It’s Complicated: Tax Revenue From Recreational Marijuana Remains Difficult to Estimate

“In this world nothing can be said to be certain, except death and taxes.” The Works of Benjamin Franklin, 1817. That idiom remains true today, and with the legalization of recreational marijuana markets, it was widely accepted that the taxes would allow state and local governments to plug budgetary shortfalls. So far, the data is limited and the results are mixed, but there are still plenty of takeaways for policymakers to consider.

Two states have accurately predicted or even underestimated the tax revenue that recreational marijuana would bring: Nevada exceeded their estimated budget figures, and Colorado got it almost exactly right. Those appear to be outliers. California missed badly with its initial estimates (as we previously wrote about here and  here), and things have not improved. According to PoliticoPro (subscription required), “[a]dvocates for legalization in California originally envisioned legalized pot raising $1 billion a year. As it turns out, the state raised not even a third of that in fiscal 2018-19, the first full year since recreational sales began. California is not alone; according to the same article, “Massachusetts had projected it would bring in $63 million in revenue for its first year of recreational pot, which ended in June, and didn’t even get half of that.”

What should policymakers take away from this mixed bag? A few things:

• First, and most importantly, legalization and taxation of marijuana can provide significant boosts to state budgets. The Nevada and Colorado experiences show that policymakers can get it right.
• Second, getting it right is not easy; predicting the size of state-level recreational marijuana markets—markets that did not previously exist and were thrust into existence via ballot imitative or legislative process—is hard. Jared Walczak of Tax Foundation said it best, “No matter how sophisticated the economic model, there are crucial inputs on which everyone is basically just guessing.” Layer on top of that the uncertainty about how consumers will transition from the illicit market, and you can see how state-budget forecasting is more art than science. Budget forecasters need to recognize that uncertainty as they proceed forward.
• Third, government budget forecasts are generally prone to be skewed to the high side, especially when there are politics involved. Legalization is often presented to legislators, officials, and the public as a new, significant tax revenue-generator that can funnel funds into education, law enforcement, infrastructure, and mental health programs, so it’s not surprising that revenue predictions sometimes prove to be rosy. Policymakers should resist the urge to overpromise, but the public should still apply an appropriate discount to any projections.
• Fourth, the illicit market is a resilient adversary that requires a carrot-and-stick approach to defeat. Policymakers must make the barrier to entry low enough that cannabis cultivators, manufacturers, and sellers will enter the legal market. They must make sure that the sales and consumption taxes do not make it prohibitively expensive and that zoning regulations do not make it prohibitively inconvenient for consumers to purchase legal marijuana. And with those steps taken, they must be willing to crack down on those who are still unwilling to enter the legal market.

Hopefully, these lessons are getting through. As more states legalize, estimating budgets should get easier as analysts are able to rely more heavily on actual, hard data instead of consumer surveys or markets from other states. With each passing year, states should be able to adjust their models and create more-reliable forecasts. But there is going to be the continued temptation to promise windfalls despite the cautionary tales of other states. The next state under the microscope will be Illinois in 2020. The state has some lofty tax projections, and with the Chicago Tribune already reporting that most insiders predict product shortfall, it’ll be interesting to see what the actual tax figures look like when it’s all said and done.

Tax revenue has been an interesting and critical challenge for state governments legalizing recreational marijuana, and it will continue to be well into the future. Be sure to check back in on our blog regularly for future updates on this topic and others that impact the industry.

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