Election Analysis: Recreational Marijuana Now Legal in Four More States

News, Wealth

Tuesday, voters in four states, Arizona, Montana, New Jersey, and South Dakota, approved ballot measures legalizing recreational marijuana. The vote was only close in one state, South Dakota. That raises the total to 15 states plus the District of Columbia that have legalized recreational marijuana one way or another.

Recreational marijuana has been a hot topic across the nation this year as many states have budgets in disarray due to the coronavirus pandemic, and marijuana is assumed to be a potential new source of revenue. Combined with a desire to decriminalize marijuana, the zeitgeist is ideal for legalization (nationwide polling shows 67 percent of Americans support legalization). After Tuesday’s results, 15 states now allow cultivation, processing, sale, and consumption of recreational marijuana. 

With South Dakota’s narrow approval of Amendment A, it becomes the first state to simultaneously legalize medical and recreational marijuana. Gov. Kristi Noem (R) and parts of the business community have been a vocal opponent of legalization.

While most states have punted the question of legalization to voters, a few states may legalize through the legislature in the upcoming sessions—especially following Tuesday’s results. Prominent among these are New York and Pennsylvania, where Governors Andrew Cuomo (D) and Tom Wolf (D) have championed legalization. In addition, neighbors to newly legal states may consider legislation of their own in an effort to avoid sending tax revenue across state borders—potentially starting a snowball effect.

Three out of the four measures approved Tuesday (Arizona, Montana, and South Dakota) will impose an ad valorem excise tax (based on price) on marijuana at the retail level. In New Jersey, this question is left to the legislature.

Table 1: State Ballot Measure’s Proposed Tax Rates
State Measure Structure Tax Rate Does the General Sales Tax Apply? Excise Tax Revenue Estimates (Mature Market/FY2025)

Arizona

Proposition 207 Ad Valorem 16% excise tax (retail price) Yes $166.3 million

Montana

I-190 Ad Valorem 20% excise tax (retail price) N/A $38.5 million

New Jersey (a)

Question 1 TBD TBD Yes N/A

South Dakota (b)

Amendment A Ad Valorem 15% excise tax (retail price) Yes $29.3 million

Sources: Ballotpedia; ballot measure fiscal notes.

(a) Ballot measure prohibits any sales taxes in addition to the general sales tax except for a local option of 2 percent. Taxes on growers or wholesalers would be allowed.
(b) Revenue estimate includes sales tax, fees, and excise tax revenue.

Local rates not included

Taxing based on price means there is a taxable event with a transaction, allowing for simple valuation. While that might be the simpler way to go, it does not necessarily offer an equitable solution. In addition to the excise tax, Arizona and South Dakota will tax recreational marijuana under the general sales tax. (Montana does not levy a general statewide sales tax.) Levying state sales taxes on recreational marijuana products should be encouraged. 

While ad valorem excise taxes may look like general sales taxes, there are important differences. Excise taxes target specific transactions due to some unique characteristic (often negative externalities), and general sales taxes fall on most consumer transactions. An excise tax should correspond to the harm it is addressing, or the cost it is internalizing, neither of which has much connection to the price at which the good is sold. Taxation should be neutral and aimed at the negative externality connected to marijuana consumption, which is best expressed by the level of THC (Tetrahydrocannabinol, the main psychoactive compound in marijuana) or weight. There are legitimate reasons for levying excise taxes on marijuana, but legislatures and voters in other states should proceed with caution. Due to their narrow base, excise taxes are not a sustainable source of revenue for general spending priorities.

Beside not being equitable, revenue raised by ad valorem taxes risks being more volatile. Since they are price-based, and prices are likely to drop as the market matures, revenue raised per ounce of marijuana purchased may drop. Quantity-based taxes would also have limited a state’s exposure to changes to federal law, which could have big implications for the tax revenue from legalized marijuana. If businesses get access to banking, federal tax deductions, or interstate trading, prices will most likely fall—reducing revenue in states relying on prices as a tax base.

