A recent Huffington Post headline read “Legal Marijuana Has Already Generated $15 Million For Schools”. The funds are appropriations from Colorado’s marijuana tax revenue. The appropriations weren’t the result of magic, but were instead the result of specific terms in Colorado’s Amendment 64 that levied an excise tax on recreational marijuana and specifically dedicated that revenue to schools. An excise tax is a tax on the sale or use of a particular good or service. It is more commonly known as a sin tax and is typically attached to goods or services deemed to be harmful or otherwise discouraged (e.g., alcohol, tobacco, and gambling).
An article from the Canna Law Blog outlines four government purposes for levying excise taxes: “1) generating revenue; 2) tailoring the tax burden to those that benefit from the services the excise tax funds; 3) controlling externalities; and 4) discouraging consumption of potentially harmful substances individuals might over-consume absent taxation.” The third and fourth purposes are the most relevant to an excise tax on marijuana, with the primary focus on controlling externalities such as youth use, prevalence of illicit markets, and marijuana abuse.
At first glance, levying an excise tax seems to be an obvious choice. But, as I argued in my last post, there are a lot of “unknowns” about how the marijuana market will respond to legalization. There is also an issue with whether the marijuana market is well-suited to an excise tax. While market research is limited, current research shows marijuana to be largely inelastic in demand. That means that market demand doesn’t change dramatically with price changes, so raising the price via taxation won’t decrease demand. Teens aged 12-17 are the only group showing any relative price sensitivity. If these numbers are true, an excise tax on marijuana won’t help control many externalities and won’t discourage consumption because people will be happy to pay more, not consume less. Even if consumption didn’t decrease, however, revenue generated from an excise tax would benefit California and could be earmarked for programs that aim to improve social welfare such as, education, youth substance use prevention, and more. This article explores some of the ways a marijuana excise tax revenues can improve social welfare and also explores some of the important drawbacks that an excise tax would have on California’s overall marijuana market.
California has experience levying excise taxes on alcohol, gasoline and tobacco products. An excise tax on marijuana is likely next in line given our familiarity and the precedents among states with recently legalized marijuana. Colorado, Oregon and Washington all implemented excise taxes on marijuana. As mentioned earlier, Colorado implemented a marijuana excise tax that specifically reserved the first $40 million raised each year for school infrastructure. Oregon and Washington, on the other hand, dedicated their excise tax revenue to a variety of different programs including, but not limited to, school funding, research on marijuana’s health impacts, youth education, enforcement of new regulations, and similar programs focused on reducing externalities. California should prioritize funding research with tax revenue given the lack of reliable data currently available. There is great need for scientific research that analyzes the health and intoxication effects of the 80 plus compounds in marijuana, the development of reliable testing modules for quality control, and also DUID. Sociological research is also important because marijuana’s current illegality severely limits our ability to gather reliable data on consumer usage patterns, the true size of the market, user quality of life, and long-term social outcomes (e.g., user productivity, mental health, and increases in overall usage).
An excise tax on recreational marijuana has both positive and negative implications for society. On the positive end, the funds collected from excise taxes can be dedicated to a particularized cause. For Colorado it is school infrastructure; for Oregon and Washington it is a host of various social programs. Either way, the excise tax revenues guarantee funds to specified causes that aim to improve social welfare.
The downside to sin taxes is that, by its nature, the tax is typically associated with the sale and/or use of a particular good or service, which presents a very costly issue for marijuana businesses. Ordinarily, businesses can deduct the costs of doing business—such as materials, rent, advertising, etc.—from revenues, meaning that they pay tax only on profit. Under federal law 280E, however, marijuana businesses cannot claim these deductions. Instead, they have to capitalize those costs and report them as cost of goods sold (COGS) once the product is actually off the shelves. However, COGS only includes direct costs of production and labor: it does not include all costs.
Given the state of federal law, recreational marijuana businesses subjected to a state excise tax will most likely not be able to deduct those taxes from their federal bill—meaning that they will have to pay for it twice. Let’s say the wholesale cost of an ounce is $50 and a retailer has to pay $50 in excise tax when she buys it from the grower. The retailer then passes the cost on to the consumer and adds $50 in profit, making the total cost of the ounce $150 ($50 to he grower, $50 excise tax, $50 markup). But even though the profit is only $50 in this scenario, the retailer cannot deduct the cost of the excise tax and instead has to pay tax on $100 ($150 revenue minus only the cost of the goods from the grower, $50). The retailer pays the excise tax and then, when that cost is passed on to the consumer, the reimbursement for the excise tax has to be reported as income. This is not a problem with excise taxes, but more a problem of excise taxes combined with 280E.
One negative aspect of these federal costs is that they force businesses to impose much higher pre-tax prices. High prices post-legalization could prove to be costly for society by way of preserving the dominance of the black market. Marijuana businesses also suffer huge profit losses due to the combination of the federal tax costs and state imposed tax burdens, such as excise taxes. These combined costs may make it difficult for such businesses to survive tax season, never mind make any profit. There have been suggestions that a potential cure may be as simple as imposing the excise tax on marijuana production so it could be included in COGS, but it is unknown whether the federal government will accept such clever maneuvering. For now, federal deduction exclusions remain a very real detriment to marijuana businesses profit margins and their ability to thrive in this burgeoning market.
Why should we care about whether marijuana businesses profit? For starters, the livelihoods of Californians depend on the state’s economic success. In 2013, California was ranked the 8th largest economy in the world. That makes for a very large pool of employees and individuals dependent on California’s economic health. Moreover, according to the ArcView Group, California’s legal marijuana market is the largest in the U.S., worth an estimated $1.3 billion. Colorado has a smaller market but legalization still created upwards of 10,000 new jobs for Coloradans. Even if California market estimates are optimistically high, the numbers and experience in Colorado reveal that marijuana business failures post-legalization could have crushing results for Californians. Thousands of individuals who invested their lives and money to this burgeoning industry would be thrust into unemployment or, worse, driven to the black market. All things considered, it would be prudent for us to examine the consequences federal deduction exclusions have for California’s economy post-legalization.
The takeaway from today’s discussion is that there are social but also economic harms that a marijuana excise tax can offset or exacerbate if not thoroughly considered in tandem. Additionally, an excise tax is just one mechanism by which the positive outcomes discussed today can come to fruition. The state could also achieve these through other forms of taxation or by funneling a portion of the funds from licensing fees into research or other worthy causes. As my title suggests, the discussion of levying an excise tax on marijuana really boils down to the question, “What is it good for?” Recall the metaphor of the marijuana tax seesaw from my first post. The consideration of a marijuana excise tax has a similar seesaw; this seesaw has competing social interests on either end. On one end we can generate funds for projects that increase social welfare (sociological research, reducing/preventing youth access, elimination of marijuana criminality), and on the other, we can increase socio-economic health (encourage new businesses, move black market participants into legal market) by generating less tax revenue to allow new (local) marijuana businesses to thrive. To remix a Motown hit song, “sing it with me, Excise tax- huh- what is it good for?…” Unlike Edwin Starr, we cannot unequivocally claim “absolutely nothing,” but it is still a worthy question to ask.
Alexa Quinn for Drug Law and Policy
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