As top Senate Democrats finalize their plan for making marijuana legal across the country, industry and advocacy groups are urging a lower tax rate.
They’re arguing that setting levies too high could allow an illegal market to keep flourishing and hit hard in some states that already legalized marijuana.
The details of senators’ vision for a federal cannabis tax regime will be a key factor in the coming weeks as Majority Leader Charles E. Schumer of New York, Finance Chair Ron Wyden of Oregon and Sen. Cory Booker of New Jersey work toward unveiling their bill in April.
Schumer said in a floor speech earlier this month that the effort aims to undo laws that have disproportionately targeted Black and Hispanic Americans. A letter he wrote to colleagues with Wyden and Booker argues to end the complications of a federal ban on a substance that’s already legal in many states. Marijuana can be legally sold for adult use in 18 states and for medical use in over a dozen more.
Schumer, Wyden and Booker released a discussion draft last summer that loosely outlined a regulatory and tax system based on those for alcohol and tobacco.
The effort looks to the Prohibition era as the most comparable historical case, though the current moment poses unique challenges. Ulrik Boesen, a senior policy analyst studying excise taxes at the Tax Foundation, noted Prohibition was undone at the federal level first, but states are driving marijuana legalization.
“There’s all these regulations and frameworks and taxations in place already that the [federal government] will have to sort of deal with and not mess up completely when they put their umbrella on top,” he said in an interview.
25 percent tax
The senators’ draft would create a federal cannabis excise tax that aims to disincentivize use, particularly by minors, while ensuring small businesses can compete with larger operations. Revenue would flow into a trust fund for communities impacted by the war on drugs, small business programs and other related spending.
Wyden said in a statement that taxes would “play a key role in preventing youth access and paying for important social equity and policy priorities.”
The Senate draft focuses on enforcement to stop sales from continuing outside of the new regulated system. Stakeholders say that should also be a consideration for the excise tax.
Under the Senate proposal, marijuana producers or importers would pay taxes semi-monthly for what they sold to distributors or retailers. The rate would start at 10 percent of the sale price and climb over five years.
It would land at 25 percent of a federal prevailing price, charged per ounce of product sold in flower form, or per milligram of THC — a psychoactive compound known to give marijuana users a high — for edibles, vapes and other alternatives.
Tax credits would slash rates in half for the first $20 million in annual sales, creating an effective rate as low as 12.5 percent for small businesses.
It’s similar to the tax regime devised by House Democrats in a bill that passed last year mostly along party lines. But that measure would offer no credit for early sales and includes a lower tax rate of 8 percent after five years, along with a $1,000 per-site tax.
Food and Drug Administration-approved products would be tax-exempt — a potential boon for medicinal usage — a category the Senate outline doesn’t mention.
It’s unclear how much revenue the Senate proposal would bring in. Removing marijuana from the list of drugs that are the most heavily restricted based on potential for abuse would allow the industry to deduct their business expenses for the first time, largely benefiting retailers.
A bigger legal industry could mean more income and payroll tax payments from new businesses and better tax compliance, which would boost collections on top of any new excise tax.
The Congressional Budget Office found that the House bill as passed in 2020 would generate almost $13.7 billion in additional revenue for the federal government over a decade. The measure’s excise tax alone would bring in nearly $5.7 billion, a sum that would likely be higher under the Senate draft’s rates.
No ‘blank slate’
But the 25 percent excise tax and five-year phase-in that senators proposed is drawing objections from a wide range of stakeholders.
Colorado Attorney General Phil Weiser, a Democrat, is among those asking senators to reconsider the tax rate. He said in an interview that Congress isn’t operating with a “blank slate” and should consider a lower rate or slower phase in for states with existing legal markets.
Colorado was the first state to set up a legal recreational marijuana market after a successful 2012 ballot initiative.
“We have an existing regulatory regime with taxation in place,” Weiser said. “And if we end up getting federal taxes on top of it, that is going to potentially raise the tax rate well beyond what we thought and potentially have some negative consequences.”
Weiser warned federal taxes too high could push people to buy across state lines — a blow to states that set up tax systems without worrying about that sort of competition — or lead to more people buying from an “underground market.”
Colorado wants to hold onto the revenue it’s generated from taxes and fees that include a 15 percent excise tax at the wholesale level and a 15 percent tax on marijuana sold in stores. In 2021, taxes generated more than $423.4 million for the state, and even more at the local level with funds going to school repairs, education and other needs.
The Tax Foundation estimated that retail prices for cannabis in states that have legalized use would rise by up to 20 percent with a federal tax. The think tank found effective tax rates could climb as high as 54 percent in Washington state and would be about 32 percent in Colorado.
The Tax Foundation’s Boesen said compliance costs and widespread access are critical factors alongside tax rates. Higher taxes can work – as they have in Washington state – if compliance costs are low and the option to buy legally is readily available, he said.
But that will differ state to state. He said effective tax rates in some states are already high, meaning legal businesses can’t set competitive enough pricing to woo customers.
Colorado lawmakers have been some of the most open to decriminalizing marijuana at the federal level.
That includes Sen. John Hickenlooper, a Democrat and former presidential candidate who’s come around after opposing his state’s ballot measure. Hickenlooper says he hasn’t studied the Senate draft but generally believes cannabis should be taxed similarly to alcohol.
Sen. Michael Bennet, D-Colo., a Finance panel member and fellow former presidential candidate, didn’t have any comment on the tax structure outlined in the Wyden draft. He’s up for reelection this year in a seat Inside Elections with Nathan L. Gonzales rates “Solid Democratic.”
‘Need to be patient’
Legalization advocates and industry groups share Weiser’s concern about a 25 percent federal tax, with many warning it would hamper the process of getting an illicit market to fade away.
A racial and economic justice-focused coalition advocating for marijuana legalization said in a comment letter that they support the excise tax structure in the Senate draft but want to see a lower rate.
Led by the Drug Policy Alliance, the coalition urged lawmakers to create other taxes including a surtax on corporate profits and an advertising and marketing-based charge, while offering carve-outs for medical marijuana.
Chris Lindsey, vice president of policy for a coalition of pro-legalization companies and advocates, the U.S. Cannabis Council, said in an interview that the Senate draft proposed a tax too steep that climbs over too short a period and in bursts too large. The group favors a competing tax proposal that’s part of a bill Rep. Nancy Mace, R-S.C., introduced last year, which would set a 3 percent rate that Congress couldn’t touch for a decade without supermajority support.
The National Cannabis Industry Association also backs a lower rate and wants to see edits to the small business incentive. Senior economist Beau Whitney said in an interview that because smaller businesses would have to pay the 25 percent rate in full before getting money back at tax time, they’d lose needed cash flow.
The group also wants a longer runway for getting to the permanent tax rate, arguing it could take several years to set up markets so businesses wouldn’t truly see a gradual rise. Whitney said a longer timeline would also allow illegal sales to die out, and that afterward the legal market could better shoulder tax increases.
“This is one of those things where tax policymakers need to be patient,” he said.
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