Of the newcomers, Arizona is especially exposed to federal legalization as Proposition 207 stipulates a maximum effective tax rate of 30 percent of retail value between state and federal taxes. In effect, Arizona’s state rate would decrease if a federal tax exceeds 14 percent of retail price. In that situation, lawmakers will only be able to amend the legislation with a 3/4 majority (voter initiatives are protected by the Voter Protection Act in Arizona), which may prove very difficult. South Dakota’s Constitutional Amendment A has the similar unfortunate effect of locking in a flawed tax structure. Down the line, were our concerns over price-based taxation to prove true, it would require the time-consuming process of a new ballot measure to change the state’s ad valorem structure. Montana’s I-190, on the other hand, can be amended by lawmakers in the future.

In New Jersey, the ballot measure is less detailed, which may prove constructive. Question 1 prohibits excise taxes at the retail level, but lawmakers are still free to impose taxes at the wholesale or manufacturer level. This allows the legislature to design neutral and stable excise taxes as well as a competitive regulatory framework. Both are crucial to creating an environment in which the legal market can prosper and reduce illicit sales and crime to a minimum.

Even though general fund revenue should not be the main priority when it comes to recreational marijuana legalization, there is revenue available to states that choose to legalize—just not in the short term. Beyond the general sales tax, legal marijuana businesses would also pay business taxes and employees would pay personal income taxes. Revenue from these broad-based taxes, combined with a potential saving as illicit operations decline, does represent general fund revenue. Expecting a large and sustained boost from marijuana-specific taxes, however, is shortsighted and represents poor tax policy.

Table 2: State Taxes on Recreational Marijuana Sales
State Structure Excise Tax Rate Does the General Sales Tax Apply?

Alaska

Specific $50/oz. mature flower; $25/oz. immature flower; $15/oz. trim; $1 per clone N/A

Arizona

Ad Valorem 16% excise tax (retail price) Yes

California

Mixed 15% retail excise tax; $9.65/oz. flower; $2.87/oz. leaves cultivation tax; $1.35/oz cannabis plant Yes

Colorado

Ad Valorem 15% excise tax (levied at wholesale by weight at average market rate); 15% excise tax (retail price) No

Illinois

Potency (Ad Valorem) 7% excise tax of value at wholesale level; 10% tax on cannabis flower or products with less than 35% THC; 20% tax on products infused with cannabis, such as edible products; 25% tax on any product with a THC concentration higher than 35% Yes

Maine

Mixed 10% excise tax (retail price); $335/lb. flower; $94/lb. trim; $1.50 per immature plant or seedling; $0.30 per seed No

Massachusetts

Ad Valorem 10.75% excise tax (retail price) Yes

Michigan

Ad Valorem 10% excise tax (retail price) Yes

Montana

Ad Valorem 20% excise tax (retail price) N/A

Nevada

Ad Valorem 15% excise tax (levied at wholesale by weight at Fair Market Value); 10% excise tax (retail price) Yes

New Jersey

TBD TBD Yes

Oregon

Ad Valorem 17% excise tax (retail price) N/A

South Dakota

Ad Valorem 15% excise tax (retail price) Yes

Vermont

Ad Valorem 14% excise tax (retail price) Yes

Washington

Ad Valorem 37% excise tax (retail price) Yes

Sources: State statutes; Bloomberg Tax.

District of Columbia voters approved legalization and purchase of marijuana in 2014 but federal law prohibits any action to implement it. In 2018, the New Hampshire legislature voted to legalize the possession and growing of marijuana, but sales are not permitted. Alabama, Connecticut, Georgia, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Minnesota, Nebraska, North Carolina, Oklahoma, Rhode Island, South Carolina, and Tennessee impose a controlled substance tax on the purchase of illegal products (the tax is normally levied on a person in possession of controlled substances). Several states allow local taxes as well as general sales taxes on marijuana products. Those are not included here.

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