Call it the story of the decade if you like, but the marijuana movement appears to be an unstoppable force at the moment.
Marijuana blazes ahead
Roughly 20 years ago, the idea of marijuana being legalized on any level would have been laughable. There wasn't a state that allowed medical or recreational marijuana to be sold, and only one quarter of respondents in Gallup's mid-1990s survey maintained a favorable view of the illegal drug. Today, there are just shy of two-dozen states that have legalized marijuana for medicinal purposes, and four states (Oregon, Washington, Alaska, and Colorado) along with Washington, D.C., are experimenting with the legalization of recreational marijuana.
We've witnessed a major shift in how the American public views marijuana. Practically all major national polls now show that a slim majority of respondents are in favor of legalizing marijuana, or share a favorable view of the drug. An even greater percentage want to see it approved for medical uses.
States have also taken a markedly different approach. Once viewed with contempt, marijuana is now looked upon as a fresh tax revenue source. Revenue generated from taxing marijuana could be used to support jobs, maintain in-state infrastructure, or even to support education.
Marijuana sales hit a milestone in Colorado
The first state to officially begin selling recreation-legal marijuana was Colorado at the beginning of 2014. As should be no surprise, having the ability to sell recreational marijuana for a longer period of time than Washington (which began in July 2014) and Oregon (which kicked off marijuana sales a few weeks ago) has allowed Colorado to rack up pot sales at a faster pace than the other states -- so much so that Colorado hit a marijuana milestone in August.
According to a column from the Denver Post, August represented the first month in the more than one-and-a-half-year history of recreational marijuana sales in Colorado that total monthly combined sales of recreational and medical marijuana topped the $100 million mark. In August, $59.2 million was sold in recreational marijuana, with another $41.3 million coming from medical marijuana. It's also been exactly a year since recreational marijuana sales surpassed medical marijuana sales for the first time in Colorado.
In Colorado, the three taxes associated with marijuana have raised an impressive $86.7 million through just the first eight months. These taxes include a 2.9% sales tax, a 10% special sales tax specifically for marijuana, and a 15% excise tax. This excise tax is what generates funds that are earmarked for Colorado's education system, assuming Colorado voters choose to use the tax revenue generated from marijuana for education as opposed to returning it to growers and other marijuana businesses in the upcoming November election.
With $639.4 million in combined marijuana sales through August in Colorado, and Washington and Oregon both ramping up their sales, the legal marijuana business will likely total more than $1 billion in 2015 for the first time ever.
Growing marijuana sales expose three big problems
Unfortunately, as marijuana sales lift off the ground, major problems are being exposed on the financial side of the business, which could wind up stunting growth in the industry, or worse yet, compromising its long-term outlook.
1. Minimal access to basic banking services
The first major dilemma is that financial institutions, for the most part, don't want any part of the marijuana industry. Based on data from the U.S. Treasury Department, just 220 of more than 7,600 banks, or about 3% of national banks, are willing to deal with marijuana-based businesses. The reason banks are keeping their hands clean of marijuana is that the plant is still considered to be illegal on the federal level. Thus, allowing marijuana businesses to have active checking accounts, lines of credit, or any financial services for that matter, could be perceived as money laundering.
The second thing to note is that if a new president takes the oval office in 2017, or the makeup of Congress changes, the hands-off approach that the federal government has taken on states managing their own marijuana industries could change. This could mean a lot of delinquent loans or charge-offs if current state laws get reversed and federal law is reinstated.
Lastly, even for banks that do want to help out marijuana businesses, there are countless hoops to jump through. Andrew DeAngelo, the director of operations at Harborside Health Center in Oakland, noted in an interview with CNBC in June that his business was on its 15th bank (yes, 15!).
In response to these stringent banking laws, marijuana businesses have had to hire a lot of security and install multiple safeguards to ensure their cash isn't literally stolen. It's not a very effective way to run a business, and it's likely holding back businesses, processors, and growers within the industry.
2. Terrifying tax consequences
The second big issue that keeps flying under the radars of consumers and investors alike is that the marijuana industry is getting absolutely shafted when it comes to taxes.
Although states have been given the OK to regulate their own marijuana industries and allow residents to vote whether or not to allow the sale of recreational and/or medical marijuana, federal tax laws enforced by the IRS still supersede state tax laws. This is important to note since the federal government still views marijuana as a schedule 1 drug (i.e., it has no medical benefit and is illegal).
According to U.S. tax code section 280E, businesses that engage in the sale of an illegal drug, including marijuana, are not allowed to deduct any type of business expenses. Not being able to deduct expenses means marijuana shops are paying tax on their gross profits rather than their net profits, and it's resulting in a much higher corporate tax bill than a normal business would pay. Unless the tax code is reformed by Congress, it'll likely be next-to-impossible for marijuana businesses to generate substantial profits.
3. A considerably larger black market
The third big dilemma for the marijuana industry is that the black market is still massive compared to the size of the legal marijuana industry. Because of the fees associated with obtaining licenses and regulating the industry in legal states, legal marijuana is often much costlier on a per-ounce basis than black market marijuana.
In an interview with Yahoo! News, Dan Riffle, the director of federal policies for the Marijuana Policy Project, said the following in regards to Colorado topping the $100 million sales mark in August:
It means that $100 million is going to licensed, taxpaying businesses, creating jobs and helping to build new schools, instead of going to cartels and drug dealers -- as is the case in the 46 states that don't regulate [recreational] marijuana.
Whereas Riffle does have a point that the tax revenue raised from the sale of marijuana is only burdening residents that choose to buy the drug, and the tax revenue generated can help fill in budget gaps, I believe Riffle is overlooking just how much of an effect black market operators can have within a state -- even a marijuana-legal one. In Oregon, the state with the cheapest legal marijuana on a per-ounce basis in the nation, legal marijuana is still priced at a substantial premium to black market marijuana. In Minnesota, the high costs of legal medical marijuana have caused some qualifying patients to ditch their monthly trip to the pharmacy in favor of buying the drug illegally.
Until the legal marijuana industry has had time to establish itself and reduce its operating costs, it's going to be veritably impossible to compete with the black market.
Keep your distance
Even though sales in the marijuana industry are smoking in the early going, the industry still largely looks like a bad investment. Unfavorable tax laws, inability to get stable financial service access, and absolutely no clarity as to when the federal government might adjust its stance on marijuana make the marijuana industry and marijuana stocks an extremely sketchy investment opportunity.
There's no denying the potential for growth in marijuana sales. But until the aforementioned issues are dealt with, investors in marijuana stocks are akin to hamsters running in place on a wheel.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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