Americans Love Pot Taxes

But hyping cannabis cash as a source of government revenue is a bad idea.

Next fall California voters can expect to see at least one ballot initiative aimed at legalizing marijuana. At press time, the leading contender is called the Control, Regulate, and Tax Cannabis Act. A legalization initiative that has qualified for Nevada's 2016 ballot is called the Regulation and Taxation of Marijuana Act, which is also the name of proposed 2016 initiatives in Arizona and Massachusetts. In 2014 Alaskans approved "an Act to tax and regulate the production, sale, and use of marijuana," while Oregonians said yes to the Control, Regulation, and Taxation of Marijuana and Industrial Hemp Act. And before the Marijuana Policy Project (MPP) joined forces with Legalize Maine in October, the name of the MPP initiative in that state was—wait for it—the Regulation and Taxation of Marijuana Act. Notice a pattern?

Activists assume that the prospect of new government revenue makes legalization more appealing, and they seem to be right. In Colorado, the first jurisdiction in the world to legalize marijuana for recreational use, voters approved pot taxes three times in four years, each time by a bigger margin.

In 2012 Coloradans said yes to Amendment 64, which legalized marijuana, instructed the state legislature to impose an excise tax of up to 15 percent on it, and earmarked the first $40 million in revenue from that tax for public school repair and construction. The initiative passed with 55 percent of the vote.

A year later, after the Colorado General Assembly decided to impose the maximum authorized excise tax plus a special 10 percent sales tax on marijuana, the new levies were presented to voters, as required by Colorado's Taxpayer Bill of Rights (TABOR). The taxes passed with 65 percent of the vote.

In 2015 legislators realized they would have to return all of the money raised by the new marijuana taxes unless voters gave them permission to keep it. That referendum also was required by TABOR, which mandates tax refunds when total state revenue is higher than projected. This time 69 percent of voters said yes to funding government programs with cash confiscated from cannabis consumers.

Ordinarily people are not all that keen on handing over more of their hard-earned money to the government. But in this case most of the people voting for the levies won't be paying them. According to federal survey data, only 13 percent of Colorado residents use marijuana. In 2013, on the same day Colorado voters approved marijuana taxes by a margin of nearly 2 to 1, they rejected an income tax increase by exactly the same lopsided margin. Both measures were aimed at funding public schools.

As with tobacco taxes, shifting the cost of government services to other people is perennially appealing. But that is not the whole story here. In Colorado the marijuana industry urged voters to approve the hefty taxes proposed by the legislature, seeing them as a token of legitimacy and a safeguard against legislative backsliding. Once the cannabis cash started flowing into the state treasury, marijuana merchants figured, they would become a revenue source to be protected rather than a nuisance to be curbed.

Although that expectation may turn out to be accurate, the prominence of taxes in the debate about marijuana legalization has created a misleading impression of their fiscal significance. While legislators always welcome extra money, the tax revenue generated by the newly legal cannabis industry does not amount to much as a share of government spending and probably never will. Furthermore, attempts to maximize the government's take by imposing heavy taxes can easily backfire by making it harder for legal cannabusinesses to replace their black-market predecessors.

Big Burden, Small Return

In February 2014, a month after legal recreational pot sales began in Colorado, Gov. John Hickenlooper projected that marijuana taxes would raise $118 million for the state the following fiscal year. The Colorado Legislative Council (CLC), which advises the Colorado General Assembly, was more conservative, putting the figure at $55 million, less than half what Hickenlooper anticipated. When the fiscal year ended last June, the actual haul was $66 million, which represented 0.3 percent of the state's $23.1 billion budget.

Even if we throw in revenue from the 2.9 percent standard state sales tax and the fees that marijuana businesses pay to their regulators at the Colorado Department of Revenue, we are still talking about substantially less than 1 percent of state spending. In September the CLC projected that revenue from marijuana-specific taxes will be $75 million this fiscal year, $88 million in 2016–17, and $83 million in 2017–18.

