Here’s Why It Might Be Time to Update Colorado’s Cannabis Tax
By Chris Stiffler, Senior Economist
It took more than five years, but Colorado’s retail cannabis industry hit $1 billion in state tax revenue in May 2019. Since Colorado retail cannabis sales were legalized in 2014, total state revenue totaled $1.15 billion through October 2019, according to the Colorado Department of Revenue. While total state taxes and fees on retail cannabis continue an upward trajectory, the excise tax on cannabis growers (the revenue source that supports a school construction fund) has remained flat since the middle of 2016. Figure 1 below shows total taxes and fees compared to the revenue collected from the 15 percent excise tax.
Before diving into why this is the case, it’s important to put cannabis taxes in context within the state budget. Even after adding up all the revenue from cannabis legalization, it generates around $200 million per year, which is only around 2 percent of the state General Fund. So while $1 billion over five years definitely sounds like a lot of money to you and me, it’s a drop in the bucket when it comes to the financial needs of our state. Put another way: the total program funding for K-12 education in Colorado during the same time period was $37.7 billion, of which cannabis taxes represented just 3 percent.
The Retail Marijuana Excise Tax is one of two cannabis taxes paid to the state. The other, a special sales tax of 15 percent which is paid by consumers when they purchase retail cannabis, is the source of most of the total state taxes and fees paid on retail cannabis.
The monthly average excise tax collection on cannabis averaged $6 million per month in 2017, $5.1 million per month in 2018, and $5.3 million per month through September 2019. The excise tax is based on the wholesale price when transferred from grower to retailer. There’s a pretty simple explanation for why wholesale excise tax collections are falling: wholesale prices are also falling. When wholesale prices drop, that means less excise tax revenue is generated from the 15 percent tax even though cannabis sales continue to increase. The result of the lack of growth in these tax collections means less money for capital school construction in Colorado.
The Retail Marijuana Excise Tax funds a portion of school construction in Colorado through the Building Excellent Schools Today (BEST) program. In FY 2018-19, cannabis taxes generated about $50 million for the BEST program for an annual total of $140 million. Recreational cannabis is one of several sources of revenue for BEST, including Colorado Lottery spillover funds, State Land Trust Funds, and interest. In FY 2018-19, BEST funds helped capital construction projects in about 30 schools across Colorado ranging from new roofs to HVAC upgrades to asbestos abatement.
After holding steady for the first two years of legalization, the wholesale price of retail cannabis has declined significantly. The wholesale price per pound was around $1,800 from 2014-2016, with a peak of $2,007 a pound in January 2015, as seen in figure 2 below. In 2018, the average wholesale price per pound fell to $759. More efficient cultivation largely drove the decline in wholesale prices.
Figure 3 shows the cannabis excise tax revenue as a portion of total taxes and fees on cannabis since 2014. In the middle of 2016, the excise tax revenue was 35 percent of the total; that number fell to 22 percent this year. While the drop in wholesale costs means flat excise tax revenue, it has translated into lower wholesale prices for retailers, and (at least theoretically) lower prices for consumers.
Other states with legal retail cannabis such as California and Maine learned from Colorado’s experience and moved to a structure that taxes cannabis by weight rather than by price. But there’s a trade-off to that method. Since retailers are facing paying higher taxes as demand grows for more and more cannabis, it could end up encouraging producers to increase the product’s potency per ounce instead—which could create health risks. There are policy responses to those fears, including creating new regulations to cap the potency of cannabis products. Those pitfalls aside, taxing growers on the basis of weight would mean steady tax revenue regardless of wholesale cannabis price levels.
This story shares inverse similarities with another Colorado fiscal policy issue involving choosing between taxing by price or taxing by weight (or in this case, volume). The majority of funding for Colorado’s roads comes from the $0.22 per gallon state gas tax. Because we tax gas on a per-gallon basis, state revenue isn’t directly affected by changes in gas prices. Colorado’s gas tax hasn’t changed since 1991, but the price of gas has more than doubled and our cars get much better fuel efficiency than they did in the early 1990s. Better fuel efficiency means cars are putting more wear and tear on our roads without drivers needing to refuel more often to keep up. If our gas tax had been adjusted for inflation, it would be $0.46 per gallon and we would have hundreds of millions more to invest in our roads, highways, and transit.
Should the gas tax be based on price? Should cannabis wholesale taxes be based on weight? These are all complicated questions, but they all speak to the fact that locking in tax policy that works one year might not be the best policy a few years later when economic and fiscal conditions change.
