Could Marijuana Be the Revenue Fix That State Governments Need?

Tax

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Tax revenue from the legalization of recreational use of marijuana could be one of the largest windfalls for state governments in recent history. The operative phrase here is “could be.”

It is no small secret that the fiscal situation in many states is tight, if not dire, and the ball is rolling on the legalization of marijuana, mostly as a medicine, but the recreational movement also has an enormous amount of momentum. It has been a long-standing argument of advocates that legalizing and taxing the drug could produce an enormous windfall for states. Economics teaches us that when the demand is there, creating a supply will yield economic activity, and the government could take a much-desired (and perhaps much-needed) cut of those cash flows.

Even in times of plenty, oiling the gears of the economic mechanism sounds like a strong argument. But now, mired in an (at best) underwhelming recovery, the argument carries a little more weight. In 2008, at the height of the crisis, the financial condition of state-level governments in the United States began to rapidly deteriorate. Revenues — mostly in the form of tax receipts — evaporated as unemployment surged. States tapped reserves, reached out for federal support, and increased taxes. Contributions to already underfunded pensions declined even further, increasing the overall liabilities of state governments.

Five years ago, all this bad news prompted Moody’s Investors Service to downgrade the financial outlook for state governments in the U.S. from stable to negative. At the time, real gross domestic product growth in the U.S. had turned negative, and economic activity would contract for six consecutive quarters between September 2009 and December 2009. Unemployment would peak at 10 percent in October that year, shortly after the U.S. returned to a path of modest economic growth.

But even as the recession came to a technical end, growth remained anemic and uneven. Some states, like those participating in the shale gas and oil boom, have bounced back much more quickly than others. North and South Dakota have unemployment rates of 3.0 and 3.9 percent, respectively. Now, five years after the downgrade, Moody’s has re-evaluated the outlook for state governments in the U.S. and determined that, as a whole, the outlook is now stable. A majority of states — 30 out of 50 — have a credit rating of either Aaa or Aa1, the highest possible.

“Improving labor and housing markets have boosted consumer confidence, and strong stock market performance has further improved state revenues,” Moody’s Vice President Baye Larsen said in a press release. “Additionally, now that the scope of federal cuts is better understood, there is less uncertainty regarding the pace of continued economic recovery.”

Establishing the recovery as “stable,” though, does not necessarily precipitate financial stability. Good news, such as the fact that a majority of states are reporting strong and sustained increases in tax revenues, is undermined by the bad, such as the fact that much of the tax gains in the first half of this year can be explain away as the result of high-income taxpayers accelerating their capital gain realizations on the expectations of future tax increases.

“The strong growth in income tax collections are considerably attributable to the behavioral responses of the highest income taxpayers,” states a report from the Rockefeller Institute of Government. What states want are reliable revenue streams. Marijuana could, perhaps, provide that. States like Colorado and Washington, where the drug is legal at a recreational level, are testing the framework to see if such a thing is possible.

Next week, Colorado will vote on whether to approve a 40 percent excise tax on marijuana that would pay for school construction, but a 10 percent sales tax that would pay for enforcement of the laws surrounding the drug’s use. State fiscal analysts suggested earlier that the taxes could pull in as much as $70 million per year. Washington has set a 25 percent tax on the drug. The revenue, though, hasn’t yet worked its way into state budgets because too little is known about what the numbers will actually look like.

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