Drugs

Marijuana Taxes in Colorado—An Early Clue

Future tax collections could turn out much lower or much higher—we still have a lot to learn.

Photo Credit: JeremyNathan / Shutterstock.com

Across America, lawmakers are eyeing tax revenue from legalized marijuana. Colorado and Washington are each officially expecting over $100 million annually in marijuana excise taxes. In a few days, the Colorado Department of Revenue is due to report how much marijuana tax was paid there for January, the first full month of recreational sales anywhere ever.

But the report on January collections will tell us next to nothing about what other states can expect, and only a little about Colorado. You can multiply January taxes by 12, but that won't show annual marijuana revenue the state can count on from now on -- for two reasons. First, the mature market will not resemble the start-up January market. Second, Colorado will start taxing some transactions that it exempted in January.

Start-up Uncertainties

In future months, Colorado's industry will probably sell more grams of marijuana than it sold in January, but at lower prices. More grams will pull taxes up. Lower prices will push taxes down. It's not clear where taxes will end up.

Some background: Colorado's Constitution calls for two recreational marijuana taxes -- a 10-percent retail tax, and a 15-percent wholesale tax. With those percentage taxes, lots of grams of pot sold at high prices mean lots of tax is collected. If the number of grams goes down, or if prices go down, less tax is collected.

The number of grams for sale in January was low. As the month began, few stores were open -- but now more stores are opening all the time. Even the stores that were open experienced a "valley of supply," as they geared up and struggled to meet demand. That low supply won't last long, but fewer grams of marijuana were sold in January than in a normal month. Fewer grams pushed January tax collections down.

A maturing industry will not just sell more units -- it will also charge lower prices. Think cell phones and large screen TVs.

Indeed, prices in January seemed abnormally high. And not just because of low supply. Prices tend to go up as demand goes up. A one-time spike in demand may have helped boost January's prices. A spike could have come from customers buying several months' supply in advance or from tourists flying in for the grand opening in record numbers -- maybe unsustainable numbers. In any event, January's high prices benefited tax collections.

So in January, it looks like low supply and maybe high demand pulled prices up, but low supply restricted the number of grams sold -- with opposing effects on tax collections. Sales in grams will increase before long, and prices will drop. The net effect on tax collections is not clear.

The "One-Time Transfer" Hole in the Wholesale Tax

Whether Colorado's maturing market helps or hurts tax collections, another factor, unique to Colorado this year, definitely pushed January collections down. Lots of marijuana escaped tax in January, and that won't keep happening long.

Of Colorado's two recreational marijuana taxes, the 10-percent retail tax got collected in January -- no problem. But Colorado's nominal 15-percent wholesale tax was not collected on lots of marijuana sold then. That failure to collect happened because of a temporary hole in the wholesale tax.

Here's the deal: On January 1, recreational pot sales became legal. So did pot growing. But marijuana doesn't mature in a day. Would customers have to wait for plants to grow? No. On January 1, there were lots of medical marijuana businesses in Colorado. (Medical marijuana remains tax exempt.) By Colorado law, only medical marijuana businesses could open up new recreational businesses at first. Regulators allowed "one-time transfers" of marijuana on hand (in inventory) from medical businesses to allied recreational businesses. That way, pot shops had something to sell on January 1.

It turns out that those "one-time transfers" escaped the wholesale tax. The tax statute just didn't catch it. Technically, the wholesale tax is "imposed at the time when the retail marijuana cultivation facility [RMCF] first sells or transfers unprocessed retail marijuana." And the RMCF is the only possible taxpayer for the wholesale tax, the statute says. No RMCF, no tax. A medical marijuana business -- the "one-time transferor" in January -- is not a RMCF. Oops, says the tax collector. Bingo, says the industry. (To be fair, this tax break comes at an opportune time for the legal industry. The industry needs to win a price war against bootleggers, who have not gone away. To win that war, the legal industry needs low prices at first. Temporary tax relief can help offset growing pains.)

Now this hole in the tax will soon close up. Soon, recreational businesses will use up their "one-time transferred" stashes, so then all recreational marijuana will bear wholesale tax. Colorado's official revenue estimators know this. They predict that wholesale tax collections will indeed grow disproportionately faster than retail tax collections.

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We can't be sure how much marijuana revenue Colorado can count on in the long run. Start-up uncertainties create confusion, and a hole in the wholesale tax makes January collections uncharacteristically low. In the grand scheme, newly legalizing states could compete with Colorado and reduce its tax collections. A federal crackdown could wipe collections out. January 2014's tax number will provide a clue about long-term, sustainable revenue, but just a clue. Future monthly collections could turn out much lower, much higher, or about the same. We have a lot to learn.