Cash-strapped states turn to legal marijuana for tax revenue, but some say they're not charging enough

Key Points
  • Michigan and New Jersey are on track to become the latest states to legalize recreational marijuana, with some of the lowest tax rates in the country.
  • Some lawmakers and advocates say the states are leaving money on the table.
  • On the other hand, supporters of lower tax rates argue that steep taxes will only drive consumers towards the black market.
Canopy Growth operations in Smiths Falls, Ontario.
Tom Franck | CNBC

Michigan and New Jersey are on track to become the latest states to legalize recreational marijuana, potentially bringing in millions of dollars in tax revenue. Still, some lawmakers and advocates say the states are leaving money on the table.

On Nov. 6, Michigan voters passed a measure to legalize marijuana for recreational use, with 56 percent voting in favor. The change will take effect on Dec. 6, however marijuana won't be available for sale until the government grants licenses to businesses sometime in 2019.

New Jersey state Senate and Assembly committees passed a bill on Monday to legalize recreational marijuana in the state. The bill will need to be approved by the full legislature as well as by Governor Phil Murphy, who supports legalization. If it passes as expected before the end of the year, New Jersey will be the 11th state, in addition to Washington, D.C., to legalize recreational marijuana.

A new stream of revenue

Recreational marijuana sales in Michigan will rake in $89 million in tax revenue for the fiscal year beginning Oct. 1, 2019, according to estimates by the state's Senate Fiscal Agency.

After funding implementation and enforcement, 70 percent of the remaining tax revenue from marijuana sales will go to schools and infrastructure repair and 30 percent will go to counties and municipalities with marijuana businesses.

The New Jersey government estimated that recreational marijuana would bring in $60 million in tax revenue before June 30 of next year alone.

"We examined other states that already have a legalized mechanism in place and took a conservative estimate based on the revenue they generated in year one of legalization," Treasury department spokeswoman Jennifer Sciortino said in March.

Tax revenue from sales that remains after funding regulatory operations will be deposited into the state's general fund.

Lowest marijuana tax rates 

Michigan and New Jersey are poised to have some of the lowest marijuana tax rates in the country, which has sparked a debate about the best taxation strategy.

Sales in Michigan will be subject to a 10 percent excise tax in addition to the standard 6 percent sales tax. The proposed bill in New Jersey imposes a 12 percent sales tax, and municipalities who host marijuana businesses can impose up to an additional 2 percent tax.

The first two states to legalize recreational marijuana, Washington and Colorado, imposed a 37 percent sales tax and a 30 percent combined excise and sales tax, respectively.

Tax revenue in Michigan "that may come from this initiative will be far less than one half of one percent of the state budget," said Scott Greenlee, president of anti-legalization group Healthy and Productive Michigan, in a statement released after the election.

"The people may have voted on the concept of legalizing marijuana, but they probably wouldn't mind more money going to the roads and schools than the pockets of the pot business," wrote columnist and author Mitch Albom in an op-ed for the Detroit Free Press criticizing Michigan's tax rate.

New Jersey Gov. Murphy is a proponent of a 25 percent tax on recreational marijuana. On the campaign trail, he touted potential tax revenues of $300 million from legalization, which is only attainable with a 25 percent tax.

On the other hand, Senate President Steve Sweeney pushed for the 12 percent tax that is included in the current bill. It is yet to be determined what the tax rate in the final legislation will be.

"I believe this is a reasonable and responsible rate that is fair to the consumers and will generate adequate revenue to support the regulatory system," he said. "We want to be competitive with other states and it is important that we put the illegal drug dealers who want to continue to sell marijuana out of business."

Supporters of lower tax rates argue that steep taxes will only drive consumers towards the black market.

"A high tax rate doesn't do much to incentivize the consumer to use legal businesses," said Josh Hovey, spokesperson for Michigan's Coalition to Regulate Marijuana Like Alcohol, which advocated for legalization, in an interview with CNBC.

California, which legalized recreational marijuana at the beginning of this year, imposes a statewide 15 percent excise tax in addition to sales and municipality taxes that can reach 20 percent.

According to a survey conducted by cannabis delivery platform Eaze, one in five Californians still purchase cannabis from the black market. The survey also found that a 5 percent reduction in the tax rate could convert 23 percent of consumers from the black market to the legal market.

Economic hardships persist

Both the New Jersey and Michigan state governments have faced their share of financial challenges.

"Our economic growth has trailed almost every other competitor state in the nation, in almost every category," Gov. Murphy said in his annual budget address in March. Credit ratings firm S&P Global calls the state pension system as one of the worst-funded in the country. Its unfunded liability totals roughly $90 billion, according to a 2017 study commissioned by then-Governor Chris Christie.

State Treasurer Elizabeth Muoio, testifying before the Senate Budget Committee in May, noted the state's "anemic post-recession revenue growth is still 6 percent below our pre-recession peak."

In Michigan, the Senate Finance Agency dubbed the state's economic growth after the 2008 financial crisis "a record-weak recovery for a record-setting recession." October tax collections for the School Aid Fund, which will receive some of the tax revenue from recreational marijuana sales, were $92 million below forecasts, according to the agency.

According to a 2016 government report commissioned by Gov. Rick Snyder, Michigan is underinvesting in transportation infrastructure by $2.7 billion each year. Governor-elect Gretchen Whitmer tweeted during the campaign that recreational marijuana should be legalized and taxed "so that we can #fixthedamnroads."

Despite the potential revenue gains, "states should be wary of trying to use marijuana tax revenue to fund essential services," warned Katherine Loughead, policy analyst at the nonprofit Tax Foundation. "As more and more states legalize, it's less of a novel concept," she said. "We could see revenues decline over time."

A step forward

Overall, however, supporters and lawmakers alike see legalization as a step forward for economic growth.

"Legalizing, regulating and taxing cannabis will be an economic driver that will allow us to reinvest in our communities," said New Jersey state Assemblywoman Annette Quijano, D-Union, during the vote on the bill.

Gov. Murphy "is committed to working with the Legislature to legalize adult-use marijuana the right way," Deputy Press Secretary Alyana Alfaro told CNBC in an email.

Legalizing recreational marijuana also lowers law enforcement costs, a boon for states where low level drug offenders make up a large share of the criminal justice system.

At any tax rate, the revenue Michigan will receive from legalization is "far more money than the zero dollars the state's collecting today," Hovey said.