Comment: Why cannabis is bringing less green to state coffers

Commentary

By Boyoung Seo / For The Conversation

Nearly half of Americans live in a state that allows legal access to recreational marijuana. Eleven more states, including Wisconsin and Florida, are considering legalization in 2024.

One of the most common rationales for legalizing marijuana is increasing state tax revenue. How much revenue comes in depends on decisions states make about regulating the marijuana industry, including how it is taxed.

I’m an economist who specializes in forecasting how various tax regimes affect markets. My expertise spans industries such as legal recreational marijuana, alcohol and tobacco. I’ve examined various taxes on marijuana in states such as Colorado and Washington to understand how much revenue has been brought in and the role state tax policies have played in that outcome.

Marijuana is taxed similar to alcohol and tobacco: Recreational marijuana taxes are generally based on price, quantity, weight or potency; much like other “sin goods” such as tobacco and alcohol products.

Taxing sin goods is thought to shape public health policy and reduce the harmful impacts these products have on the public. These taxes, also known as excise taxes, are usually higher on sin goods than taxes on other products by design.

Taxing these goods aggressively is about more than government greed. It is well understood that alcohol and tobacco use creates burdens on society such as increased violence and health care costs. Economists like me call these impacts on people who are uninvolved in a situation “negative social externalities.”

Studies have shown that marijuana can have adverse health risks, too; especially in adolescents. So, governments often structure taxes on marijuana to try to limit its consumption.

Most states with legal marijuana impose a marijuana sales tax. Others use a combination of sales taxes and a quantity or weight-based tax. For instance, a half-dozen marijuana brownies that weigh a pound could be taxed as “six” or taxed on their weight.

Taxes based on potency, a common practice for liquor taxation in most states, is also designed to reduce consumption. Taxes on spirits are generally much higher than the taxes on wine and beer. Marijuana potency can be taxed on the product’s level of THC, the main psychoactive compound in cannabis.

Why state tax revenues fell so short: In 2012, Colorado and Washington became the first two states to legalize recreational marijuana, and sales began in 2014. These states tax marijuana aggressively compared with other states.

For instance, Colorado imposes a 15 percent sales taxes on marijuana, paid by consumers, and another 15 percent on weight, paid by retailers; compared with New Mexico, which has only a 12 percent sales tax. Washington’s tax is even higher at 37 percent.

With taxes set high, Colorado and Washington expected their new marijuana industries to generate significant tax revenue. These predictions relied on surveys of illegal marijuana use and likely overestimated the consumption of legal marijuana, which tends to be more expensive than street drugs.

In 2014, then-Gov. John Hickenlooper predicted Colorado would collect more than $130 million in revenue from marijuana taxes in the first fiscal year of sales. The actual tax receipt was about $88 million.

Washington experienced a similar shortfall. The state Office of Financial Management projected it would earn $434 million in taxes in fiscal year 2015, more than twice the revenue it received.

What’s more, both states’ tax revenue from alcohol and tobacco were undercut by marijuana. Research I published with economist Keaton Miller found that people were consuming marijuana instead of alcohol and tobacco, causing revenue from these other sin goods to drop.

In Washington, our research estimates 40 percent, or $56 million dollars, was siphoned off liquor, wine and cigarette tax revenue from July 2014 to June 2015. Both states did earn more taxes overall than before legalization, but the total increase is not as large as politicians predicted.

On top of not collecting the expected tax revenue, states such as California, Oregon and Colorado have experienced a slowdown, and even a decrease, in marijuana sales and tax revenue. One reason is because as these markets mature, the average price for marijuana is dropping. Lower prices are leading to decreases in sales tax revenues.

For instance, marijuana prices in Colorado dropped 60 percent from 2014 to 2023. Colorado has been losing tax revenue ever since, and Washington’s case is not much different.

Taxing THC potency as the solution: One tax regime that seems safe from falling prices — as long as the same amount of marijuana is sold — is a potency-based tax, which taxes marijuana based on its THC content. To date, just three states — New York, Illinois and Connecticut — tax THC potency.

New York taxes marijuana flowers at 0.5 cents per milligram; concentrates at 0.8 cents per milligram of THC; and edibles at 3 cents per milligram. That’s in addition to the 9 percent state sale tax and 4 percent local tax.

Are potency-based taxes the way to create a stable stream of tax receipts? The answer is no.

A potency-based tax will be effective only if consumers have a strict preference for higher potency products and resist switching to low-potency ones to avoid taxes. But research I conducted with Keaton Miller, Benjamin Hansen and Caroline Weber found that consumers don’t care much about marijuana potency.

Our research also found that growers and processors can easily reduce the THC potency of their products without incurring too much cost. They do so by shortening the grow time, changing the product mix or providing low-potency products as testing samples. As a result, potency taxes could have the unintended consequences of encouraging suppliers to sell products with lower THC because they likely would still earn similar profits.

So, is there one ideal tax structure that can generate a robust stream of marijuana tax revenue? Not really. Tax policies do influence the market, but they can do little to overcome soft demand. From that perspective, a decline or stagnation in state tax revenues from marijuana is inevitable. As the market matures and more states legalize marijuana, consumers will have more buying options, and competition will intensify.

That means both the price of marijuana and tax revenues associated with its sale will likely drop further in the future.

Boyoung Seo is an assistant professor of business economics and public policy at Indiana University. This article is republished from The Conversation under a Creative Commons license.

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