A first-of-its-kind look at state excise taxes on legal cannabis sales finds that taxing the substance can be a meaningful source of state revenue but cautions that achieving sustainable revenues over time will be difficult under the price-based tax structures adopted in most states thus far.
Released Jan. 23 by the Institute on Taxation and Economic Policy, the report (Taxing Cannabis) examines every month of data released through January 2019 by states that have legalized sales of recreational cannabis. In the case of Colorado, the first state to allow legal recreational cannabis sales in 2014, the report looks at nearly 60 months of data.
Excise taxes collected from recreational cannabis sales surpassed $1 billion for the first time in 2018. The $1.04 billion in cannabis excise taxes collected across half a dozen states last year rivaled the $1.16 billion in excise taxes collected from alcohol sales in those states. This sum is likely to grow as more states move to legalize cannabis sales and more consumers begin purchasing it in legal stores. Already, cannabis taxes raise more revenue than alcohol excise taxes in Colorado and Nevada, and the same is projected to occur in California by 2020.
“State excise taxes on cannabis can generate meaningful revenues, but not enough to fundamentally transform state budgets,” said Carl Davis, ITEP research director and an author of the report. “Further, if states fail to structure the tax properly, the long-run result will be unpredictable or even declining revenue. States should plan ahead for a dramatic drop in cannabis prices and should structure their taxes accordingly.”
Added Misha Hill, the report co-author, “There are many reasons to legalize cannabis, including some rooted in equity about the disproportionate number of black and Latino Americans incarcerated for drug related crimes, though rates of cannabis use are similar across all demographic groups. This report takes a neutral position on legalizing cannabis while also identifying tax policy recommendations and best practices.”
The report notes the best way to structure an excise tax on cannabis is to assess a weight-based tax and allow the tax rate to gradually rise with inflation. Such a structure can ensure that states can count on a consistent source of revenue even in the face of ongoing reductions in cannabis prices. The report also urges lawmakers concerned about the illicit market for cannabis to phase-in their cannabis taxes gradually over time, rather than locking in permanently low rates of tax in an effort to discourage illicit market sales.
Some key findings:
Excise tax collections on retail cannabis surpassed $1 billion for the first time in 2018. This was a 57 percent increase from the previous year, driven both by legal sales in California and increased sales in five other states where cannabis sales are legal (Alaska, Colorado, Nevada, Oregon and Washington state).
The $1.04 billion in total excise taxes raised from cannabis sales was more than triple the amount ($304 million) raised in these states from excise taxes on beer and wine and on par with the $1.16 billion from all alcohol sales.
General sales tax on cannabis also raised substantial revenue: more than $300 million in 2018.
Cannabis tax revenues are meaningful and growing but they still represent less than 1 percent of total state and local tax collections in the six states reporting data.
The price of cannabis is falling rapidly in many states with legal markets. These large and ongoing price cuts pose a serious challenge to the revenues that can be raised from any tax linked to the price of cannabis.
Nationwide legalization and taxation of recreational cannabis could generate nearly $11.9 billion in state and local excise and sales tax revenue each year.
More than half a dozen states have gained real world experience on how to tax a product that was not sold for legal recreational use just five years ago. Their experience provides invaluable information that lawmakers around the country can use to understand the potential impacts of cannabis legalization both on tax revenues and more broadly.
