Weed and greed: How marijuana taxation went up in smoke

This is a story about weed (i.e., marijuana or cannabis), and it’s a story about greed — greed on the government’s part, which encourages more greed on the part of those willing to break the law for profit.

There has been a long-running debate over legalizing the recreational use of drugs, especially marijuana. Proponents argued that legalization – or at least decriminalization – would undermine black market sales of those drugs. Prices would fall and organized crime and gangs, which have long profited from the distribution and sale of illegal drugs, would diminish. Meanwhile, the government could regulate vendors to ensure quality and safety and, most important to the politicians, tax their sales.

While I never agreed with the argument, it didn’t seem unreasonable. What was needed was a test case to prove the theory. Now we have one.

Twenty-two states have legalized the recreational sale and use of cannabis, and for many of them the theory has, well, gone up in smoke.

The federal status of cannabis has not changed. According to the U.S. Drug Enforcement Administration (DEA), “The FDA [Food and Drug Administration] and DEA have concluded that marijuana has no federally approved medical use for treatment in the U.S. and thus it remains as a Schedule I controlled substance under federal law.”

Whether that assessment is correct or not, that hasn’t stopped several states. According to the Tax Foundation, “Recreational marijuana taxation is one of the hottest policy issues in the U.S.”

The sales and excise tax rates imposed on the product can vary significantly from state to state. And in some cases, cities add their own sales tax.

Washington state, for example, imposes a 37 percent sales tax on the retail price of marijuana, Virginia has a 21 percent tax, Montana 20 percent, Oregon 17 percent and Vermont 14 percent. Several states impose an excise tax on both the wholesale and the retail price. Others tax the amount a customer buys.

Excessive tax rates on any product or service always encourage some people to game the system or move to the black market.

But high tax rates aren’t the only stumbling block. Several states have a fairly arduous application-and-approval processes for becoming a licensed marijuana vendor. In some states it can take months for an application to move through the licensing process and still be denied a license. That opens the door for vendors to ignore the process and begin selling the product anyway. And if they ignore the licensing process, they can ignore collecting the tax.

Wall Street Journal reporters Zusha Elinson and Jimmy Vielkind recently looked at what’s happening to the cannabis market in California and New York. Seven years after California legalized the production and sale of marijuana, “Unlicensed sales totaled $8.1 billion last year, dwarfing legal sales of $5.4 billion, according to estimates by New Frontier Data, a cannabis analytics firm.”

The reporters cite one cannabis industry consultant saying, “When you start seeing tax rates that are approaching 30 to 40 percent on products, it’s really going to be difficult to compete against the remnants of an illegal market.”

For example, Los Angeles has a 10 percent city cannabis tax, then there’s a 15 percent state sales tax on the product, plus a standard 9.5 percent sales tax.

Maybe that’s one reason Los Angeles has 354 licensed marijuana shops but between 700 and 1,000 unlicensed shops and delivery services.

As for New York, after two years, “just five shops sell marijuana legally in New York City, while 1,400 bodegas, smoke shops and other outlets without licenses do, according to an estimate by the city sheriff.” Many of those unlicensed shops openly advertise their products because the city is so lax about enforcing the restrictions.

While several of the states have done a better job of controlling the black market, it’s always there. And the reality of interstate commerce means that even states that have not legalized recreational marijuana get caught up in the act.

Oklahoma allowed the commercial cultivation of marijuana for medical purposes in 2018, and now, “The Sooner State has become the biggest source of black-market weed in the country, the Oklahoma Bureau of Narcotics estimated this month.”

Once the government gets greedy and starts imposing very high taxes, it encourages a black market where safety regulations, quality controls and sanitation may be lacking. As soon as illegal vendors realize that they can cut some corners and save money, they get greedy too, hoping to reap outsized profits.

Greedy politicians always push for high tax rates, which leads to gaming the system or illegal activity. Greed leads to more greed, and especially with weed.

Merrill Matthews is a resident scholar with the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter @MerrillMatthews