The Election Just Added Four More States to the ‘Legal’ List for Recreational Marijuana, So, Just How Much Tax Revenue Does That Mean?

Four states – Arizona, Montana, New Jersey and South Dakota – legalized recreational marijuana. Mississippi, gave a thumbs-up to medicinal cannabis. And South Dakota voted to legalize both.

Those votes speak to the growing comfort with cannabis usage, of course, but also to expectations for what cannabis might contribute to its host states’ economies. “What last week confirmed – through ballot referendums in five politically disparate and regionally removed states – is that even in a polarized cultural climate, cannabis reform has established itself as an issue of common cause,” John Kagia, thought leader for New Frontier Data, wrote in a recent blog post.

All, well and good, but when legislators invite legalization advocates to “Show me the money!” uncertainty looms as to the answer. One obvious reason is the newness of these state markets: But predictions are being made nonetheless. The nonprofit Tax Foundation has estimated these excise tax estimates for the newly legal states once their markets mature (in 2025): $166.3 million for Arizona, $36.5 for Montana, and $29.3 million for South Dakota. (New Jersey’s “to be determined” tax estimate depends on whether lawmakers there impose an excise tax at all, which remains a question).

Certainly, these financial figures of legalization are “meaningful,” says the Tax Foundation’s senior policy analyst Ulrik Boesen, but, he says, there’s a caveat. “If [states] are in the hole due to the pandemic, these numbers are not going to change it,” the analyst said in an interview last week “Thirty-nine million dollars will not really change that.

“My concern is that if lawmakers are looking at marijuana as a way to raise general revenue, they may try to ‘revenue-maximize’ – to tax it at the highest possible rate to get as much tax revenue out of it as possible rather than focus on what the whole point of the tax is.”

And that “point”? “Previously illegal activity can now be legal activity,” Boesen pointed out. Yet the only way to do that, he emphasized is to “make sure it’s competitive with the illegal market.”

In short, states can’t get too greedy. This is why jurisdictions must be cautious about determing those excise taxes – which are special taxes imposed over and above the usual 6 percent or 8 percent “ad valorem” sales tax.

Alcohol, gasoline and tobacco are among the products that states already attach excise taxes to. In addition, the idea behind an excise tax, Boesen said, should be to raise funds not just for general revenues but for societal impact projects. This means funds to be used to counteract any negative impact that alcohol, tobacco and, newly, marijuana, create. This can mean treatment programs, research and education on harmful effects.

In this context, the tax expert described the excise tax rates for the three newly legal states – 16 percent for Arizona, 20 percent for Montana and 15 percent for South Dakota – as being relatively low and cautious. In contrast, he said, consider Washington State’s rate of 37 percent. Also consider the cumulative rate for California, which taxes cannabis both at the cultivator level (where it’s taxed by weight) and again at the retail level, together with a number of local taxes.

“So the effective level can be between 40 and 50 percent,” Boesen noted. Most legal states’ rates, he said, range between 10 and 25 percent. And most states levy a sales tax, “So in Michigan you’ll have 10 percent excise tax and a 7 percent sales tax on top.”

The point, Boesen said is not to tax legal cannabis so high that consumers accustomed to buying from the illegal market will be discouraged from converting to legal dispensaries.

Besides, excise and sales taxes don’t exist in a vacuum, Boesen said: There are corporate taxes and property taxes and employee income tax states receive. And then there is the important societal advantage of decriminalization. According to FBI data, marijuana arrests affect black and brown men four times more than white men.

“This is no longer to be considered a criminal act, to smoke or eat or vape marijuana – THC,” Boesen said. “We don’t want to put people in jail for smoking marijuana. Make it legal and you don’t have to.”

Finally, regardless of what states do or don’t do about legalization, they may be facing a tsunami that can’t be held back. “[Legalization] has bipartisan support across the nation,” Boesen said. “I think there will be a snowball effect.” That snowball effect often stems from geographic proximity. How can New York State not legalize now that neighboring New Jersey is just a 20-minute PATH train ride ride away? Pennsylvania, Connecticut and Virginia are other eastern seaboard states expected to legalize soon, Boesen said.

And all this makes sense, as no state wants its neighbor to earn substantial revenue off its own citizens. As of the 2020 election, 15 states and the District of Columbia are now legal for recreational marijuana and 36 (and D.C.) for medicinal cannabis.

Once the majority of states legalize – and that’s coming — it’s no stretch to imagine legalization at the federal level following, and then interstate commerce connecting up a cannabis industry, which New Frontier Data’s Kagia wrote, expects to surpass $19.1 billion in sales this year and $38.3 billion, by 2025.

“We now have a pointless prohibition because half the country has legalized,” Boesen said. “Maybe we should legalize it today.”