Kentucky income tax cut boosts paychecks but raises concerns over future budget cuts

LOUISVILLE, Ky. (WDRB) — Kentuckians are seeing slightly larger paychecks this year after the state cut its income tax rate, but policy experts warn the move could lead to significant budget shortfalls and reduced funding for schools, health care and other public services.

Kentucky lowered its income tax rate by half a percentage point in 2025, dropping it from 4% to 3.5%. While the cut increases take-home pay for workers, it also reduces state revenue by more than $700 million each year.

“It is resulting in a large hole — a reduction in state revenues — that will impact our ability to fund schools, health care, infrastructure and other things,” said Jason Bailey, executive director of the Kentucky Center for Economic Policy.

The nonpartisan group recently released a report previewing Kentucky’s 2026–2028 state budget. Bailey said upcoming budget decisions will carry greater consequences as the state faces multiple financial pressures at once.

“The decisions that are going to be made about the budget are that much more consequential,” Bailey said.

In addition to lower income tax collections, job growth in Kentucky is slowing, and the state is responsible for higher federal cost shares for programs such as SNAP and Medicaid following recent changes in federal law.

The 2025 budget faced a $156 million shortfall.

To close that gap, most state agencies were required to cut spending by about 3%. Bailey said the next budget cycle could bring even deeper reductions.

“That could impact how big a kid’s class size is at school. It could impact whether services are available, like the senior meals program that was cut for a time earlier this year,” Bailey said.

Whether additional cuts are unavoidable remains an open question.

“Whether or not it’s inevitable depends on the willingness of the General Assembly to, one, draw down its reserves,” Bailey said.

Kentucky currently has a $3.7 billion rainy day fund. However, state law requires income taxes to continue declining — all the way to zero — if certain fiscal benchmarks are met.

“That is nearly half of the state budget that would be eliminated, so no one has laid out a plan as to how that math is going to add up,” Bailey said.

Lawmakers who support the tax cuts argue the policy will stimulate economic growth.

“It’s staying in the taxpayers’ pockets, which is better, I think, for the economy and certainly better for workers in Kentucky,” said state Rep. Jason Nemes.

State lawmakers must finalize the next budget by April 15th.

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