Prospects for tax cuts are greater than ever now that the U.S. Senate narrowly approved a GOP tax bill early Saturday morning. The House of Representatives passed another version of tax reform in November. Now, the two chambers must work out their differences to produce a final bill for President Trump to sign.
Unsurprisingly, Democrats and Republicans disagree about exactly who will win and who will lose with the tax plan. However, there's one group that stands a pretty good chance of benefiting: marijuana stocks. And it's not just because of the proposed reduction in corporate taxes from 35% to 20%. Here's the real reason why the GOP tax bill could be great news for marijuana stocks.
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A SALT shaker
Both the Senate and House tax bills eliminate federal deductions for state and local taxes (SALT). This includes all income and sales taxes, although a deduction for up to $10,000 in property taxes would remain in place. The impact of this change will be felt especially hard in high-tax states. For example, some residents of New York and New Jersey could see their federal taxes rise by as much as 7% to 8%.
Officials in several states with especially high tax rates are concerned that citizens hit worst by the change could opt to move to a state with lower taxes. That wouldn't be shocking. Texas and Florida, the two states with the greatest numeric population growth in 2016 don't have state income taxes. Four of the top 10 states with the highest percentage population growth in 2016 had no state income taxes.
There's a real possibility that current high-tax states decide to cut taxes -- or at least avoid raising taxes -- to prevent a greater exodus of taxpayers. In New Jersey, for example, plans to impose a new tax on millionaires appears to be in jeopardy, with the likelihood that federal deductions for state and local taxes will go away.
If these high-tax states reduce taxes, or forego plans to raise taxes, current services must be curtailed and/or new revenue sources must be found. And that's where marijuana comes into play. States with budget challenges will likely look increasingly to marijuana legalization.
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States on the watch list
This has already become something of a trend. The two states with the highest income taxes -- California and Oregon -- have already legalized recreational use of marijuana. So has the District of Columbia, which has the seventh-highest taxes in the nation.
Which states could be on the watch list for turning to legalized recreational marijuana if the GOP tax bill becomes law? Probably all of the remaining top 10 high-tax states should be included: Minnesota, Iowa, New Jersey, Vermont, New York, Hawaii, and Wisconsin.
Some of these states are already moving in the direction of fully legalized weed. New Jersey is at the top of the list. Governor-elect Phil Murphy pledged in his campaign to legalize recreational use of marijuana. If he fulfills that pledge, New Jersey would become the second-largest market for marijuana in the U.S. after California. And if New Jersey legalizes marijuana, it wouldn't be surprising for New York to follow suit.
At least one prominent official in Hawaii thinks his state will also legalize recreational marijuana. State senator Will Espero has predicted his state, which already allowed legal medical use of marijuana, will join others in full legalization of the drug. One main reason he gave was the need for additional revenue. And his prediction was made before the U.S. House and Senate passed their tax bills eliminating federal deductions for state and local taxes.
Marijuana stocks poised to benefit
If additional states legalize recreational marijuana, especially big states like New Jersey and New York, marijuana sales will explode. So which marijuana stocks are in position to benefit?
Scotts Miracle-Gro (SMG +1.83%) would probably enjoy nice growth from further legalization. The company is the go-to source for many marijuana growers for supplies that are essential in their operations. These supplies include fertilizer, hydroponic products, and lighting systems.
For investors hoping to ride the wave of marijuana legalization, but who don't want to take on too much risk, Scotts stock is one of the best plays on the market. While Scotts has seen nice growth with its expansion into the cannabis market, the company still makes more than four-fifths of its revenue from its consumer business, which sells lawn and garden products.
Another potential winner from more states legalizing recreational marijuana is Aphria (NASDAQOTH: APHQF). While most Canadian medical marijuana growers have stayed away from the U.S. market, Aphria has expanded operations in the U.S. The company has a foothold in Florida, and has plans to move into other states that have legalized medical marijuana. I would expect increased legalization of recreational marijuana in the U.S. to present another growth opportunity for Aphria.
But should investors jump aboard this so-called "green wave?" I recommend caution.
The odds are great that a version of the GOP tax cuts becomes law. I also suspect more states will look to marijuana legalization to generate additional revenue, in part because of the consequences of tax reform. However, marijuana remains illegal at the federal level -- and Attorney General Jeff Sessions could soon take steps to crack down in states that have legalized the drug. For investors wanting to profit from growth in marijuana, looking north to Canada, or to cannabinoid-focused biotechs, still appears to be the better moves right now.
