Justice Department Declines to Endorse Pot Taxes (Except by Implication)

USDOJUSDOJYesterday Rob Corry, head of the campaign against Colorado's proposed marijuana taxes, got a response from U.S. Attorney John Walsh to his October 9 letter asking about the Justice Department's position on the issue. "The U.S. Attorney's Office does not take a position on state initiatives," wrote Jeff Dorschner, Walsh's spokesman. "However, the Department of Justice has made it clear in recent guidance on marijuana enforcement that there is an overriding importance of a strong and effective state regulatory system with sufficient resources to be effective in practice, not just on paper."

Although Walsh is not endorsing Proposition AA, which would authorize a 15 percent excise tax and a special sales tax of up to 15 percent, Dorschner's response lends support to the argument that approving the initiative will help discourage federal interference with marijuana legalization in Colorado. Brian Vicente, chairman of the pro-AA Committee for Responsible Regulation, puts it this way in a recent Denver Post op-ed piece:

In a memo issued by Deputy Attorney General James Cole last month, detailing how the federal government will respond to the marijuana measures passed in Colorado and Washington, he wrote that a "robust" system of regulations could address federal enforcement priorities by "replacing an illicit marijuana trade that funds criminal enterprises with a tightly regulated market in which revenues are tracked and accounted for."

But the U.S. Department of Justice was not giving Colorado carte blanche to move forward with its regulated system. Rather, the memo provided a stern warning that the federal government would be monitoring the state to ensure that there were "necessary resources" to enforce the regulations that exist.

The acknowledgment of the benefits of regulating marijuana is a dramatic shift by federal law enforcement officials, and we are grateful for the respect they have given our state and its voters. In return, we are firmly committed to respecting their concerns by ensuring that the necessary resources they desire are available.

The Committee for Responsible Regulation warns that "without the funding from Prop AA, the Colorado marijuana industry will be in peril, and without the proper resources to establish a strict regulatory system, at risk of federal prosecution." It calls Proposition AA "an opportunity to show the federal government that Colorado is fully capable of responsible, effective, and reasonable regulation of retail marijuana," adding that "the passage of Proposition AA will ensure that Colorado has the necessary resources to implement this robust regulatory structure."

The committee also responds to Corry's argument that the taxes authorized by Proposition AA (and Question 2A, a Denver initiative that would allow a municipal sales tax of up to 15 percent) will perpetuate the black market, thereby undermining effective regulation:

It is unlikely. The combined taxes on retail marijuana sales will add about 22 percent to the retail cost of marijuana products. This is a relatively small premium to pay for the convenience of purchasing high quality, tested, and labeled marijuana and marijuana products from regulated stores. By comparison, the total tax on marijuana and marijuana products in Colorado is far lower than in the state of Washington, where the combined taxes may add 35-40 percent to the retail cost.

That 22 percent estimate tracks a projection that researchers at Colorado State University (CSU) made in a report last April, based on an excise tax of 15 percent, a special sales tax of 15 percent, and the standard 2.9 percent statewide sales tax. It does not take into account local sales taxes, which in Denver (the center of the cannabis industry) total around 5 percent, or Denver's proposed municipal sales tax, which could end up being as high as 15 percent. Furthermore, as I mentioned yesterday, the CSU estimate is based on questionable assumptions about production cost and markup (as well as an apparent error in applying the excise tax to the premarkup production cost rather than the wholesale price, although that does not matter as much). Projections by BOTEC, the consulting firm hired by Washington's marijuana regulators, assume substantially higher production costs, which have an important impact on the post-tax retail price. 

The Committee for Responsible Regulation says Washington's combined taxes "may add 35-40 percent to the retail cost," but that is not quite right, at least according to BOTEC's numbers. BOTEC calculates that taxes will represent about 37 percent of the retail price, which is not the same as raising the retail price by 37 percent. Rather, in that scenario, the taxes raise the retail price by 58 percent. That makes Colorado's taxes look even more modest by comparison. But if you include local as well as state taxes, the combined impact in Denver, where most of the state-licensed pot stores will be located, is to raise the retail price by around 43 percent, or almost twice the number cited by Proposition AA's supporters. And if you assume a production cost of $900 a pound (as BOTEC does in one scenario) rather than the $600 estimate used in the CSU report, the after-tax price for marijuana in Denver could be more than $300 an ounce, compared to an average price of $238 reported by current buyers of high-quality marijuana in Colorado. So prices for legal marijuana in Denver could very well end up being substantially higher than black-market prices if the proposed taxes are all approved by voters next month and set at the maximum authorized rates.

If that happens, will the Colorado General Assembly and the Denver City Council lower rates to help legal pot shops compete with black-market suppliers? Or will they be tempted to keep taxes high in the hope of generating more revenue? Reducing rates might actually boost revenue by allowing licensed sellers to attract more business. But will legislators be wise enough to take advantage of that dynamic, especially with two levels of government competing for revenue and each reaping some of the benefit from the other's tax cuts? Proposition AA's backers, which include many of the dispensaries that next year will be serving the recreational market, are putting a lot of trust in politicians' ability to learn from experience and anticipate unintended consequences.

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