Local governments also raise money from marijuana sales. In Denver, where marijuana merchants are concentrated, cannabis consumers pay a total of 8.25 percent in local taxes, which includes both standard sales taxes and a 3.5 percent pot-specific levy that voters approved in 2013. That's on top of the state's 15 percent excise tax, 10 percent special sales tax, and 2.9 percent standard sales tax. Local taxes on marijuana sales raised $10.6 million for Denver in 2014—0.6 percent of the city's $1.7 billion budget.

Although Colorado's marijuana tax revenues are unimpressive, all those taxes add up to a big burden on consumers. Amendment 64, which is now part of the state constitution, says marijuana should be "taxed in a manner similar to alcohol." But in practice Colorado is taxing it much more heavily, which helps account for the fact, trumpeted by marijuana tax enthusiasts, that the state's pot-specific revenue last fiscal year exceeded its alcohol-specific revenue: $65 million vs. $42 million.

In September, after the Department of Revenue released those figures, Mason Tvert, an organizer of Amendment 64 who is now MPP's communications director, crowed that "marijuana taxes have been incredibly productive over the past year." That's true when you consider how much more popular beer, wine, and liquor are than cannabis. But the comparison dramatically demonstrates Colorado's failure to tax marijuana "in a manner similar to alcohol."

The heavy taxes help explain why a black market in marijuana persists in Colorado more than three years after the drug was legalized. According to state estimates, licensed stores provided about 60 percent of the cannabis that Coloradans consumed in 2014, with the rest coming from home growers, untaxed caregivers, or illegal dealers. No one really knows the true breakdown, since the calculation relies on an iffy estimate of total cannabis consumption. But those missing marijuana buyers troubled legislators enough that they decided to reduce the special sales tax on marijuana from 10 percent to 8 percent as of July 2017. Presumably they understand that setting taxes too high can reduce total collections by driving consumers away from state-licensed stores, in the process undermining one of Amendment 64's main goals: moving the marijuana business out of the shadows.

Half a Billion, 62 Million, Whatever

The problem is more serious in Washington, where taxes are higher. I-502, the marijuana initiative that voters approved in 2012, imposed a 25 percent tax at each of three levels: sales from growers to processors, from processors to retailers, and from retailers to consumers. In 2015 the legislature replaced that three-tier system with a single 37 percent tax on retail sales. The change allows marijuana businesses to avoid paying federal income tax on money collected by the state. Previously the retail-level tax was officially imposed on the merchant, making it a business expense, which marijuana businesses are not allowed to deduct thanks to a provision of the Internal Revenue Code aimed at black-market drug dealers. Now the tax is officially imposed on the buyer, so it is not counted as part of the merchant's revenue.

The consolidation of Washington's marijuana taxes did not make them any lighter, and now the burden is clearer to consumers. The 37 percent marijuana-specific tax is in addition to standard state and local sales taxes, which in Seattle total 9.6 percent. Hence taxes alone make marijuana purchased from state-licensed stores in that city nearly 50 percent more expensive than it would otherwise be. Add the expenses imposed by state regulation, and you can understand why legal cannabusinesses have trouble competing on price with untaxed, unregulated pot dealers.

In 2015 legislators sought to reduce competition with state-licensed outlets by enacting a law that shuts down Washington's many medical marijuana dispensaries, which existed before I-502, unless they can obtain licenses from the Liquor and Cannabis Board (LCB) and, not incidentally, start paying taxes. That still leaves black-market dealers, who seem to be thriving. The LCB established quotas for marijuana production based on the assumption that state-licensed stores would initially capture 25 percent of the market. Last July, a year after legal recreational sales began in Washington, LCB Deputy Director Randy Simmons put the stores' share of total cannabis consumption at 10 percent.

Washington's take from marijuana taxes in its first year of legal recreational sales ($62 million) nevertheless exceeded Colorado's ($44 million), presumably because Washington's market is larger and its tax rate is higher. That revenue comparison is based on Colorado's collections from January 1, 2014, when sales started there, through December 31, 2014, and Washington's collections from July 1, 2014, when sales started there, through June 30, 2015. If we instead look at revenues in both states for fiscal year 2014–15, Colorado comes out a bit ahead: $66 million vs. $62 million.

