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States Bet on Cannabis Sales to Bolster Tax Revenue

July 23, 2021 4 Min Read State and Local Tax Services, Business Tax
Thomas M. Frascella
Thomas M. Frascella Director, Tax Strategies, State & Local Tax Group Leader

Note: The purpose of this article is not to comment on the public policy benefits or detriments regarding the legalization of the recreational use of marijuana. Rather, the purpose is to explore the methods states have used to tax the product.

We have written a number of articles in the past about states’ growing budget shortfalls and the tactics they are utilizing to raise revenue. One such tactic resides with the legalization of recreational marijuana use, a relatively new trend in the United States and one that many states have looked to as a new revenue source as other traditional revenue sources have diminished. This is evidenced by the fact that a growing number of states have enacted taxes on marijuana cultivation, distribution, and/or retail sale as an alternative to other unpopular revenue raising measures, such as higher personal income tax rates.

Currently, approximately 11 states impose some type of tax on the sale of recreational use marijuana. More than 30 states also allow for the sale and consumption of medical marijuana.  The legalization of recreational marijuana is complicated due to the fact that it has addictive qualities and is a product with potentially significant societal costs. As such, recreational marijuana joins the ranks of other similar products such as alcohol and tobacco.

State taxing schemes related to the taxation of recreational marijuana use differ. Most states impose an ad valorem tax (more commonly referred to as sales tax) based on price. However, some states impose a tax based upon weight or THC content. In addition to the general sales tax, many states also impose an excise tax at various stages of product development and distribution. For example, Colorado, the first state to tax the sale of marijuana, imposes a 7 percent excise tax at the wholesale level based upon the average market rate and a 15 percent tax at the retail level. Illinois imposes a tax at the wholesale level and a general sales tax based upon the potency of the marijuana ranging from 10 percent up to 25 percent.

Anecdotally, California, one of the largest economies in the United States, originally projected $1 billion in annual tax revenue from the cultivation and sale of cannabis. While the state has not yet realized it $1 billion goal, it did generate $310 million of tax in fiscal year 2019 and is projecting $435 million of tax revenue in fiscal year 2021. Revenue collected by California is used to support youth anti-drug campaigns, environmental projects, and public safety.

Currently, Pennsylvania has not legalized the recreational use of marijuana, while New Jersey and New York became the latest states to legalize and tax recreational use of marijuana.

The legalization and taxation of the recreational use of marijuana still has many public policy prejudices and societal pressures to overcome. Although states have proven that they can raise meaningful revenues from the taxation of the recreational trade, they must also carefully balance external policy considerations – such as societal costs caused by consumption and the competition with operators in the illicit market to convert users to the legal market – with revenue.

It is likely that more states will join the movement to legalize and tax the recreational use of marijuana. In so doing, states should learn from their predecessors and design a tax that will not use the added revenue as a source for its general fund, but rather to fund drug awareness programs as well as public school funding. As the industry continues to mature, the methods of taxing the sale will undoubtedly mature with it and lead to a design that provides states with a more predictable means of estimating the potential tax revenue. In the future, as current limitations such as interstate sales ease or disappear, we may see a tax that becomes more consumer-based like a traditional sales tax. For now, it appears as though the best design relies upon an excise tax imposed on the cultivation and distribution of the product.

Thomas M. Frascella can be reached at Email or 215.441.4600.

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Thomas M. Frascella

Thomas M. Frascella

Director, Tax Strategies, State & Local Tax Group Leader

State and Local Tax Services Specialist

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