Why Colorado's Marijuana Legalization Initiative Could Be In Vain

State policy makers need to develop sensible marijuana regulations, not destructive ones.

On Election Day, voters in Colorado and Washington passed ballot measures legalizing marijuana, setting the stage for a new, legal commercial marijuana market in both states. These electoral victories confirm what polling firms like Gallup had already discovered: A majority of Americans support legalizing marijuana. The "marijuana majority" (a moniker derived from an organization of the same name) now hopes for successful implementation, but it's not the only one.

Cash strapped states no doubt are salivating at the potential deluge of new revenue. (Both measures are unique, so for clarity this piece will focus on Colorado.) The Colorado Center on Law and Policy estimates Colorado's Amendment 64 will generate $60 million annually, a figure that could double after 2017. This fiscal bonanza would come primarily from new tax revenue generated from excise taxes on wholesalers and new state and local sales taxes—but also avoided costs to the criminal justice system.

It would be a mistake for states to think that they can restore fiscal balance by raising revenues from marijuana legalization rather than curbing their spending addiction. That said, these revenues will materialize only if legalization is done right.

Even if the federal government allows the states to go forward unmolested—a big "if" given the Obama administration's demonstrated zeal to bust medicinal marijuana shops—there are a number of regulatory and tax issues that the states must first settle to create a functioning marijuana market. This won't be easy, but it is vitally important that policy makers make the right calls lest the whole legalization movement gets derailed.

On the regulatory front, the key would be to regulate marijuana like alcohol and avoid over-regulation. Many of the regulations are either necessary or unavoidable. These include: preventing minors from buying marijuana, providing consumers with product labeling, and restricting advertising, among other things.

One thorny issue that every legalization effort will confront concerns determining what precisely counts as driving under the influence of marijuana? Colorado's initiative clearly states that driving under the influence will remain illegal and it does not task the state with addressing the issue further. However, some Colorado lawmakers have pushed for automatic convictions for drivers with five nano grams of tetrahydrocannabinol (THC)—the main psychoactive ingredient in marijuana—per milliliter of blood.

But this is problematic given that THC can remain in the user's system in small amounts for days or weeks after consumption. Hence, recreational consumers who are not currently under the influence could be unfairly targeted if policy makers choose crude testing that can't differentiate past use from present intoxication. This is justifiably prompting civil liberty concerns.

Beyond regulation, Colorado policy makers also need to grapple with peculiar wrinkles in their own laws before they can impose excise taxes on marijuana. The initiative authorizes the legislature to enact an excise tax on wholesale marijuana producers of up to 15 percent. The first $40 million of that excise tax revenue is slated for the school capital construction fund annually, a feature that prompted justifiable criticism from the "center-right" coalition. But the Taxpayer's Bill of Rights (TABOR) amendment to the Colorado constitution requires voters to approve all tax increases. Colorado's attorney general has indicated the language in Amendment 64 "did not comply" with TABOR. Hence, separate voter approval of the excise tax is likely, creating some political risk for implementation.

What's more, all of this has to be sorted out by January 2014. That's because if the state fails to start issuing licenses by then as required, the law automatically authorizes local governments to issue their own regulations and licenses after 90 days. It is far from clear whether local governments will be able to navigate implementation if the state can't, but this is an intentional safety valve built into the law to allow the initiative to move forward in case of political intransigence. If it comes to that, the result may be disjointed local regulations that slow the market's development. Confusing or uncertain regulations will discourage entrepreneurs from investing the capital necessary to open new businesses, jeopardizing the expected revenues as well.

Another way in which these revenues might leak out of the state's grasp is if the state fails to establish a proper regulatory and tax framework for legal channels in a timely fashion: The amendment allows adults over 21 to possess one ounce of marijuana and exchange that amount without remuneration. It also allows possession of up to six plants. (This provision was not included in Washington state's initiative.) This opens the door for legal non-revenue generating channels. One could even imagine sophisticated non-profit co-op networks of home growers largely operating off the books.

But there are also illegal channels to worry about if taxes are too high or regulations are too burdensome. Then, despite legalization, it will be hard to dislodge the existing black market which has everything in place, including production, supply chain management, and distribution—all of which already puts legitimate businesses at a distinct disadvantage.

Colorado and Washington's marijuana legalization initiatives are huge steps forward toward a sensible drug policy that ends the horrible damage that the drug war has inflicted on the liberty and property of Americans engaged in an activity that hurts no one. They also hold the promise of opening up new revenue streams while reducing spending on drug enforcement, which is especially appealing to policy makers in a down economy.

All of this will be jeopardized if Colorado and Washington officials botch implementation. But if they develop sensible regulations and create a functioning marijuana market, they will become models for the rest of the country. The stakes couldn't be higher—for them and everyone else.

An earlier version of this article appeared at Real Clear Markets.