With several states contemplating legalization of recreational marijuana, and federal lawmakers starting the process of federal descheduling, it is a good time to examine the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. implications of legalization. Taxes play a crucial role in the success of marijuana reform, as competitive prices in a licensed market are key to convert illicit consumption to the legal market.
Marijuana legalization has been gaining momentum at the state level in recent years, partially because of the prospect of new tax revenue. In 2021 alone, four states (Connecticut, New Mexico, New York, and Virginia) have passed bills to legalize. Thus far, 19 states’ voters or legislatures have passed legislation to offer licenses to sell recreational marijuana as well as impose excise taxes. Most of those states also apply their general sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. to cannabis sales, and some allow localities to levy additional taxes.
While it is still a relatively new market (Colorado was the first state to legalize cannabis in 2012), excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. revenue figures to date can help lawmakers get a sense of the revenue potential at different rates and contribute to the development of sound marijuana tax policy.
The following table shows the states that levy excise taxes on marijuana. It includes the tax design, final revenue in fiscal year (FY) 2020 and estimated revenue for FY 2021, and revenue per capita generated in the same fiscal years. In total, states with licensed markets collected $1.7 billion in FY 2020 from state-level excise taxes.
Note that these numbers do not include sales tax or local tax revenue from marijuana transactions.
| Collections in States with Operational Markets in FY 2020 and FY 2021 | ||||||
|---|---|---|---|---|---|---|
| State | Tax Design | Tax Rate | Revenue FY 2020 | Revenue Per Capita FY 2020 | Projected Revenue FY 2021 | Projected Revenue Per Capita FY 2021 |
| Alaska | Specific | $50/oz. mature flower; $25/oz. immature flower; $15/oz. trim; $1 per clone | $24,540,009 | $33.55 | $29,051,904 | $39.71 |
| California | Mixed | 15% retail excise tax; $9.65/oz. flower; $2.87/oz. leaves cultivation tax; $1.35/oz cannabis plant | $525,943,734 | $13.31 | $757,482,335 | $19.17 |
| Colorado | Ad valorem | 15% excise tax (levied at wholesale by weight at average market rate); 15% excise tax (retail price) | $307,278,327 | $53.36 | $410,584,023 | $71.30 |
| Illinois (b) | Potency (ad valorem) | 7% excise tax of value at wholesale level; 10% tax on cannabis flower or products witd less tdan 35% tdC; 20% tax on products infused witd cannabis, such as edible products; 25% tax on any product witd a tdC concentration higher tdan 35% | $52,698,873 | $4.16 | $315,645,689 | $24.91 |
| Massachusetts | Ad valorem | 10.75% excise tax (retail price) | $51,684,592 | $7.50 | $104,428,106 | $15.15 |
| Michigan (c) | Ad valorem | 10% excise tax (retail price) | $31,364,000 | $3.14 | $75,000,000 | $7.51 |
| Nevada | Ad valorem | 15% excise tax (levied at wholesale by weight at Fair Market Value); 10% excise tax (retail price) | $105,180,947 | $34.15 | $153,227,327 | $49.75 |
| Oregon | Ad valorem | 17% excise tax (retail price) | $133,150,349 | $31.57 | $175,106,330 | $41.52 |
| Washington | Ad valorem | 37% excise tax (retail price) | $468,502,946 | $61.52 | N/A | N/A |
| (a) Average collections used to project full year collections. Full FY2021 available in Colorado and Illinois. Data missing for Q2 2021 in Nevada and California. Missing June 2021 data in Alaska, Oregon, and Massachusetts. For Michigan, tde projection is tde state’s May forecast, as Michigan’s fiscal year runs from October to September. No data available for Washington. | ||||||
| (b) Illinois started collecting taxes in January 2020. | ||||||
| (c) Michigan started collecting taxes in December 2019. | ||||||
| Source: State Revenue Departments, Tax Foundation calculations. | ||||||
In FY 2020, California led the way with the highest marijuana excise tax revenue of $526 million, followed closely by Washington and Colorado, which collected $469 million and $307 million, respectively. While not all data is yet available, those three states are also expected to have generated the largest revenue in FY 2021.
Both Washington and Colorado have ad valorem excise tax designs for marijuana, meaning the tax is based on the value of marijuana. Washington has a 37 percent tax rate on the retail value of marijuana while Colorado levies a 15 percent tax on both wholesale and retail. An ad valorem tax is contrasted with a specific tax, which is based on a per-unit basis. California’s marijuana tax design is mixed, combining an ad valorem tax and specific taxes. It has a 15 percent tax on marijuana retail value and taxes flowers at $9.65 per ounce, leaves at $2.87 per ounce, and fresh plants at $1.35 per ounce.
Since these states are of vastly different size, it is useful to look at the revenue per capita of marijuana taxes. When adjusted for population size, Washington leads the way with $61.52 in marijuana excise tax revenue per resident, followed by Colorado ($53.36) and Nevada ($34.15). Colorado anticipates a significant gain, to $71.30 per capita in FY 2021, but similar estimates are not yet available for Washington.
On the other end of the spectrum are Illinois ($4.16 per resident) and Michigan ($3.14 per resident) with the lowest revenues per capita from marijuana excise taxes. Neither had an operational market for the entirety of FY 2020, so the comparatively low return was to be expected, and both looked to have significant growth in FY 2021. This is particularly true of Illinois, which reported a 600 percent increase in excise tax collections between FY 2020 and FY 2021.
While most states, including Michigan, levy taxes based on price, Illinois has a potency-based ad valorem tax with three rate brackets that increase with higher THC (Tetrahydrocannabinol) concentrations. Illinois’ system is a de facto category-based tax scheme where flower will generally be taxed at 10 percent, edibles at 20 percent, and concentrates at 25 percent.
It is unfortunate that the majority of states rely on price as a tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , as prices share no association with the negative externalities (harm) associated with consumption. However, change may be afoot: New York and Connecticut, which both passed legislation in 2021, adopted taxes that rely on potency. A potency-based tax better addresses the negative externalities that correspond to higher THC content.
Revenues are projected to increase in FY 2021 compared to FY 2020 in all nine states that had an excise tax in both years. This makes sense, as legal marijuana markets are still maturing in the states.
While marijuana excise taxes can be meaningful sources of tax revenue, some designs are better than others. Furthermore, excise taxes are generally not stable sources of revenue, so lawmakers must think carefully about how to best address externalities, support emerging markets, and spend revenue.
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