Strategies for Effective Cannabis Taxation in the United States: Insights From The Tax Organization

In December 2023, The Tax Organization, a non-profit entity, issued a comprehensive report titled “Cannabis Taxation: Lessons Learned from U.S. States and a Blueprint for Nationwide Cannabis Tax Policy.” The report, delving into the nuances of marijuana taxation and its implications, presents several critical lessons derived from the implementation of marijuana laws and the establishment of legal markets.

Optimal Tax Rates for Market Competitiveness

One key lesson is the necessity to set tax rates low enough to enable legal markets to compete with or surpass the illicit market. The report highlights that current research indicates instances where legal and taxed cannabis is often overtaxed, hindering legal markets from capturing a more substantial share of the market activity occurring in the black market.

Revenue Potential and Volatility

The report underscores the significant revenue potential of legal marijuana markets. However, it also notes that these revenues may take years to materialize post-legalization and can be volatile, particularly if taxes are imposed ad valorem (based on the value) rather than ad quantum (based on quantity). In 2022, states collectively collected nearly $3 billion in marijuana tax revenues, with substantial contributions from well-established markets like California, Washington, and Colorado.

Consistency in Tax Design Across Jurisdictions

Consistency in tax design across jurisdictions is emphasized as a crucial aspect. The report points out that while current differences in tax policies across states may be inconsequential while state cannabis operations remain isolated, these differences could become significant once interstate commerce is permissible. The potential for tax arbitrage is highlighted, and the report suggests that states should be prepared to reform tax designs to avoid such issues.

Best Practices for Cannabis Taxation

The report recommends a nuanced approach to marijuana taxation, considering the diverse range of cannabis consumption products. It suggests taxing by potency where possible and weight where THC content measurement is impractical. The proposed hybrid weight-potency tax would allow for higher rates on more potent products, reflecting higher societal costs associated with their consumption.

Furthermore, the report suggests levying taxes early in the value chain, similar to alcohol and tobacco excise taxes. This approach minimizes the number of taxpayers and ensures that excise tax revenue is directed towards addressing external harms related to marijuana consumption, such as public safety, youth drug use education, and cessation programs.

The report advocates for a simple, low-rate, and low-cost tax system that has the potential to generate significant revenue while simultaneously mitigating social harms associated with cannabis by transitioning illicit market transactions into a legal framework. As legal markets for cannabis products continue to evolve, the implementation of effective tax policies remains a crucial component of their success.

The full report can be found here.