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September 19, 2012

What will be the real tax dynamics if (when?) a state legalizes marijuana?

The question in the title of this post is prompted by this effective new AP piece, which is headlined "Pot Could Be Tax Windfall, but Skeptics Abound." Here is how the article gets started:

A catchy pro-marijuana jingle for Colorado voters considering legalizing the drug goes like this: "Jobs for our people.  Money for schools.  Who could ask for more?"  It's a bit more complicated than that in the three states — Colorado, Oregon and Washington — that could become the first to legalize marijuana this fall.

The debate over how much tax money recreational marijuana laws could produce is playing an outsize role in the campaigns for and against legalization — and both sides concede they're not really sure what would happen.

At one extreme, pro-pot campaigners say it could prove a windfall for cash-strapped states with new taxes on pot and reduced criminal justice costs.  At the other, state government skeptics warn legalization would lead to costly legal battles and expensive new bureaucracies to regulate marijuana.

In all three states asking voters to decide whether residents can smoke pot, the proponents promise big rewards, though estimates of tax revenue vary widely:

— Colorado's campaign touts money for school construction. Ads promote the measure with the tag line, "Strict Regulation. Fund Education." State analysts project somewhere between $5 million and $22 million a year. An economist whose study was funded by a pro-pot group projects a $60 million boost by 2017.

— Washington's campaign promises to devote more than half of marijuana taxes to substance-abuse prevention, research, education and health care. Washington state analysts have produced the most generous estimate of how much tax revenue legal pot could produce, at nearly $2 billion over five years.

— Oregon's measure, known as the Cannabis Tax Act, would devote 90 percent of recreational marijuana proceeds to the state's general fund. Oregon's fiscal analysts haven't even guessed at the total revenue, citing the many uncertainties inherent in a new marijuana market. They have projected prison savings between $1.4 million and $2.4 million a year if marijuana use was legal without a doctor's recommendation.

I vaguely recall from my 2L tax class that the definition of income for federal tax purposes includes even ill-gotten gains.  Thus, those making money currently on medical marijuana sales in various states should already be paying federal income tax even though they are violating federal criminal laws.  Consequently, if (when?) a state legalizes all marijuana sales and allows more persons legally to earn income, there ought also be a benefit to the federal tax coffers as well even if federal criminal law does not change anytime soon.  (Dare I joke that maybe Mitt Romney will come to endorse pot legalization initiatives with the hope of reducing the percentage of voters who pay no federal income tax?)

September 19, 2012 at 02:24 PM | Permalink


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I see no possible tax windfall so long as federal policy remains the same. There are definite savings to be had by giving up on the drug war, but that is a far cry from actually bringing in more tax dollars.

Actually, I thought that some places had already tried such things and had them enjoined. Although that might have been states both trying to say drugs are contraband and at the same time impose taxes.

Posted by: Soronel Haetir | Sep 19, 2012 4:11:46 PM

I have been seeking a tax professional because I am very clueless on the tax world. However, I know that the medical marijuana industry is non-tax-exempt. I think this is mainly because of the negative views that revolve around the drug. I personally don't condone the use of marijuana, but believe it has some use in the medical world.

Posted by: Michael Cornelia | Sep 20, 2012 9:49:46 AM

There will surely be a tax windfall of some scope if it's outright legalized, and the cited $5-$22 million range is wide enough that, for Colorado's population, I suspect that estimate likely captures it. As with alcohol, at a minimum they'll collect sales taxes, plus any extra excise tax imposed through regulation. A quick check found the following excise tax rates for alcohol:

8¢ per gallon for 3.2% Beer
8¢ per gallon for Malt Liquor (beer)
8¢ per gallon for Hard Cider (apple and pear only)
7.33¢ per liter for Vinous Liquor
60.26¢ per liter for Spirituous Liquor

The caveat would be that if the feds crack down on sales the state has legalized, there may be none at all. But Colorado's a swing state and no matter who wins the election in November, I'd wonder at the wisdom of any Administration snubbing CO voters, assuming they pass it.

That said, as SH suggests, the savings from ratcheting down the drug war - particularly for PDs (of both types, police and public defenders) and county jails - would likely be more substantial than any tax revenues, whether or not the feds intervene, making it economically worthwhile in any event.

Posted by: Gritsforbreakfast | Sep 20, 2012 10:45:46 AM


Except I am pretty sure the feds would be able to enjoin the collection of any such sales tax, and I'm pretty sure they would exercise that power if indeed it is available.

Not going along with throwing people in jail is quite a lot different from trying to create a legal market in something the feds are trying to destroy. Much like how the proposed city owned marijuana grow operations in California (Oakland if I recall correctly) pretty much imploded after the feds started to realistically threaten city officials with prosecution.

Posted by: Soronel Haetir | Sep 20, 2012 11:56:19 AM

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