Tax Analysts Blog

Why Exactly Are We Taxing Pot?

Posted on Jan 22, 2014

The New Hampshire House is poised to pass a law legalizing marijuana use -- and taxing it. The bill, HB 492, sponsored by Rep. Steve Vaillancourt (R), would impose a 15 percent sales tax on retail marijuana purchases and a $30-per-ounce sales tax on wholesale purchases. It would raise about $30 million a year. Truth be told, New Hampshire is unlikely to join Washington and Colorado in freeing the people to smoke pot. Democratic Gov. Maggie Hassan has vowed to veto the measure if it reaches her desk. Hassan is obviously not as open-minded as the lefty Republicans pushing legalization. I think pot should be legalized, Hassan’s uptightness notwithstanding. Many more states will be following Colorado and Washington soon.

The impetus for legalization is twofold. First, people are tired of government regulation of what everyone knows is a victimless crime. Almost everyone who is 65 or below has either tried pot or knows someone who tried it. President Obama smoked pot, and he became the leader of the free world. It’s no big deal. But many people want to legalize pot because of the potential tax revenue it will bring in. Many people think legalization will not only create a euphoric society, but solve their budget problems as well. Personally, I think anyone who sees pot as a financial windfall is already high.

But I must ask: What is the rationale for imposing special taxes on marijuana? Excise taxes are appropriate to pay for externalities – the costs to society of using the product that are not borne by the market. But it is unclear what, if any, externalities are created by smoking pot. In fact, if there were any serious externalities, the nationwide push for legalization would not exist. Pot should be subject to sales tax in states with a sales tax. But from a pure tax policy perspective, it is not clear what the rationale is for imposing special taxes on marijuana.

Read Comments (7)

Bruce BartlettJan 21, 2014

The prospect of gaining revenue is the primary reason states are considering
legalization. Take away the potential windfall and the legalization effort
dies. Thus the justification for special taxes is that it pays for
legalization.

vivian darkbloomJan 22, 2014

Excise taxes on legal marijuana sales are imposed for the same reason that
states sponsor gambling. If you think about it, particularly with respect to
the latter, this has nothing to do with Pigou.

David BrunoriJan 22, 2014

Bruce, Vivian, Emsig, and Edmund,

I get it and agree. Basically, this is about raising revenue pure and simple.
And Bruce is correct that without the promise of revenue there is no
legalization. Ensig, I understand the Ramsay Rule. But it always assumes
inelasticity. That might work for a land tax, but few commodities are quite
that inelastic. Besides, there are more things inelastic than pot -- like food
and air and water. Anyway, thanks for commenting.

emsig beobachterJan 22, 2014

David: Modern optimal taxation has relaxed most of the rigid assumptions of the
original Ramsay Rule. I'm sure the state legislators in NH did not consult
modern optimal taxation theory to come up with their special excise tax on
marijuana.

edmund dantesJan 23, 2014

I concur with Mr. Bartlett. What's more, I believe that the CO marijuana tax
is over 30%! So 15% seems like a smaller price to pay. Just so long as they
don't add a regular sales tax on top of it.

emsig beobachterJan 23, 2014

Mr. Bartlett's observation is correct -- a government will impose a tax on
something or someone in order to raise revenue. Moreover, as you pointed out,
one reason to impose a special excise tax is to correct a negative externality
-- the activity of one person imposes a cost on another and the tax purportedly
reduces the level of the harmful activity. However, in the case of marijuana,
there may be no blatant negative externality that would call for a heavy
corrective excise tax. This does not mean that the state of NH is wrong to
impose a special tax on marijuana.

It ahs been shown mathematically, and under rigid assumptions, that the optimal
commodity tax rates should vary inversely to the elasticity of demand for the
commodity -- this is the "Ramsay Rule" of commodity taxation which was brought
out in a 1927 article in the Economic Journal by Frank P. Ramsay. This rule has
been modified over the years to account for necessities, the impact on work
effort, etc., but the core of the rule still stands. Therefore, if the
legislators in NH believe that the demand for marijuana is inelastic, then a
special excise tax, ceteris paribus, will raise the desired amount of revenue
with the least distortion.

Pat OglesbyJan 25, 2014

My sense is that revenue enhancement is not always the primary reason
legalization is advancing. That is, marijuana revenue (about which I've
written two articles for State Tax Notes) is often the caboose on this train.
The locomotives seem to include racially disparate enforcement, libertarian
thinking, the evident folly of the drug war, and self-interest of ganjapreneurs
and consumers. In Colorado, especially, taxes will be quite low as economies
of scale push down the return from ad valorem taxes.

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