Cannabis is fast becoming one of the top excise revenue sources for states that have legalized the substance. Cannabis excise tax revenue collection, as a matter of fact, is outpacing liquor tax collection in most states where it has been legalized.
This was highlighted by a recent article in Forbes when cannabis tax revenue in Massachusetts surpassed the liquor tax revenue just two years after enactment of legalization. The two-year mark appears to be the break-even point, looking across most states, when cannabis tax revenue surpasses liquor taxes.
But beyond surpassing liquor tax revenue, cannabis taxes are quickly becoming a major excise tax revenue stream. Washington State, for example, collects twice as much tax from cannabis than it collects from liquor. In 2020, this amounted to $473.9 million in cannabis revenue, compared to $244.5 million collected for liquor sales.
And this trend only continues as the legal market for cannabis matures. California, which legalized cannabis in 2016, reported cannabis tax revenues of almost $1.1 billion from cultivation, excise, and sales taxes in 2020, or almost three times what California collected in taxes on liquor sales at $407.5 million. California is on track to break this record further as cannabis taxes in 2021 topped $1.3 billion but hasn’t yet reported liquor sales for a comparison.
Colorado, the first state to legalize the crop ten years ago in 2012, shows what an important source of tax revenue cannabis can become for a state.
In 2021, Colorado collected $423 million in cannabis tax revenue compared to $53 million collected on liquor, or almost eight times as much. And it even collected double its 2019 cigarette excise tax collection of $197 million.
Although Colorado most recently more than doubled its excise tax from $0.84 to $1.94, cannabis tax collection will likely continue to exceed cigarette taxes, since much of the cigarette tax increase will be subsumed by increased black market activity, as was the case in California.
In California, cannabis would have already been the biggest excise tax revenue item had it not been for a $2 excise tax hike in 2016. That year, California collected just over $1 billion tobacco taxes, and with cigarette tax collection in steady decline, cannabis tax collection by now would have surpassed cigarette tax collection. But with the $2 excise tax increase, the tobacco tax revenue now stands at $1.7 billion.
This however raises an important point and concern about excise taxes and their unintended consequences. California effectively tripled its cigarette excise tax from $0.87 to $2.87, yet did not collect triple the excise tax the following year. Where did all that volume and revenue go?
A public health study showed that the effective self-reported price for cigarettes increased by $1.84, or less than the tax increase, and the study found that ‘no evidence suggested that Proposition 56 was associated with the changes in the prevalence of current or daily cigarette use, cigarette consumption per day, or the prevalence of current or daily use of non- cigarette tobacco products’.
In other words, the tax increase did not change smoking behavior and yet it didn’t augment tax revenues by the increased amount either. Smokers were getting their cigarettes from cheaper smuggled sources, which points to a significant black market for cigarettes in California.
The Tax Foundation most recently reported that an estimated 47.7% of California’s cigarette consumption might be smuggled in from out of state – a staggeringly high number and an important warning sign for tax collection on cannabis.
Cannabis will continue to be an irresistible revenue source for legislators. Cannabis legalization efforts will continue to accelerate, as my team and I predicted in our last article on this issue in July 2020. Last year alone, seven states legalized cannabis, bringing the total to 18 states with legalized recreational use and 38 states with legalized medicinal use. Dozens of states are looking to join their ranks in the years to come.
Cannabis tax revenue will quickly become an important tax revenue source for states, surpassing liquor tax collection within 2-3 years and potentially surpassing tobacco taxes within 7-10 years after legalization.
However, with the increase in tax revenue come several risks for policymakers. As the states become more reliant on cannabis taxes, they will increasingly be tempted to raise those taxes, as they have shown a propensity to do with cigarette and tobacco taxes. Yet, many tax increases never realize their projected revenues, as much of the potential new revenue goes to growing black markets instead.
Furthermore, rapid tax increases in cannabis will also stifle a budding industry that is starting to emerge. And, more importantly, it will hinder the transition from an illicit cannabis market to a legal cannabis market.
This author has explored this issue many times, most recently in the November 2021 issue of Tax Stamp & Traceability News™, when we looked at the rampant growth of ‘burner distributors’ in California, which were sparked by stifling regulation, high taxation, and lax licensing controls.
As states embark along the path to legalization, it will be crucial for them to implement a thorough, yet sensible, regulatory, licensing and taxation scheme that can maximize tax revenue, and accelerate the establishment of and transition to a legal marketplace, while ensuring that it does not increase the illicit market. As such, states should focus on several pillars:
Learn from your predecessors: study best practices on regulation, licensing, taxation, enforcement, and technology. Elected leaders, state officials, and tax revenue authorities are well advised to talk to government officials, law enforcement, industry participants and consumers in those states to learn what has worked and what hasn’t. The Tax Stamp & Traceability Forum™, to be held in May, in Malta, might be an excellent opportunity for such discussions.
Comprehensive, flexible, and sensible regulatory and licensing scheme: the purpose of regulation needs to be to bring as much of the current illicit market into the legal market, encourage new participants into the legal market, while discouraging participants not willing to play by the rules. This includes a rigorous, but not arduous, licensing scheme, from seed to sale – with background checks, physical location inspections and ongoing reporting – which at the same time considers how to protect state registrants from federal overreach.
As my team and I have reported, and as shown through the black-market experiences in Canada and California, growing and distribution licenses should entail the most thorough and cumbersome requirements, while retail licenses should be simple and widely available, in order to build and encourage a legal market.
Appropriate and rigorous enforcement mechanisms: the trade in cannabis has, and is going to, continue to attract the criminal element, especially when tax revenues grow into the hundreds of millions and tax evasion becomes a lucrative proposition.
Legalization needs to include funding mechanisms to support new enforcement units. Simply including or subsuming cannabis within existing enforcement structures is likely to lead to a lack of enforcement due to a lack of focus and inadequate resources.
Establishing and funding dedicated departments and enforcement personnel will ensure that adequate focus, resources, and manpower are used to ensure compliance and suppress illicit activity. This needs to also include appropriate fines, penalties, and sanctions to deter non- compliance.
Sophisticated technology to aid enforcement, tax collection and consumer safety: cannabis legalization has unique technology needs and requires a detailed accounting of product from seed to sale. Several stand-alone tax stamp, as well as track and trace, solutions are on the market, with METRC being the dominant player. Yet, as shown in my recent article, these systems need to be closely examined to ensure there are no loopholes for criminals to exploit.
Track and trace technology for cannabis will need to satisfy consumers that are increasingly looking for ways to authenticate their purchase, as well as tax collectors wanting to track and trace product from seed to consumer, and law enforcement looking for ways to quickly spot illicit product and trace diverted product back to its source, potentially even across state lines.
Cannabis might just be a green gold mine for tax collectors. But like any mining operation, getting the overall design, structure, basic shafts and underlying technology correct will be the difference between a lucrative mine for many decades or one collapsing under its own tax and regulatory burden.
Sven Bergmann is the founder and CEO of Venture Global and advises brand owners, technology providers and governments on anti-counterfeit strategies, programs and technologies. Send your comments to SBergmann@VentureGlobal.com.