by far the biggest budget-related decision of the 2023 General Assembly. The bill reduces the state income tax rate from 4.5% to 4% starting in 2024, which follows the reduction from 5% to 4.5% at the start of this year due to 2022’s HB 8.
Since the individual income tax is the largest state revenue source – providing 41% of the General Fund revenues prior to HB 8 – these cuts are very expensive. Reducing the rate to 4% will cost an estimated $1.3 billion annually compared to a 5% rate by fiscal year 2025, or more lost revenue than the state spends on all higher education institutions. And the cuts primarily benefit the wealthy, with 65% of the tax cuts going to the richest 20% of people.
When the legislature passed HB 8 last year, it also applied the sales tax to over 30 new services, including parking, moving costs, marketing services, wedding space, taxi cabs and family portraits. However, that expansion raised only $1 for every $12 the state will lose by moving to a 4% income tax. And the legislature reversed course this session by once again exempting marketing services from the sales tax through the passage of HB 360, along with other changes, further diminishing the small amount of revenue previously raised. HB 360 will likely result in a loss of $35 million annually, based on a fiscal note attached to an earlier version of the bill (and perhaps more, as HB 5 that passed the legislature on the last night of session removed social media from the new sales tax on telemarketing, benefitting Google and other tech companies). As shown in the graph below, the state has now cut $18 in taxes for every $1 it has raised the last couple of years.
The legislature is cutting taxes aggressively as though the current high level of tax receipts are permanent. But the economy is uniquely strong at the moment, with the Kentucky unemployment rate lower now than it’s been 98% of the months in the last 45 years. Inflation also remains high, which pushes up tax receipts because prices and wages are artificially elevated. Those factors will mask the full impact of these tax cuts in the short-term. But with the Federal Reserve aggressively raising interest rates, there is rising uncertainty about where the economy is headed and persistent concerns about a recession.
Nevertheless, in HB 360 the legislature included language that made clear that its intent is full elimination of the income tax in the coming years, wiping out nearly half of the state General Fund receipts. Next session they’ll consider a cut in the rate from 4% to 3.5%, which if enacted would increase the net cost of the tax changes to nearly $2 billion annually by fiscal year 2026, as shown below. That’s almost as much as the state spends now on core funding for all of our K-12 schools (known as base SEEK). Such a cut will create a painful reckoning in the not-too-distant future.
And to make understanding of the future risk more obscure, in HB 360 the legislature shortened the time horizon in which the independent Consensus Forecasting Group (CFG) will look at future revenues. The bill eliminates a planning report that previously came in August of odd-numbered years and provided a four-year estimate of future revenues. Now the CFG will do one fewer forecast each budget cycle, and no forecast will look further ahead than two years, making the long-term impacts of these tax cuts less clear.
The legislature passed HB 5, which will phase out the local property tax on bourbon held in inventory over the next 20 years. This tax exemption will deeply harm the budgets of counties and cities that face numerous costs in providing public services to the booming bourbon industry, including fire and emergency protection, roads, and water and sewer services. In addition, these localities must deal with the impact of whiskey fungus on quality of life in their communities. The bill also permanently limits what schools can receive from the industry, which will result in additional contributions by the entire state through the SEEK school funding formula. This tax giveaway is happening while the bourbon industry has never been more profitable. Distilleries are expanding rapidly across the state, with 400% growth over the last dozen years, and the tax has been no impediment.
The General Assembly also passed HB 551, which legalizes sports betting. However, that bill will raise only approximately $20 million a year (though no official fiscal note has been posted), less than the $35 million annually the state will lose through HB 360. The dollars from HB 551 are dedicated to the permanent pension fund, with 2.5% set aside for problem gambling assistance.
Some additional appropriations, primarily for the juvenile detention system
Despite $2.7 billion sitting in the state’s rainy day fund due to recent revenue surpluses, the legislature did little to provide additional appropriations for services. The biggest area for which new funds were appropriated is the juvenile detention system, which has been plagued by understaffing and incidences of mistreatment of the children housed in the system. Through HB3 and Senate Bill (SB) 162, the legislature appropriated $11.4 million this year and $64.2 million next year to the juvenile system and for matching raises for correctional officers, for a total of $75.6 million from the General Fund.
