States Challenged to Optimize Cannabis Tax Revenues

For the states with cannabis initiatives on the ballot this fall, there is a fine line between passing legislation and being prepared to implement the new law. With time and more states considering legalizing recreational use of marijuana, state-and-local taxation (SALT) of this industry will be a hot topic for a long time. Government officials on the state level may learn from the missteps of other states who have already legalized cannabis, but have struggled to temper SALT tax rates for this burgeoning industry.

Like any new player entering a marketplace, the cannabis industry has a learning curve to contend with, and its share of uncertainties. For example, the cannabis tax rates in Colorado, Oregon, and Washington, initially large, were reduced to curtail the growth of local black-markets. While there are no metrics available to clearly see if reduced cannabis SALT tax rates have made a dent in black-market sales, state tax revenues haven’t turned out to be the largesse that some states were expecting.

Now, as we head into the mid-term election cycle, recreational marijuana is on the ballot in several states. Eight states and the District of Columbia have legalized the use of marijuana, and have realized the ability to generate tax revenue. The states that have legalized marijuana thought that new tax revenue from cannabis would be plentiful. It has been that way to a certain extent. But with high marijuana tax rates remaining in some states, those taxes may be aiding and abetting growth of black-markets.

Going back to the early days of our nation, the United States first taxed distilled spirits starting in 1791; a move by the 2nd United States Congress under the Washington administration. There was spirited debate over passing what is known as the Excise Whiskey Tax, a very unpopular tax. How unpopular? The “Whiskey Rebellion” led by grain farmers in the southern United States and Pennsylvania led to the U.S. government dispatching 13,000 militia, which put an end to that tax revolt.

One can argue that sin taxes, or the decline thereof, led to the creation of the Federal Income Tax System during Prohibition, but that is another story.

Our country’s legacy on sin taxes is really part of the story of the many battles and wars we fought to fight for freedom. After the Civil War, the United States implemented a national cigarette tax to raise revenue to assist with the cost of the war. In recent years, U.S. states themselves have fought budgetary battles as federal support has diminished.

With declining revenues from other sin taxes like tobacco, legalized marijuana revenues may not turn out to be “found money” in a few years, but rather another stable source of funding the existing tax base. After all, we have had 227 years to study the revenue effects of taxing alcohol in the United States. It’s highly doubtful we will see a "Marijuana Rebellion" any time soon.

One of the biggest issues facing the industry about taxation is that marijuana is illegal federally. If more states join in legalizing marijuana, they may lead to changing the law federally. Even with this uncertainty, states are certainly going to consider legalizing marijuana, tempted by potential tax dollars and the growth of the industry, and with that will be a separate set of SALT taxes, subject to interpretation. For those in the cannabis industry, it’s wise to get yourself a good “interpreter” who has a firm grasp on tax-compliance issues.