Policy Recommendations

  • Maintain aggregate net effective tax rates (inclusive of state, local, and supply chain taxes) at 20 percent or below.
  • Enable local governments to generate cannabis tax revenue, but cap local tax rates at 3-5 percent.
  • Restrict all state and local cannabis taxes to the final point of sale.
  • Base tax rates upon final retail prices instead of by weight or THC content.
  • Distribute a portion of state cannabis tax revenue to local governments on a pro-rata dispensary license basis

Importance of Setting Proper Tax Rates

Taxation is a fundamental component of state and local cannabis reform efforts. To support a safe, well-regulated, and profitable cannabis industry, governments must set appropriate tax rates. The total demand for cannabis in the U.S. (including the unregulated market) is estimated to be around $52.5 billion annually. As such, there is considerable tax revenue to be made for state and local governments that adopt adult-use cannabis laws and implement sensible tax policies. However, if lawmakers pass burdensome tax rates and the price of legal cannabis far exceeds illicit market prices, consumers will continue purchasing from unregulated sources.

Balancing Optimal Revenue Generation and Illicit Market Displacement

When setting cannabis tax rates, lawmakers must strike a balance that accounts for both goals of generating revenue and reducing the unregulated market. Taxes must be high enough to cover the cost of the regulatory and oversight needs of the cannabis industry, as well as create new revenue streams to fund key programs and initiatives, such as public schools and infrastructure. Excessively high taxes drive consumption to the illicit market, making it difficult for licensed businesses to compete and discouraging prospective entrepreneurs from entering the legal market. Research shows that while cannabis consumers are willing to pay up for legal products, they are still relatively price-sensitive and will revert to the unregulated market if prices surpass a certain threshold.

The Challenge Posed by Multiplicative State and Local Taxes

In certain jurisdictions, policymakers have imposed multiple layers of taxation across the cannabis supply chain (e.g. a jurisdiction that has a retail cannabis excise tax at the final point-of-sale may also have a tax on cultivators, manufacturers, and transporters). State and local policymakers often overlook the compounding impact of multiplicative taxation, which can inflate legal market cannabis prices well above what the vast majority of consumers are willing to pay. As a result, policymakers should avoid imposing taxes down the cannabis supply chain and instead restrict taxes exclusively to the final point of sale.

Excessive Tax Rates are a Barrier to Entry For Small and Social Equity Owned Businesses

High tax rates present a major barrier to entry into the cannabis industry, particularly for those with limited access to capital. Excessive taxation makes it difficult for even well-funded operators to compete with the illicit market, and that burden is amplified for small businesses. Policymakers who wish to support a diverse cannabis industry and facilitate the entry of social equity and small businesses into the cannabis market should take into consideration the role that tax rates play in determining the viability of these businesses.

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