Budget Blog

States Face a Number of Issues When Legalizing Marijuana

By Brian Sigritz posted 05-14-2019 02:48 PM

Over the past several years, the number of states legalizing marijuana has quickly grown across the United States. According to the National Conference of State Legislatures (NCSL), a total of 34 states and the District of Columbia have established medical marijuana programs, while 10 states and the District of Columbia have legalized marijuana for recreational use. Some issues that states face when legalizing marijuana include determining the appropriate level of taxation, forecasting marijuana revenue, the budgetary impact, establishing a regulatory framework, and contending with banking issues and current federal laws. At NASBO’s upcoming Annual Meeting, to be held in August in Seattle, Washington, state budget officers will discuss these and related issues concerning marijuana legalization.

Status of State Taxation/Sales of Marijuana
Source: Federation of Tax Administrators)

Taxation of Marijuana
As noted by the Tax Foundation, while 10 states have legalized the use and possession of recreational marijuana, only eight of these states currently have legal markets that levy taxes on recreational marijuana.  Alaska, California, Colorado, Massachusetts, Michigan, Nevada, Oregon, and Washington have set rates for taxing marijuana, while Maine and Vermont have legalized recreational marijuana but have not yet established a legal market, and the District of Columbia allows for growing and possessing marijuana, but not the sale of marijuana in a legal market. According to the Tax Policy Center, most states tax marijuana as a percentage of the retail price, ranging from 10 percent in Nevada to 37 percent in Washington, while a few states have a tax on the wholesale transaction between cultivators and distributors or retailers; the tax on the wholesale transaction may be either per ounce or a percentage of the price. States use of marijuana revenue include programs related to drug prevention and treatment, public safety, economic development, education, youth programs, and health care. Other uses for marijuana revenue include transfers to local governments, deposits to the rainy day fund, and administrative costs associated with legalization. In Colorado, Michigan, Nevada, and Oregon language was included in state ballot initiatives stipulating that a portion of marijuana revenue be used for education, according to the Education Commission of the States.

Forecasting Revenue
Another issue states face when legalizing marijuana is forecasting revenue. At a recent Federation of Tax Administrators (FTA) conference, Kile Porter of Nevada’s Department of Taxation discussed his state’s experience. Porter said that before you start it is important to understand the goals of legalizing marijuana, the tax structure, and the regulatory structure. He also highlighted important assumptions including that nobody is an expert on the subject yet, the price in the legal market will likely be higher than the black market, and that the legal market may get off to a slow start. Other issues to consider include the potential for vertical integration, the difficulty in obtaining consumer data, the impact of product mix, the impact of special events, the risk of consumers breaking the law, and projecting the amount of marijuana purchased by tourists or visitors from other states.

Budgetary Impact
According to S&P Global Ratings, while marijuana legalization may generate some additional revenue for states, it is unlikely to be the answer to states’ budget pressures. S&P Global Ratings notes that marijuana revenue is unlikely to change the long-term credit quality of states, funding key budget expenses with marijuana tax revenue could ultimately expose state budgets to pressures when the economy contracts, and that the legalization of marijuana comes with costs, some of which are unintended and yet to be realized. S&P Global Ratings also points out that marijuana revenue is small compared to the state’s general fund budget. For example, for fiscal 2019, marijuana is projected to account for 2 percent of Colorado’s general fund budget and 1.7 percent in Washington.

Policy Issues
Earlier this year, the Institute on Taxation and Economic Policy (ITEP) released a report on taxing marijuana. The report described the various options for structuring taxes on marijuana and identified approaches currently in use. The report found that marijuana tax revenue tends to grow fastest in the first few years after legalization, and that the price of marijuana is falling which will pose a challenge in many states. The report also recommends that states should apply marijuana excise taxes based wholly or partly on the weight being sold, that weight-based tax rates should be indexed to grow alongside the rate of inflation, that states should phase-in taxes over time rather than locking in permanently low rates, and that earmarking marijuana revenue to specific public services should be done sparingly.  

Additionally, the Rockefeller Institute of Government recently released a report detailing six issues states need to consider regarding marijuana policy. The first issue is determining the proper level of taxation, including establishing a rate that is high enough to allow the state to generate revenue, but competitive enough to minimize the black market. The second issue raised is how to deal with a cash-only business with many financial institutions leery of running afoul of federal regulations. Third, is the need to determine the actual economic development impact, including the number of jobs created by legalizing marijuana. A fourth issue is the fact that while the number of Americans supporting marijuana legalization has rapidly grown, many people may not want a marijuana-related business in their neighborhood. Fifth is the issue of marijuana as a tool for social justice reform; some states have made an effort to address social justice issues related to previous marijuana enforcement and are attempting to reduce barriers to entry in the marijuana industry. A sixth and final issue states should consider according to the Rockefeller Institute is keeping marijuana green, namely that marijuana cultivation is not necessarily an environmentally friendly procedure.

Banking and Current Federal Law
Regarding the issue of banking, a bipartisan group of state treasurers recently submitted a letter to Congressional leadership urging advancement of legislation allowing states with legalized marijuana “…to bring these activities into the safety and security of the national banking system.” The letter points out that states and the federal government have a shared interest in promoting public safety, upholding the rule of law, and bringing grey market activities out of the shadows and into a transparent, regulated banking system. It further states that financial institutions currently face enormous barriers and legal risks in providing banking services to state-licensed marijuana businesses, while adding that businesses operating in cash pose a significant public safety risk. As noted in a recent Route Fifty article, in March, the U.S. House Financial Services Committee approved a bill which would safeguard banks working with state-legal marijuana businesses against related legal risks. Similar legislation has been introduced in the U.S. Senate.

It is likely that in the coming years the number of states legalizing marijuana will only grow. States that have examined marijuana legalization this year include Connecticut, Illinois, New Hampshire, New Jersey, New York, Pennsylvania, and Rhode Island. States that are currently considering legalizing marijuana will have the opportunity to learn from states that have already legalized it and issues they faced with determining the appropriate level of taxation, forecasting marijuana revenue, the budgetary impact, establishing a regulatory framework, and contending with banking issues and current federal laws.