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Taxing Marijuana: Four Questions

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Marijuana legalization brings tax questions: Whether to tax, how much, for whose benefit, and by what measure. None of the answers is obvious.

Whether to tax

Some think marijuana should bear no special taxes. Their theory will face voters next month in Colorado, where proposals to tax legalized marijuana 15 percent at wholesale and 10 percent at retail -- along with various local taxes -- are on the ballot. Those proposals face strong opposition. If they fail, marijuana will bear only regular sales taxes (2.9 percent at the state level).

It's hard to answer the "Whether" question without first looking at the other questions about taxation. Here goes.

How much?

To start with, taxes need to pay for the expenses of implementing and enforcing legalization. After that, taxes could bring political support by benefiting the public.

But taxes should stay low enough to put organized bootleggers -- tax cheaters -- out of business. A fixed tax rate may be too low at first as newly legal businesses pay extra, one-time costs to start up. That same fixed rate will make little sense as economies of scale push down pre-tax production prices -- to maybe as low as $20 or $25 an ounce. A flexible rate, like that timidly suggested in Denver, is the ideal.

Who benefits?

American consumers today reportedly spend around $30 billion a year for marijuana. That's a pot of gold. Where will that money go? Some of it could disappear. Consumers wouldn't mind a price cut, naturally enough. But their main complaint is illegality, not high prices. John Prine described marijuana prices this way: "You may see me tonight with an illegal smile. It don't cost very much, and it lasts a long while."

Ganjapreneurs -- producers and sellers of legal marijuana -- are lining up to share in that $30 billion (or whatever the number turns out to be). But tempering the profit motive may go a long way toward building public support - and toward addressing concerns of worried parents. Colorado's successful 2012 initiative enticed voters with taxes for school construction; Washington's helped a laundry list of programs. Marijuana revenue could go into the general fund, or allow cuts of unpopular taxes. There will never be a "right" way to split up the money.

How?

So far, taxes have been based on percentage of sales price. That's easy to calculate: It requires no weigh stations or product testing. But a percentage base is easy to get around. Free Joint Giveaways, like those designed to boost opposition to taxes in Colorado, would be tax free, since any percentage of zero is always zero. And how would anyone figure the tax on hotel stays bundled for one price with free marijuana? When the seller winks at the buyer when selling something for below its fair market price, it's hard for auditors to figure out its "real" price -- that's how Google, Starbucks, GE, and other multinationals make a laughing stock of international tax rules.

Price-based taxes will swing wildly up and down as an industry starts up and prices find equilibrium. That's not good. If we look for analogies, price is not the base for any federal alcohol tax. Taxes on liquor and wine depend on alcohol content; beer taxes depend on volume.

Taxing marijuana by weight would solve some problems, but powerful ounces would be taxed the same as weak ounces. Still, the choice for marijuana plant material is either price or weight: Taxes based on content of psychoactive THC (tetrahydrocannabinol) won't work. Test results are not replicable because the material is not fungible enough - not consistent in THC content. Liquids are fungible, though, so potency could be the tax base for oils -- marijuana concentrates.

Still, percentage-based taxes don't require indexing for inflation. In real terms, unindexed Federal alcohol taxes have shrunk dramatically since the last increase, in 1991.

Meanwhile, California localities tax growing area or excessive electricity use associated with indoor growing. And the Federal Tax Code uses an entirely different method to tax marijuana. Code section 280E taxes all federally illegal drugs by denying deductions not only for advertising and marketing, which parents dislike, but even for local fees and property taxes.

Whether, Reconsidered

Taxing marijuana is no easy matter, but tax-free marijuana could cause a voter backlash -- or intervention from a federal government worried about leakage to other states and underage users. The Colorado taxes on the November ballot will show what voters are thinking.

A state monopoly would be the most cautious approach to legalization, but states have steered clear of selling through state stores, which would directly violate federal law.

We are not even at the end of the beginning of figuring out the revenue issues -- and many more things -- around legalized marijuana.

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