Vermont May Be the Next State to Legalize Recreational Marijuana Sales

August 7, 2020

According to news reports, the Vermont legislature is ready to advance S54 this month or next, to legalize cultivation and sales of marijuana in the state beginning in 2022. Versions of the bill have been approved by both chambers. The current regulatory situation in Vermont is unique, as marijuana possession has been legal since January 2018. Before heading to the governor for signature, the two chambers will have to work out their differences in bicameral committee.

Under the House version, an excise tax rate of 14 percent of retail value (and the state’s 6 percent general sales tax) would be imposed, whereas the Senate version would impose a 16 percent rate and allow for a local option of 2 percent. Under the Senate bill, recreational marijuana would be exempt from the general sales tax. Notably, the Senate proposal would also ban flower with more than 30 percent of THC and solids containing more than 60 percent of THC. That would make Vermont the only state to ban products exceeding certain THC levels.

If S54 passes, Vermont would follow the trend of taxing marijuana by retail price. (Alaska is the only state that does not tax marijuana by retail price; see the table below.) Even though this may the simplest and most popular option, it is not ideal. A principled excise tax design that best captures the externality would be based on a combination of potency and weight. Although this introduces complexity to the tax design, it makes the tax more equitable.

In Vermont, the Legislative Joint Fiscal Office (JFO) estimates that a 14 percent excise tax would raise $4.2 million in the first full fiscal year. The revenue would be allocated with 30 percent to misuse prevention and 70 percent to the general fund. The other option, a 16 percent retail tax, would, according to the JFO, raise $5.4 million in the first full fiscal year (both estimates are mid-range). Revenue allocations are not described in the Senate bill. The excise tax proposed by the Senate bill raises 29 percent more revenue even though the rate is only 14 percent higher. This is likely due to the effect of the sales tax exemption in the Senate bill, which produces a lower overall tax burden, with an effect on overall sales volume.

Authorizing a legal market for recreational marijuana is not free, however. The state will incur some costs before the sale is made. Both bills appropriate more than $800,000 to establish a Cannabis Regulation Fund.

Forecasting excise tax revenue has proven difficult in the past as states have generally over- or underestimated demand. In 2014, Vermont commissioned a RAND Corporation study that estimated that Vermont could raise between $20 million and $75 million in tax revenue a year from marijuana legalization, but also cautioned that these figures were highly uncertain and could be affected by federal regulation or neighboring states offering lower rates on marijuana.

A report authored by Denver-based law firm Vicente Sederberg, published August 5, estimates that Vermont is likely to collect up to $12 million from the 14 percent retail excise tax in the first full year, and $13.9 million from a 16 percent retail excise tax. The report estimates excise revenue between $37 million and $42 million after five years depending on the final tax rate. The significant difference in revenue projections is caused by differences in the estimation of total consumers: JFO does not include border consumers and assumes lower average consumption per consumer. Our own analysis, based on tax collections in Alaska, Colorado, Nevada, Oregon, and Washington, suggests that Vermont would raise $12 million in the first full year after legalization and $32 million annually in a more mature market. To put this in perspective, Vermont’s Joint Fiscal Office expects a $332 million shortfall in FY 2021.

While there has long been a desire to legalize recreational marijuana in Vermont, many other states are considering legalization in light of the coronavirus pandemic and the resulting fiscal difficulties for states. The hope is that tax revenue from legal marijuana sales may provide much needed revenue for struggling states and localities. Whether legalization can actually deliver on that promise remains to be seen—at least in the short run. The revenue estimations above illustrate that excise revenue is unlikely to solve long-term budget woes.

There is still much we do not know about the recreational marijuana market and how best to regulate and tax it, as legalization is a still relatively new trend. Nonetheless, it is likely that more states (and maybe the federal government) legalize in the coming years. As more states consider legalization, lawmakers should take note of the experiences of the states already allowing legal sales and consumption. While some challenges will change as the legal U.S. market grows and matures, many will remain. Designing excise taxes (and regulations) will play a key role in allowing the legal market to undercut and outcompete the illicit market, which should be one of the first priorities. Legalization of recreational marijuana should not be done in expectation of a short-term revenue bump from excise collections.

To that end, policymakers would be well-advised to remember that excise taxes should only be levied when appropriate to capture some externality or to create a “user pays” system—not as a general revenue measure. Due to their narrow base, excise taxes are not a sustainable source of revenue for general spending priorities. That is not to say that there is no new revenue available to states that choose to legalize. As any other consumer product, recreational marijuana should be taxed under the general sales tax. Additionally, legal marijuana businesses would pay business taxes and employees would pay personal income taxes. Revenue from these broad-based taxes, combined with a potential saving as illicit operations decline, does represent general fund revenue. Expecting a large and sustained boost from marijuana-specific taxes, however, is shortsighted, and represents poor tax policy.

State Recreational Marijuana Excise Tax Rates and Structure
State Structure Tax Rate

Alaska

Specific

$50/oz. mature flower; $25/oz. immature flower; $15/oz. trim; $1 per clone

California

Mixed

15% retail excise tax; $9.65/oz. flower; $2.87/oz. leaves cultivation tax; $1.35/oz cannabis plant

Colorado

Ad valorem

15% excise tax (levied at wholesale by weight at average market rate); 15% excise tax (retail price)

Illinois

Potency (ad valorem)

7% excise tax of value at wholesale level; 10% tax on cannabis flower or products with less than 35% THC; 20% tax on products infused with cannabis, such as edible products; 25% tax on any product with a THC concentration higher than 35%

Maine (a)

Mixed

10% excise tax (retail price); $335/lb. flower; $94/lb. trim; $1.50 per immature plant or seedling; $0.30 per seed

Massachusetts

Ad valorem

10.75% excise tax (retail price)

Michigan

Ad valorem

10% excise tax (retail price)

Nevada

Ad valorem

15% excise tax (levied at wholesale by weight at Fair Market Value); 10% excise tax (retail price)

Oregon

Ad valorem

17% excise tax (retail price)

Vermont

Ad valorem

TBD: 14% excise tax (retail price) or 16% excise tax (retail price)

Washington

Ad valorem

37% excise tax (retail price)

Sources: State statutes; Bloomberg Tax.

(a) Maine legalized recreational marijuana in November 2016 by ballot initiative. The state is slated to implement a legal market later in 2020.

District of Columbia voters approved legalization and purchase of marijuana in 2014 but federal law prohibits any action to implement it. In 2018, the New Hampshire legislature voted to legalize the possession and growing of marijuana, but sales are not permitted. Alabama, Connecticut, Georgia, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Minnesota, Nebraska, North Carolina, Oklahoma, Rhode Island, South Carolina, and Tennessee impose a controlled substance tax on the purchase of illegal products (the tax is normally levied on a person in possession of controlled substances). Several states allow local taxes as well as general sales taxes on marijuana products. Those are not included here.

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