With falling marijuana prices, states that have legalized marijuana will need to figure out how that will impact the tax revenue they were anticipating. (Ed Andrieski, Associated Press file)

Falling marijuana prices mean trouble for states that have legalized

The arrival of 2017 will bring many changes to the country, including falling marijuana prices in states that have legalized a recreational market. Cannabis users may cheer this news, but it heralds the start of an enduring budgetary headache for states that tax legal marijuana sales based solely on price.

New data from one legalization state illustrate the point. Colorado’s Department of Revenue assesses the going price for marijuana every six months and uses this information to calculate the value of the state’s 15 percent tax on pot production. The progression of marijuana prices over time in Colorado perfectly parallels the pattern in Washington after that state legalized: Prices briefly spiked due to initial supply shortages, but then began dropping as the marijuana industry matured and expanded. Wholesale prices in Colorado tumbled 24.5 percent over the past year to $1,471 per pound.

The marked descent of post-legalization prices was predicted by most marijuana policy experts. Nothing raises the price of a commodity like making its production, use and sale illegal, and that’s why an easy-to-grow plant like marijuana was able to command wholesale prices of $5,000/pound or more under prohibition. But as a walk down the aisle of your local grocery store will convince you, legal plant products – be they corn, almonds, red roses or allspice – don’t sell for anything near that amount, and legalized marijuana won’t either. Indeed some analysts think that once a fully developed legal market is in place, the natural wholesale place for pot could fall to less than $50 a pound.

Colorado, like Oregon, Washington, Nevada, Massachusetts and Maine, taxes marijuana as a percentage of the drug’s price. For these six states, sinking prices translate automatically into sinking tax revenue per sale. In Colorado’s case, the 24.5 percent drop in marijuana’s price brings the amount of tax per unit of marijuana down by exactly the same proportion. The state will start 2017 assessing a tax of only 15 cents per average-sized joint. Even if wholesale prices drop far less than what most analysts project in the coming years, the state’s tax revenue per unit of marijuana sold is going to be even lower in 2018 and lower still after that.

This puts Colorado and the other states with price-linked taxes in a bind. The only way to collect the same amount of revenue from year to year when taxes collected per unit sold are swiftly diminishing is to have substantially increased sales volume. In the case of Colorado, for example, unless the state’s volume of consumption rises by one-third in 2017, it will take in less marijuana tax revenue this year than it did last year. With each subsequent drop in marijuana prices, another compensating increase in consumption would be needed to stop tax revenue from withering.

But an explosion in the population’s marijuana consumption could incur other costs, such as more auto accidents by drivers who are stoned, an increase in heavy cannabis users dropping out of school, and so on. If the state adopts measures to cut soaring consumption, it will by definition lose tax revenue, potentially making the recreational marijuana system unable to pay for its own regulatory costs. This will infuriate voters who assumed legalization would not only cover industry regulation but would also fund schools, health-care programs and the like.

Two states with legal recreational marijuana avoid this problem. Alaska taxes marijuana at $50 per ounce regardless of its current price. California assesses both a sales tax based on price and a grower tax that, like Alaska’s, is a flat amount per ounce. By coupling a price-based sales tax with a invariant tax per ounce on growers, California places a solid floor under its marijuana tax revenue regardless of how far pot’s price falls.

The six legalization states with taxes based entirely on marijuana’s price have fiscal and political challenges ahead of them. Any other states that legalize would be wise to consider what marijuana expert Pat Oglesby calls California’s “belt and suspenders” approach to marijuana taxation, which insulates a state from the risk of having to subsidize an industry whose creation was supposed to relieve taxpayer burden rather than increase it.