Barriers to Marijuana Tax Revenue in Washington State

It’s harder than you think to get significant tax revenue from legal marijuana

Prior to the 2012 election in which Washington voters passed a marijuana legalization initiative, state officials estimated that legalization would generate up to $560 million in new tax revenue in its first year, with the expected state income projected to increase in later years. Subsequent work by Jon Caulkins and the BOTEC analysis group that the state retained for policy advice estimated annual state marijuana consumption at 165 million grams. Will the State of Washington really reap $3.39 in tax revenue for every gram of marijuana consumed?

It’s not likely, for at least four reasons:

1. Ad valorem tax revenue is dependent on the price of marijuana, which will fall under legalization

The initiative created a marijuana industry modeled on the alcohol industry, with a tri-part structure of growers, processors and retailers. A 25% tax was assessed at each transfer point and sales tax (statewide average 8.87%) is also applied at retail. Note that you can’t just add those numbers to get the effective rate at retail because marijuana increases in value as it moves through the production chain. When that is taken into account, tax at retail works out roughly to 45% of purchase price.

That’s a set up for enormous revenue if marijuana prices stay constant, but they will not. Illegality, by design, imposes many costs on the drug business. For example, you have to compensate employees for risk of arrest and enforce contracts privately. That’s why legalization will lower marijuana prices, perhaps by as much as 80% or even more. Unless the price drop leads to a spectacular increases in consumption, ad valorem taxes will bring in substantially less revenue than expected.

Some organizations and individuals advocating marijuana legalization propose excise taxes (e..g, $50/ounce irrespective of market price). This should generate more predictable revenue and also have the public health benefit of putting a floor under effective price.

2. The medical marijuana system is very loosely regulated and tax-free for consumers Continue reading “Barriers to Marijuana Tax Revenue in Washington State”