Case Study: Taxing a New Industry

Legalization of recreational marijuana at the state level and how to tax it: Examples from Colorado and California.

Since 1970, marijuana has been classified a Schedule I controlled substance by the U.S. federal government. Despite this, voters and/or legislatures in 19 states and Washington, D.C. have voted to legalize growing, processing, selling, or consuming recreational marijuana for adults over 21 years of age.

More states are contemplating the benefits of legalizing recreational marijuana and taxing it as a new stream of revenue. In fact, a key point when legalizing recreational marijuana is tax design. Most states that currently allow and tax sales have opted for a price-based (ad valorem) excise tax and levy the general sales tax on recreational marijuana sales.


Problems and Considerations

Some states have had relative success in legalization, while others have struggled to integrate the new industry into communities, business practice, current code, and taxation.

There are various options for taxing recreational marijuana. Some are best for government revenue, and some for small and new businesses and consumers. Some states have multiple tax layers in place from legalization. The difference in approach in legal states makes a direct comparison among current policies difficult.

There are still many unknowns when it comes to the taxation of recreational marijuana, but as more states open legal marketplaces and more research is done to understand the externalities of consumption, more data will be available.

State recreational marijuana taxes, state recreational marijuana tax rates, State excise taxes on recreational marijuana, New York recreational marijuana legalization 2021, state excise tax rates on recreational marijuana


Colorado

Colorado voted to legalize recreational marijuana in 2012, permitting use by adults over 21 years old. The following year, a proposition was approved that allowed the state to levy an excise tax of up to 15 percent on unprocessed retail marijuana and a retail sales tax of 10 percent. The state’s sales tax on most goods is 2.9 percent, while recreational (retail) marijuana is subject to a 10 percent tax, more than three times the regular rate. The marijuana sales tax is levied on the consumer, while the excise tax is levied on the grower (producer).

The revenues from excise taxes and sales taxes are allocated to different areas of the budget. Sales tax revenue is split among various areas of the budget:

Colorado Marijuana Sales Tax Revenue

Marijuana Tax Cash Fund

64.67%

General Fund

14.00%

State Public School Fund

11.33%

Local Governments

10.00%

All revenue from the excise tax goes to the Building Excellent Schools Today (BEST) Fund, to finance costs of repairs and upkeep of public schools.

Colorado excise tax revenue, Colorado recreational marijuana tax revenue, cannabis tax revenue


California

California legalized the sale and use of recreational marijuana in 2016, which went into effect in January 2018. According to one study, illicit sales still outnumber licensed sales three to one.

The state levies a cultivation tax on cultivators based on weight and category, a 15 percent excise tax on wholesalers and distributors, the state retail sales tax of 7.25 percent, a local sales tax up to 1 percent, and local business taxes up to 15 percent.

Though excise and cultivation taxes are on the production and seller’s end, consumers may pay around 23 to 40 percent in taxes at time of purchase.

Of note, the cannabis excise tax is levied at the wholesale level, resulting in the California Department of Tax and Fee Administration (CDTFA) calculating an Average Market Price (AMP) value by marking up the wholesale value by 80 percent. This means that marijuana worth $100 at wholesale will be taxed at 15 percent at the AMP value of $180. The markup rate increased due to inflation as of January 2020.

Another unique aspect of marijuana taxation in California is that tax rates vary among cities. For example, in Los Angeles, the consumer faces the 15 percent excise tax, a 10 percent local business tax, and a 9.5 percent sales tax. In Los Angeles, marijuana dispensaries are taxed 2,808 times more than other businesses.

California Marijuana Excise Tax Revenue*

Youth Anti-Drug Programs

60.00%

Environmental Programs

20.00%

Public Safety Grants

20.00%

*Revenue after allocation to regulatory costs and research

California marijuana excise tax revenue fails to meet marijuana tax collections projects, recreational marijuana tax revenue, cannabis tax revenue


Summary of Policies

Complicated and burdensome tax structures and rates make it difficult for new, small, and minority-operated-and-owned businesses to open or remain open.

The multitude of taxes in California, for example, have resulted in tax pyramiding and an environment where it is more profitable to sell and more affordable to purchase in the illicit market.

California’s projections for marijuana tax revenue were not met due to the burden that the tax rates and structure created. It was simply too difficult for licensed businesses to compete with illicit operations.

Conversely, Colorado’s relatively simple and less burdensome system of taxing recreational marijuana has allowed the legal market and tax revenues to grow.

However, in both states, the taxation of recreational marijuana does not adequately meet the principles of sound tax policy: simplicity, transparency, neutrality, and stability.

  Colorado California

Simplicity

 ✔️  ❌

Transparency

 ✔️  ❌

Neutrality

 ❌  ❌

Stability

 ❌  ❌

Further Reading

Below are some resources regarding recreational marijuana legalization and taxation from Tax Foundation and other sources. Please conduct additional research on the case prior to discussion.


Reflect on the Following Questions

  • What is the problem(s)?

  • How do these policies meet (or not meet) the Principles of Sound Tax Policy?

  • What general options are available to develop more sound policy?

  • Who are the stakeholders and what are their interests?

  • How has this problem been addressed in other states?

Was this page helpful to you?

No

Thank You!

The Tax Foundation works hard to provide insightful tax policy analysis. Our work depends on support from members of the public like you. Would you consider contributing to our work?

Contribute to the Tax Foundation

Featured Primers

Featured Case Studies



TaxEDU was made possible thanks to the generous support of the Stiles-Nicholson Foundation.