In any case, Washington's revenue at this point—which amounts to about 0.2 percent of total state spending, even if you include the standard sales tax—is a far cry from the I-502 campaign's talk of "more than a half billion dollars in new revenue annually" (which would be about 1.5 percent of state spending). Mark Cooke, campaign policy director at the ACLU of Washington, which was a big supporter of I-502, thinks that prediction could still come true. "Ten or 15 years down the road," he told The Seattle Times last July, "that may be accurate." Washington's Office of Financial Management projects that state revenue from marijuana sales will total $1 billion during the next four years, or about 0.6 percent of projected spending.

Seattle City Attorney Pete Holmes, another I-502 backer, is bullish about the future of marijuana taxes in Washington. "When we get to full capacity and displace the illegal market," he said in an interview with the Times, "imagine what revenues will be." But displacing the illegal market may be difficult as long as taxes account for nearly a third of marijuana's retail price.

Cross-Border Competition

Oregon, where voters approved a legalization initiative known as Measure 91 in 2014, is taking a different approach. Measure 91 called for taxes of $35 per ounce on marijuana flowers, $10 per ounce on marijuana leaves, and $5 per immature marijuana plant, to be paid by the producer. In 2015 the state legislature replaced that scheme with a 17 percent sales tax; local governments are allowed to impose additional taxes of 3 percent or less.

Those taxes do not kick in until stores licensed by the Oregon Liquor Control Commission begin operating in late 2016. In the meantime, pre-existing medical marijuana dispensaries have been allowed to serve recreational consumers since October 1. From then until the end of the year, no tax was collected on marijuana sales—not even a standard sales tax, since Oregon does not have one. A temporary 25 percent marijuana sales tax took effect on January 1, 2016.

That tax-free period had a dramatic impact on marijuana stores across the border in southwestern Washington. KATU, the ABC station in Portland, reported in November that three pot shops in Vancouver, a Washington city 15 minutes from Portland, had lost one-third to one-half of their revenue since the beginning of October. Even with Oregon collecting marijuana taxes, there will be a big gap between the states. In Vancouver cannabis buyers pay a 37 percent state marijuana tax plus 8.4 percent in standard sales taxes, for a total of more than 45 percent. In Portland cannabis buyers will eventually pay, at most, a total of 20 percent—less than half as much. Oregon stores will continue to have a substantial price advantage as long as Washington insists on taxing marijuana so heavily.

Marijuana taxes in Alaska, where voters also approved legalization in 2014, are higher than Oregon's but lower than Washington's: $50 per ounce sold by growers. The marijuana initiative that will be on Nevada's ballot next November includes a 15 percent excise tax on the "fair market value" of marijuana sold by growers. The leading California initiative authorizes three levels of taxation: $2 per square foot of canopy on commercial growers, $15 per ounce on the first sale, and a 10 percent retail sales tax. The Arizona initiative includes a 15 percent tax on retail sales, while the Maine initiative imposes a 10 percent sales tax. The proposed sales tax in Massachusetts is even lower: 3.75 percent for the state, plus up to 2 percent for local governments.

Justice Is Its Own Reward

Although marijuana taxes continue to figure prominently in debates about legalization, most of these initiatives include levies substantially lighter than the ones imposed by Colorado and Washington. It looks like marijuana activists have realized that, nice as new revenue might be, it is much less important than eliminating the black market, which is one of legalization's main selling points. There is also an issue of consistency here: After all the talk about how marijuana is no worse than alcohol in moral terms and better in terms of health hazards, it hardly seems fair or reasonable to impose taxes that imply it's much worse.

Dangling the promise of found money in front of voters tends to undermine the moral case against pot prohibition. If it is fundamentally unjust to treat cannabis consumers and the people who supply them as criminals, no bribes should be necessary to right that wrong. After all, same-sex marriage proponents did not argue that states should treat gay and straight couples equally because of the sales tax bounty that would result from a flood of wedding-related purchases.

Gov. Hickenlooper, who is no fan of Colorado's Amendment 64, recently argued that "this whole notion of legalizing recreational marijuana should not be addressed and…analyzed as 'this is a source of new revenue,' that this is going to help us build roads or this is going to help us expand other worthy programs." He's right. Such expectations are not only exaggerated; they're beside the point.