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As more state lawmakers across the country consider opening new, legal cannabis markets, new tax systems to support them must also be developed. Monitoring cannabis taxes is a good way to identify bad actors, address the illegal market, and bring in additional state revenue. But as is often the case with the U.S. cannabis industry, there is no federal standard. Tax rates for medical and adult-use markets vary from state to state, shifting the balance between taxes as a check on legal sales and expensive, multi-layered costs that drive patients and new consumers away.

Don’t get me wrong, there is room to improve cannabis tax structures and prevent diversion. Current estimates speculate about 90% of cannabis sales go untaxed through the illegal market. Even the U.S. Treasury Inspector Generalrecommended “the IRS develop a comprehensive compliance approach for the marijuana industry, including a method to identify businesses in this industry and track examination results.” Taxing cannabis ensures sales are accounted for in legal markets.

In the 33 states where medical cannabis is legal, most local tax structures replicate the tax structure on national medical treatments, where there are almost no taxes on prescription and over-the-counter drugs. In other words, medical cannabis markets are either untaxed or taxed at a much lower rate than adult-use markets. However, all fees for medical marijuana cards, prescriptions and doctor’s appointments are passed on to the patient.

On the other hand, most of the 11 U.S. adult-use cannabis markets impose state sales taxes, local sales taxes, and cultivation taxes, leaving consumers with add-on costs of up to 30%. And the effective federal tax rate for adult-use cannabis businesses can be as high as 90%, since they do not qualify for tax deductions on normal business expenses. Perhaps as a result, some legal cannabis businesses still run under-the-table sales to bring in additional revenue. The federal government believes there will be over $240 million in unpaid taxes from cannabis businesses over the next five years.

The ways in which states and municipalities use the new revenue also varies. In California, cannabis tax revenues help fund job placement assistance and substance use disorder treatment in communities most affected by past drug policies. Similarly, Oregon and Nevada cannabis taxes help pay for education programs, including in drug prevention and treatment. A Colorado town is using its cannabis tax revenues to help residents and businesses pay their utility bills and rent and give the local hospital and health department extra funding. And in the wake of George Floyd’s death, the Portland City Council is moving to divest marijuana tax revenue funds from the city’s police department. As cannabis legalization becomes more normalized, its taxes are likely to migrate away from legalization-related programs such as law enforcement to other public service areas more critically impacted by immediate needs like budget shortfalls from COVID.

Taxes help state governments monitor their legal cannabis markets and ensure revenues correspond with a licensee’s inventory. For instance, a 2019 audit in Nevada found that information reported in tax returns didn’t match information entered into the state’s track-and-trace software. The state was then able to follow up with businesses that had reporting deviations.

However, too many burdensome layers of taxation may undermine the cannabis marketplace and turn consumers and businesses away towards the unregulated market. As states move to legalize, they must create new structures that don’t push its residents to cheaper, unsafe, criminal market products. Without this balance – either on the local, state, or federal level – the U.S. will struggle to become an international leader in the emerging cannabis industry.

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By Lewis Koski for Forbes