Kentucky Capitol (Getty Images)

FRANKFORT, Ky. – Kentucky can expect a big revenue surplus of $1.4 billion when the state’s current fiscal year ends on June 30.

That was the prediction Wednesday of a group of experts — called the Consensus Forecasting Group — which is charged with making official forecasts of revenue for budgeting purposes.

If the forecast proves close to accurate, it will mark the third consecutive fiscal year when tax revenues produced a huge surplus.

Also, if the forecast is accurate, it likely would allow the Kentucky General Assembly to consider another reduction in Kentucky’s income tax rate under a landmark tax bill known as House Bill 8 passed by lawmakers earlier this year.

As the surprising upward revenue trend of the past few years has shown, predicting how much tax money will flow into state coffers is a tricky business. Frank O’Connor, chairman of the forecasting group, noted Wednesday that factors far beyond Kentucky’s control — such as international events in Ukraine, China or elsewhere — can quickly throw any revenue forecast “out of whack.”

Still, Wednesday’s prediction was made with some confidence if only because receipts are already in hand for the first five months of the current fiscal year. And those receipts show solid growth.

The forecast

Here are the basic numbers from Wednesday’s forecast:

• In the current fiscal year (July 1, 2022 through June 30, 2023) General Fund revenues are expected to grow by 3.4% to a total of $15.2 billion. That would produce a surplus of $1.44 billion over the requirements for the current budget.
• In the following fiscal year (July 1, 2023 through June 30, 2024) revenues are expected to grow by 1.7% to hit a total of nearly $15.5 billion.

O’Connor, professor emeritus of economics at Eastern Kentucky University, said the forecast does not anticipate a recession in the next 18 months.

“This anticipates that the economy is going to continue to move along, not spectacularly but more gently,” O’Connor said. He said he was a bit more pessimistic than most members of the group.

The forecast does account for the loss of revenue that will result from a reduction in the income tax rate from 5% to 4.5% effective on Jan. 1 that was part of HB 8.

But it does not account for an additional reduction in the income tax rate under the terms of HB 8 that lawmakers seem likely to pass when they convene next month in regular session.

House Bill 8

The new law not only reduced the income tax rate from 5% to 4.5% effective Jan. 1, 2023, but it set up a complicated process in which the General Assembly could consider in each future year an additional cut of a half a percentage point in the income tax rate so long as two conditions were met showing that the General Fund enjoyed strong financial health in the prior fiscal year. Those conditions are:

• The balance in the state’s reserve fund (commonly called the ‘rainy day’ fund) at the end of the fiscal year is equal to at least 10% of total revenues in the prior year.
• The total revenue in the prior fiscal year exceeded spending in that prior year by at least an amount equal to what it would cost if the income tax rate was reduced by a full percentage point.

Those two conditions were met at the end of last fiscal year, allowing lawmakers to consider cutting the rate again in January. If it does so, then the income tax rate will drop to 4% effective Jan. 1, 2024.

Supporters of HB 8 say it is a responsible way to gradually reduce the income tax rate, making Kentucky more competitive with states that have low rates or no income tax at all.

They also hope that a year from now continued revenue growth will allow them to consider yet another cut in the rate (to 3.5% effective Jan. 1, 2025) when lawmakers convene in 2024.

Wednesday’s forecast of revenues for the 2022-23 fiscal year indicate that it is likely.

Republicans who hold super majorities in both the House and Senate say Wednesday’s forecast shows Kentucky remains on solid financial ground. They say the state can afford the income tax rate cut to 4% they plan to pass in January.

Sen. Chris McDaniel, the Taylor Mill Republican who chairs the Senate budget committee, said of the new forecast, “I’m glad to see it … We had a pretty good idea that things were holding up strong.”

McDaniel said he expected, but was not sure, that if the forecast proves true that the 2024 legislature will be eligible to consider yet another half percentage point to 3.5 percent. “A lot has to happen before this fiscal year ends, so it’s ?still to early to say,” McDaniel said. But he said because lawmakerscrafted HB 8 with the two safeguards to avoid revenue crashes as happened in Kansas a decade ago, he expected that the General Assembly will approve future rate reductions when those safeguards are met.

But critics warn that permanently cutting the income tax rate to 4% next year based on temporary good times, produced in large part by federal economic stimulus policies, will have damaging consequences for the state’s ability to fund public education and other programs in the not-too-distant future.

Jason Bailey, executive director of the Kentucky Center for Economic Policy, advocates for a more progressive tax system with higher income taxes and lower sales taxes. Bailey said that the anticipated surplus is largely a result of the legislature’s failure to adequately fund important parts of the current budget including teacher raises, child care and housing and other emergency needs resulting from weather disasters in the east and west.

He also warned that the legislature’s anticipated move next month to cut the income tax rate to 4% will be costly. “If that reduction is approved, then revenues for the 2024 fiscal year will not grow, but drop a bit,” Bailey said.