In the United States, state and federal excise taxes play a crucial role in shaping the business landscape for various industries, particularly those associated with vices, such as tobacco. While federal excise taxes do not currently apply to marijuana, state excise taxes (SET) are increasingly significant for the recreational marijuana sector, influencing economic dynamics within states where it is legalized. Typically, SET on marijuana mirrors the structure seen with tobacco products—particularly in the way it is often levied as an ad valorem tax, which is calculated based on the value of sales made by business licensees selling marijuana. Notably, however, there are key differences in how these tax frameworks operate across various states with legalized recreational marijuana.
The Dominance of Retail-Level Excise Taxes: Retail-level SET is prevalent in the largest legal marijuana markets across the U.S. Among the nine states projected to surpass $1 billion in total sales (covering both recreational and medical marijuana) in 2024, seven impose SET solely on retail sales, while only two states apply it to both cultivators and retailers.
This retail-centric focus distinguishes marijuana SET from tobacco excise taxes, typically imposed at the distribution level. The varying tax rates across states further highlight this disparity. For instance, Massachusetts levies a SET of 10.75% on consumer sales of marijuana. California enforces a 15% SET on the gross receipts from cannabis sales, while Washington takes a more aggressive approach with a SET of 37% on retail sales.
From a tax policy perspective, implementing SET at the retail level can enhance transparency, making it clearer to consumers how much tax they are contributing when purchasing marijuana. Retail-level SET, particularly when itemized on receipts, allows consumers to fully grasp the tax implications of their purchases, promoting a more informed buying experience.
Understanding tax transparency is especially vital in the evolving legal landscape of marijuana in the U.S. As the market matures, consumers need to be aware of how policies like SET influence their experiences and choices in the dispensary. Moreover, the foundational purpose of excise taxes is to shape consumer behavior by encouraging market participants to recognize and internalize the costs associated with products deemed to have external costs, such as those impacting public health.
By establishing SET on marijuana, states signal an intent to regulate consumption levels. An effective retail-level SET structure enables regulators to monitor shifts in demand resulting from these taxes.
Examining Multi-Level SET in Illinois and Colorado: In contrast to the retail-only model, both Illinois and Colorado utilize a multi-tiered SET framework, taxing marijuana at different stages within the supply chain. Illinois implements a “privilege tax” of 7% on the gross receipts from a cultivator’s initial transfer of cannabis. If this transfer occurs between affiliated entities, the Illinois Department of Revenue can set a predetermined “selling price” for tax purposes. In addition, Illinois applies a retail-level SET of between 10% to 25% on consumer purchases, depending on the type and THC concentration of the product. Similarly, Colorado charges a 15% SET on cultivators’ first sales or transfers of unprocessed marijuana to retail outlets, as well as a separate 15% retail-level SET on sales made by retailers.
However, this two-layer taxation system may inadvertently create disparities in tax burdens between vertically integrated and non-vertically integrated producers. If the tax bases calculated by the government, such as the “selling price” or “average market rate,” do not accurately reflect market realities, vertically integrated operations could face higher effective tax rates compared to their non-integrated competitors. To mitigate these inconsistencies, reforming the SET structures in Illinois and Colorado could be beneficial, ensuring fairness across different business models.
Pathways for Reform in Illinois and Colorado: For lawmakers in Illinois and Colorado considering a shift towards the retail-only SET model, the path appears clearer for Illinois. Through straightforward legislative amendments, Illinois could abolish its “privilege tax” and, should it be necessary, adjust retail-level SET rates upward to harmonize with models adopted in other significant markets. Such reform not only streamlines taxation but ensures that the framework governing the industry remains coherent and equitable as the recreational marijuana markets continue to evolve.
In summary, as states continue to grapple with the implications of marijuana legalization, understanding and refining the structures of excise taxes is essential. Balancing effective revenue generation with consumer fairness will ultimately shape the future landscape of the marijuana industry in the United States. Following recent discussions on taxation for cannabis cultivators, a significant shift could eliminate the necessity for applying differential tax bases to affiliated growers. In contrast to Illinois, Colorado’s Special Excise Tax (SET) on cultivators’ sales and transfers is mandated by Article XVIII, § 16 of the Colorado Constitution.
This constitutional requirement presents a barrier to the consolidation of the SET at the retail level unless amendments to the state constitution are made. To address this challenge, lawmakers in Colorado could propose legislation that directs the Department of Revenue to permit affiliated cultivators to record their production costs within the seed-to-sale inventory system in a manner similar to how non-affiliated cultivators report contract prices. The “cost” for these affiliated cultivators would encompass various expenses, such as property taxes, lease payments, insurance, labor, nutrients, growing mediums, and utilities.
By utilizing this comprehensive “cost” as the tax base, the state could impose the constitutionally mandated tax in a manner that reflects actual market conditions, rather than relying solely on a rigid “average market rate” calculation. Alternatively, the Colorado General Assembly holds the option to introduce the issue of constitutional reform regarding the SET to the ballot, contingent on a two-thirds majority vote in each legislative chamber. Should the electorate approve an amendment to eliminate the requirement for taxing cultivators, Colorado could then work towards consolidating its SET into a unified tax imposed at the retail level.
Implications Going Forward In the increasingly complex landscape of cannabis legislation, the tax structures within each state are pivotal in shaping the future of the market. For industry stakeholders, grasping the similarities and differences among the various SET frameworks across major recreational markets is crucial for strategic planning. Even if federal legalization of marijuana occurs, state taxation will likely remain a significant compliance consideration, as evidenced by the regulatory landscape surrounding tobacco products. Jean E. Smith-Gonnell regularly contributes legal insights on cannabis issues for Reuters Legal News and Westlaw Today.
