The move toward legalized marijuana has gained momentum in recent years, and a majority of states now have laws on the books that allow residents to use marijuana for at least some purposes. The early success of measures to make medical marijuana legal led to more extensive legalization efforts aimed at allowing recreational use. High-profile events like the recent legalization of pot in California and the U.S. Department of Justice's decision to rescind its early policy and allow federal prosecutors to enforce federal drug laws will only heighten the debate between proponents and opponents of legalization.
One argument that many proponents of marijuana legalization made early on was that regulating marijuana sales would lead to extensive tax revenues for forward-looking states. Indeed, that has been the case in many of the most prominent early adopters of marijuana legalization, with states like Washington and Colorado seeing considerable impacts to overall budgets as a result of marijuana-related taxes. Yet more recently, states have gone beyond simply looking at marijuana as a cash cow and instead are incorporating broader policy thinking into the way they structure state taxes on pot. The prevailing trend appears to be toward lower taxes, even if that results in less state revenue.
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Starting out high
When states first started adopting marijuana legalization laws, taxes were an important element of gaining political support for the measures. Many anticipated that there could be higher public costs involved with legal marijuana, including setting up the infrastructure of regulation and enforcement of new guidelines. Accordingly, tax rates have tended to get set at high levels. Washington initially had the highest tax rate of 37% among the first four states that allowed legal pot for recreational use, according to data from the Tax Foundation, while Colorado weighed in at 29% and Alaska and Oregon charged 25% tax rates.
Tax revenue from the measures proved to be significant. In Colorado, lawmakers initially expected about $70 million in tax revenue, but the law produced $113 million in taxes during 2015. Washington saw initial collection of about $62 million in marijuana excise taxes between July 2015 and June 2016, and collection estimates for the subsequent year are seen doubling to $134 million, according to the Tax Foundation.
Taxes on the decline
Yet over time, many states have started to adopt a more user-friendly tax rate structure on marijuana sales. Alaska, Colorado, and Oregon have all taken steps to reduce their tax rates on marijuana. Moreover, new states considering legalized marijuana for recreational use have considered lower excise tax rates than those initially chosen by early adopting states. Many ballot initiatives have set lower rates in the 10% to 25% range, with a 15% excise tax set in California.
Two primary reasons explain falling marijuana taxes. First, states have a policy interest in balancing the amount of tax revenue they raise with the incentives that high taxes create in promoting black market sales of marijuana. Colorado's experience with a high tax rate showed that illicit pot sales continued at alarming levels. Lower taxes make it less profitable for black market sellers to make illegal sales, diverting more business through legal regulatory channels.
At the same time, there's also likely a competitive aspect to marijuana taxation. In the West, where states are larger, it typically makes less sense to travel to a different state just to obtain marijuana at a lower tax rate. As smaller states like New England's Massachusetts, Vermont, and Maine move forward with marijuana legalization efforts, taxing authorities in different jurisdictions will have to be mindful of not creating huge incentives for interstate movement of marijuana by coordinating tax rates.
What to expect from marijuana taxes
California should provide an interesting look at the taxation issues related to marijuana in 2018. Even though its 15% excise tax is less than that charged in many other jurisdictions, some note that additional cultivation taxes, as well as the existing framework of high sales and local business taxes that affect marijuana producers in the same way as any other business, could add up to an uncomfortably high overall tax rate on pot.
All of this will play into the policy debate on marijuana going on right now at both the state and the federal level. As important as the business of marijuana is to many investors, the revenue and public policy implications will keep governments highly interested in hanging onto the reins of their regulatory and tax structures.