Those monies include:
- $38 million for salary increases in the departments of juvenile justice and corrections (this money comes from funds previously set aside in the permanent pension fund, rather than as a new appropriation)
- $3.4 million for renovation design of the Jefferson County Youth Detention Center, $10 million for the first round of renovation, and $2 million for operations of that facility
- $9.7 million for 146 to hire new juvenile justice workers
- $4.5 million to renovate and upgrade a former youth development center in Jefferson County to house younger children and those charged with less serious offenses
- $4 million for higher security at detention facilities including the construction of perimeter fences
- $1.8 million to hire a design expert to return to the regional juvenile detention model
- $1.5 million for a diversionary program for youth who are severely mentally ill
- Other monies for a new youth offender management system, to transport female youth, and for a study.
While some of those funds are necessary – particularly the salary increases for poorly-paid juvenile system employees – there is real concern that restored facilities in Jefferson County will increase the incentive for law enforcement, prosecutors and judges to detain more Louisville youth. That risks us moving backward on recent gains made in reducing juvenile incarceration. HB 3 also increases detention and its potential consequences by requiring a mandatory hold of up to 48 hours for youth charged with certain offenses and removing the confidentiality of juvenile records for three years for some offenses. The General Assembly took these actions without also making much larger needed investments in diversion and community supports for kids.
On the issue of state employee raises, the 2023 General Assembly allocated only a portion of the $200 million appropriated last year, which had been enough to provide a 12% across the board raise on top of last year’s 8% increase. Last year’s raise came after 14 years of low or no raises and severe problems attracting and retaining employees due to poor compensation. However, the 2023 General Assembly allocated only $89 million of the $200 million for a 6% raise through HB 444 (plus an extra $2,000 for each judicial branch employee). That leaves $110 million on the table until next session, which the legislature will decide how to use following a compensation study. Given current rates of inflation, HB 444 allows worker pay to continue treading water but does not allow Kentucky to gain any ground lost in the past.
Similarly, through House Joint Resolution 76 the legislature released only $66 million of $150 million appropriated last year for renovation and improvement of the state parks. The released monies are to go for campground upgrades, utility improvements and broadband installation. Through HB 553, the legislature then earmarked $7.5 million of the original $150 million to emergency repairs at Lake Barkley State Park, and $5.5 million for emergency repairs to Jenny Wiley State Park. However, that leaves $71 million unallocated. The legislature’s stated reason for not releasing the full funds was an unmet stipulation that the funds be spent with a plan that includes private and/or local partners with a 50% match, as opposed to letting the state continue operating the parks as they have for many decades.
The 2023 legislature transferred $20 million to a new Rural Housing Trust Fund to address the need for disaster housing from the western Kentucky tornadoes and eastern Kentucky floods. Rather than a new appropriation using the state’s large rainy day fund, the legislature transferred those dollars from existing funds established to deal with the many costs from those disasters, including for public infrastructure. A total of $10 million comes from the Eastern Kentucky Fund that will be dedicated for eastern Kentucky housing, and $10 million from the Western Kentucky Fund for housing in that region. The damage from the eastern Kentucky floods in particular is extensive, and federal dollars and personal and local resources will not come close to meeting the need. An estimate from the Ohio River Valley Institute and Appalachian Citizens Law Center puts the cost at $450 – $950 million for housing alone. While $10 million for eastern Kentucky housing this session is a much-needed start – and may be the first time the state has ever dedicated General Fund money to a housing fund – considerably more help will be needed.
Other significant budget changes include:
- $16.6 million for construction of the Bowling Green nursing home, costs for which have gone up substantially from the initial estimates due to inflation.
- Recalculation of K-12 SEEK funds to school districts using current attendance data, allowing fast-growing districts to avoid losing funds because of the way SEEK was temporarily calculated during the pandemic.
Note: analysis will be updated if the governor vetoes or line item vetos relevant appropriation and revenue bills passed on the session’s final two days.