THE BLOG
02/26/2014 12:39 pm ET Updated Apr 28, 2014

Marijuana Taxes: Time Will Tell

While marijuana revenue could be a promising new source of income for states, a wide range of expectations underscores how little we know so far about what mature markets will look like one day. Last week, early projections for marijuana revenue in the first two legalizing states gave way to new ones. In Colorado, expectations rose; in Washington, they collapsed. As projections zig-zag, other states considering legalization don't know what to expect.

In Colorado, the number jumped by 60 percent, from $67 million to $107 million. That's for the first fiscal full year of marijuana excise taxes. The old, lower number came from the Legislature last August; the new, higher one came from the Governor on February 18.

In Washington, the number collapsed from $1.6 billion to $129 million -- a drop of over 90 percent. Oops. Those numbers are for marijuana excises by the end of Fiscal 2017. The old, higher number came from a criticized 2012 legislative estimate; the new, lower, more plausible one came from the state's official Forecast Council on February 19.

That's confusing. But even comparing the official forecasts is confusing. The numbers above are just for excise taxes. Colorado's wholesale excise tax rate is 15 percent; its retail rate is 10 percent. In Washington, both those rates are 25 percent, and a third 25-percent tax, on producer sales, sometimes applies, too. In comparing estimates for excise taxes apples-to-apples style, there are lots of oranges to ignore, in the form of ordinary sales taxes, license fees, business and occupation taxes, out-year projections, dedicated uses, and more. In Washington, for instance, over 80 percent of marijuana excises are sent straight to health care, substance abuse, public health and other programs -- and never enter the General Fund.

Tougher than interpreting what the States report, the real work of predicting the future and estimating marijuana revenue involves a host of imponderables. To start with, excise taxes don't apply to medical marijuana -- at least for now. So any consumer who qualifies as a "patient" avoids taxes. Meanwhile, bootlegging will not dry up overnight, and revenue collections depend on law enforcement's willingness and ability to crack down on illegal sales.

As time goes on, competition from other, newly legalizing states could reduce tax receipts in Colorado and Washington. A federal crackdown on all state-legal marijuana could make taxes vanish completely.

Market maturation is bound to bring more uncertainty. Tax receipts in both Colorado and Washington are tied to pre-tax marijuana prices, and receipts may suffer as prices decline. Eventually, pre-tax prices will deteriorate as costs drop. Businesses will move up the learning curve and new efficiencies will develop. Marijuana companies will experiment and improve; nonrecurring startup expenses for professional fees and the costs of raising capital will be fully amortized; new market entrants will create more competition and more supply.

Those price declines will mean less revenue per ounce sold, since taxes are a percentage of price. But more ounces will probably be sold legally and thus taxed -- for two reasons. First, lower prices will attract consumers. Second, bootleggers, still paying the extra costs of sneaking around, won't be able to match legal prices. So bootlegging will fade away. But it's hard to say how soon all this might happen. And will higher volume at lower prices bring more tax revenue, or less? It could go either way.

That's a lot of uncertainty. But can Colorado and Washington collect the revenue they expect by adjusting to changing market conditions?

Colorado's Taxpayer Bill of Rights ties its Legislature's hands: No tax increase without a referendum. (Ordinarily, there isn't much hurry, but the marijuana market might evolve quickly.)

Washington can be more nimble. The Legislature can amend voter-passed initiatives, like the new marijuana law, sooner or later. For two years, two-thirds of each House must agree, but after that, it's majority rule. Washington might adjust not only tax rules but also market size -- and charge what the market will bear.

Meanwhile, seeking more certainty, serious proposals for legalization in 2014 -- bills in Maine, Maryland, New York, and Rhode Island, and an initiative in Alaska -- take another approach. They would tax marijuana by weight. Taxing by weight instead of percentage of price avoids automatic revenue loss as prices go down. That takes away some of the uncertainty -- but hardly all of it.

For the time being, as estimates fluctuate and as markets evolve, we are in the dark. It could be years before we know how much sustainable revenue to expect in the first two legalizing states. Still, states that have waited may get a clearer idea of just how to legalize -- and what revenue to expect -- as the experiments being conducted in Colorado and Washington begin to show results.