Taxing Marijuana

Taxing

Tax revenues are a powerful incentive for states to embrace legalization. According Colorado’s Department of Revenue, Colorado has already collected nearly $22 million in marijuana taxes, licenses and fees in fiscal year 2014. According to an April 7, 2014, article on CBS Denver, Gov. John Hickenlooper originally forecasted $134 million in taxes and fees would be collected during the next fiscal year, but he revised his forecast in early April to project $20 million due to market volatility. Regardless of Hickenlooper’s revised projection, other states are beginning to eye the prospects hungrily.

Two particularly sticky issues emerge, however. First, taxes must be assessed in ways that do not cripple the industry in its most vulnerable phase. Second, as long as federal marijuana laws continue to be unsettled, collecting taxes may be difficult.

Emerging Tax Structures

Most states tax or contemplate taxing sales on the basis of weight. New Hampshire, Maine and Maryland are studying a flat rate of between $1 and $2 per gram. Colorado officially has a dollar-based system, but because the formula is unworkable, defaults to a weight-based scheme. It taxes the more potent bud at a higher rate than leaves and other plant parts, which are generally used for making concentrates. Alaska, Rhode Island, New York and Oregon are considering a two-tier plan similar to Colorado’s.

Washington State taxes marijuana sales at 25 percent of the dollar value. This tax is assessed either two or three times in a given transaction: when the producer sells to a separate processor, (a step that frequently does not happen); when the processor (or the producer) sells to a retailer; and finally, when a retailer sells to a consumer. It is essentially a value-added tax structure.

The problem with a dollar-based structure is that the tax is highest when the prices are highest. Prices will likely be highest in the startup phase of an industry, before efficiencies and economies of scale can bring costs down. Many argue that an industry’s infancy is a time to keep tax rates low to prevent customers from returning to the black market. Adopting a dollar-based structure may risk killing the goose that lays the golden egg.

Alcohol is taxed on the basis of potency. The higher the proof, the higher the tax. Taxing marijuana sales on THC content is more difficult because the potency of the raw material is not consistent. Taxing more homogeneous concentrates this way might work. Although no proposals to do this currently exist, it remains a theoretical possibility.

Collection is Another Matter

If they cannot collect the money, the most elegant and enlightened tax structure does states no good. All eyes are on Washington State, where the owner of a medical marijuana dispensary has challenged the state’s authority to collect sales tax as long as marijuana remains illegal under federal law.

Martin Nickerson is being simultaneously prosecuted for marijuana distribution and targeted by the Department of Revenue for not collecting and remitting sales taxes. Nickerson asserts that he cannot pay the tax without incriminating himself in the criminal case, in violation of his federal constitutional rights. The state has also seized more than $800 from his bank account. Nickerson is a very sympathetic defendant in many ways, but as the saying goes, hard cases make bad law.

The question threatens Washington State’s ability to collect taxes on the newly legalized recreational marijuana industry, as well as the existing medical market. Irrespective of the outcome in this case, the problem is not going to go away for any state that legalizes marijuana until the conflict between state and federal law is resolved.

It seems utterly contrarian to take the position that taxation is a good thing. To quote no lesser legal light than John Marshall, “The power to tax involves the power to destroy.” Nonetheless, the power to tax also implies the power to legitimize, to bring an industry out of the shadows. States will have greater incentives to legalize marijuana sales as workable ways of assessing taxes emerge through experience. The critical piece still missing is resolution of the conflict between state and federal law.

Anne Wallace is a New York lawyer who writes extensively on legal and business issues. She also teaches law and business writing at the college and professional level. Anne graduated from Fordham Law School and Wellesley College.

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