The cannabis industry has experienced significant growth since Colorado’s first legal sale of adult-use cannabis eight years ago. In 2021, the 11 states that allowed legal sales raised almost $3 billion in cannabis excise tax revenue, up 33 percent from the previous year. While still a small part of state budgets, cannabis taxes are beginning to surpass other “sin taxes” that states have had on the books for years.
Interestingly, most of the states that allowed cannabis sales last year raised more revenue from cannabis excise taxes than from alcohol excise taxes and profits. In total, cannabis revenues outperformed alcohol by 20 percent. Colorado stands out among this group, with cannabis taxes raising seven times more than its excise taxes on alcohol. Low alcohol tax rates are the norm across much of the country as their real value has been eroded by years of inflation and policy inaction.
However, four of the 11 states that allowed for legal cannabis sales raised more revenue from alcohol last year. Moreover, because the alcohol industry is significantly larger than the legal cannabis industry, its overall tax contribution from general sales taxes, fees, various local taxes, and other levies surely surpasses that from cannabis. Nonetheless, it is remarkable that in just a few years, the narrow “sin taxes” that states created to apply to cannabis purchases have managed to surpass the comparable taxes that have long applied to alcohol.
While both alcohol and cannabis revenues are overshadowed by tobacco, which remains the top “sin tax” revenue source in states, cannabis taxes are generally growing faster than tobacco taxes. The share of U.S. adults who smoke cigarettes has fallen by 40 percent in just 15 years, and tobacco tax revenue is stagnating or declining in many states. In contrast, revenue from legal cannabis tends to start low but grow quickly as legal businesses ramp up production and sales.
However, there are reasons to be concerned about the long-run trajectory of cannabis tax revenue. Federal legalization of cannabis is almost inevitable, and when that occurs, the industry will undergo a major transformation as it gains access to interstate commerce, banking services, and routine tax deductions. Once multinational corporations can begin growing cannabis on an industrial scale and shipping it across state lines, a significant drop in cannabis prices is guaranteed. At that point, states that have built their cannabis structures exclusively around falling prices will find themselves facing revenue disappointment.
The good news is that states have straightforward options to prepare for this moment. Reworking cannabis taxes so that they apply to the quantity being purchased, like taxing per ounce of flower or per milligram of intoxicant, will allow for a more sustainable tax base than taxing at a percentage of a falling price. Every state in the nation already taxes alcohol and tobacco based on the quantity being purchased, so extending that approach to cannabis is the next step.
