Marijuana tax revenues habit-forming for states

No one really knew what would happen when Colorado legalized marijuana. Maybe the money would transform Colorado’s schools or destroy the Mexican drug cartels. Or turn the state’s youth into potheads and embolden the illegal market. 

In 2014, the year legal recreational cannabis hit the market in Colorado, the state pulled in . Addiction treatment programs and law enforcement are the most common categories, and almost half of states with recreational marijuana spend at least part of the revenue on education.

These priorities are chosen to appeal to voters because recreational marijuana is often legalized through a referendum process, according to Daniel Shortt, a lawyer who specializes in cannabis policy.

“You’re negotiating with voters in trying to legalize this substance, which is intoxicating,” Shortt said. “Certainly there’s the perception that there could be some potential harm. So the idea is that you’re using the revenue to the betterment of the public.”

In some cases, the revenue funds broadly popular priorities. In Colorado, for instance, schools received around $90.3 million of marijuana tax revenue from 2017-2018 — a lot of money, but a drop in the bucket of the state’s $5.8 billion education budget that year. 

The public finance world generates ideas to bond against almost any government revenue stream, and cannabis is no exception.

Some have been pushing for cannabis-backed bond issuances since 2010, when a California measure to legalize recreational marijuana was on the ballot.

The 2010 measure was defeated, but reversed course and approved legal recreational pot in 2016.

The idea for “cannabis-based municipal bonds” was formalized in 2020 in a paper from MPG consulting, formerly Marijuana Policy Group.

The paper pushed back on the most common argument against weed-backed debt — federal prohibitions on banking services for a drug that remains a federal controlled substance. 

But so far, states’ use of marijuana tax revenue to back debt has been much less flashy. Massachusetts sends some of its revenue to issuers like the Massachusetts Bay Transportation Authority and the School Building Authority. And in Michigan, marijuana tax revenue is about 5% of the state’s Trunk Line Fund, which priced a $1.2 billion deal earlier this year. 

Marijuana tax revenue is decidedly credit-positive for states, Buswick said. Using the revenue as an incremental source of funding for programs like education or transportation is a responsible budgeting decision for states, especially when it was a new source of revenue. 

“Corporate income, personal income, sales tax, they’re going to remain the predominant drivers for governments, but [cannabis] can give optionality to solve problems and close gaps. And that non-correlation in the revenue type can help smooth problems,” Buswick said. “When you’re looking at that willingness and ability to repay debt, when you have greater options just to cure your problems, it’s a general credit benefit, but it’s not a driver.”

The largest source of uncertainty for this source of revenue is still at the federal level, where cannabis remains illegal. The Biden administration is considering rescheduling marijuana from a Schedule I drug to a Schedule III, which could relax the potential penalties for doing business but still leave sellers in violation of the law. 

Under current laws, it’s also illegal for banks and insurance companies to serve cannabis businesses, so businesses often have to do many transactions in cash. Members of congress have repeatedly introduced legislation to change this, although a bill has yet to pass. Fitch analyst Eric Kim said this change could increase cannabis sales and tax revenue because conducting business would become so much easier. 

Kim said that as marijuana taxes become a standard source of revenue in many states, states and municipalities may find other uses for the money. Eleven states allow local governments to levy their own taxes on marijuana, although it’s not clear how many municipalities do so.

“Increasing the cigarette tax in some way can often be part of a basket of measures to help manage budget challenges or provide some revenues for a needed resource,” Kim said. “If there are changes at the federal level and it becomes more mainstream, I would not be surprised to see cannabis taxes as one of those policy levers states will look to to manage budget issues in the future.”

Denver, where the cannabis tax accounts for at least 4% of the city’s total tax revenue, may have been the first government to try this strategy. The city raised its special sales tax on marijuana to 5.5% from 3.5% in 2018, and spent the extra revenue on affordable housing, Escudero said. It’s yielded $38.7 million for affordable housing since 2018.

“Since we were the ones who did it first, we were kind of the guinea pigs a little bit, whether this was going to work or it wasn’t going to work,” Escudero said. “And we’re happy that we’ve delivered so far, where all the extreme predictions about legalization haven’t occurred.”