The Legal Marijuana Market Slumps — And So Do Tax Collections
Billy Hamilton is the deputy chancellor and CFO of the Texas A&M University System. In 2015 Hamilton led Texas Republican Gov. Greg Abbott’s Strike Force on the Health and Human Services Commission to complete a management analysis of the agency. Before that, Hamilton was the deputy comptroller for the Texas Office of the Comptroller of Public Accounts from 1990 until he retired in 2006. He is also a private consultant, advising on numerous state tax matters.
In this installment of State Tax Merry-Go-Round, Hamilton examines the recent downturn in the legal marijuana industry, finding that the business is likely to change as it matures.
Not pointing any fingers here, but if you are among the 18 percent of Americans who use marijuana at least occasionally, chances are you’re using less of it right now than you did in 2022. You’re probably also using less now than you will be by the time summer rolls around.
The seasonal dip in consumption isn’t dramatic, but the trend shows up in consumption data over several years, according to a study that appeared in the cheerily titled journal Drug and Alcohol Dependence in 2021.1
Using quarterly national survey data from 2015-2019, the researchers found that as the calendar year progresses, marijuana use grows, increasing in the summer and fall months before dropping as a new year begins. The trend was independent of the annual growth in marijuana use overall and was found in nearly all demographic groups surveyed regardless of sex, race, ethnicity, or educational level. Teens were an exception. Their marijuana use, unsurprisingly, peaks during the summer but declines thereafter back to winter and spring levels.
The researchers speculated that the dip in marijuana use during winter months could be a result of several factors, including a lower supply during that time of year, colder weather keeping people inside who normally smoke outdoors, or people quitting marijuana as a New Year’s resolution.
The study essentially showed that there’s a seasonality to marijuana use that’s often masked in the data because of the growth in regular, legal marijuana use as more states legalize pot for recreational and medical purposes. California was the first state to legalize medical marijuana in 1996. Recreational marijuana was first legalized in 2012 by Washington and Colorado. The first retail cannabis stores opened in 2014. In November 2022 two states — Maryland and Missouri — legalized the adult use of marijuana for recreational purposes, bringing the number of states in which recreational use of marijuana is legal to 21 plus the District of Columbia. Also, 39 states and the District of Columbia have legalized medical marijuana.2
With this expansion in the last decade, a new industry has emerged from the shadows and has become a small but growing part of the economy — and a part of many Americans’ everyday experience. The 18 percent of adults who reported using marijuana in the most recent surveys is significantly higher than the 9.5 percent who reported using the drug in 2012. But lately, there’s been what might be called a disturbance in the Force concerning the marijuana market, and it has a lot of people wondering what comes next.
An Extinction-Level Event
The source of the upheaval is, inevitably it seems, COVID-19. The pandemic had a dramatic impact on the marijuana market, with sales surging during the long months of isolation before vaccines became prevalent: “What we saw in 2020 was a massive spike in sales tied to the pandemic as people stayed home, had government stimulus money, and not a lot to do,” Chris Walsh, CEO of Marijuana Business Daily, said in an interview with CNBC.3
Recently, though, sales have slowed significantly, according to a report from cannabis data firm Headset, and the effects of the slowdown are now buffeting the industry. The pandemic boom drew more producers and sellers into the market, but since then, “pandemic-fueled demand has evaporated just as new grow operations flood the market with cannabis. It has turned what had been unending growth into the industry’s first downturn,” Colorado Public Radio (CPR) noted in a report on the state’s marijuana market.4 Headset’s study of the more established markets in California, Colorado, Oregon, and Washington found that the frequency of marijuana purchases at stores and the amount of money people spend in stores have been declining since July 2021.
The report describes the resulting market disruptions in somewhat dire terms: “Sales are softening, operators are going under, layoffs are ramping up, retailers are closing doors, financing is drying up, and the list goes on.”5 People in the industry have taken to talking darkly about a coming “extinction-level event” in the industry. (A similar extinction-level event was predicted in early 2020 when the pandemic temporarily brought the capital markets to a near standstill, choking off cash needed by the industry.)6
Though no extinction-level event has taken place yet, 2022 was a bumpy ride for the industry. Take, for example, the world’s largest legal marijuana market, California. The state’s voters approved legalization of recreational marijuana by approving Proposition 64 in 2016, and legal sales began in 2018. The market grew rapidly — until last year. Today, the state’s adult-use marijuana retail market is on track to shrink for the first time since legal commercial sales began. State-licensed dispensaries reported $1.27 billion in taxable adult-use sales for the third quarter of 2022 — a nine-quarter low going back to the second quarter of 2020 — according to data released in November 2022 by the California Department of Tax and Fee Administration.
One result of these market disruptions is a drop in marijuana tax revenue. Through the third quarter of 2022, California retailers had reported just over $4 billion in adult-use taxable sales, representing a 7.5 percent decrease compared with the first three quarters of 2021, based on tax and fee administration department data, although the data sometimes changes fractionally after the fact because of amended and late returns and other adjustments.7
In the third quarter, adult-use sales generated roughly $242 million in taxes, including $128.4 million in excise tax and $113.6 million in sales tax, a drop from the same period of 2021. California’s total marijuana tax revenue has now declined for five consecutive quarters. The third quarter also represents the first time the state’s cultivation tax reported zero collections because of legislation that eliminated the $161-per-pound rate previously imposed on licensed growers.
Eliminating the cultivation tax was a significant signal of the industry’s problems — and a nod to some of its more unsavory byproducts. To understand why, it’s important to understand how marijuana is taxed by the states. Today, there are essentially three types of marijuana taxes, and their use varies from state to state.
First, some states levy taxes based on a percentage of the retail price, not unlike a general sales tax, though typically at a higher rate. A TaxVox blog report by Richard Auxier noted that this is the most popular type of marijuana tax, with 11 states solely using it and five using it in addition to other taxes.8 State tax rates range from 10 percent in Michigan, Nevada, and Rhode Island to 37 percent in Washington. Local governments also almost exclusively impose a percentage tax, but their rates typically are capped between 2 and 5 percent.
Second, there are taxes based on the level of tetrahydrocannabinol, the primary active ingredient in marijuana. TaxVox reports that Illinois levies a higher retail tax on high-THC products, while Connecticut and New York tax per milligram of THC.
Finally, there are weight-based taxes, usually levied on marijuana growers, that are calculated differently in each of the five states with this tax, but in most cases, these plant cultivators weigh their product and apply a rate that often varies by part of the plant — for example, flower is taxed at the highest rate because it is the most potent part of the plant.
And therein lies the problem. Weight-based taxes aren’t affected by price, and in a period of declining prices and sales, the industry argues that the taxes have become onerous to legal sellers, which can fuel the illegal market. That explains why California, along with Oregon and Washington, have repealed these taxes to assist legal cannabis businesses and stem the sales of black-market pot.
California lawmakers eliminated the weight-based cultivation tax on growers in July 2022 in A.B. 195, a bill that contained several other measures designed to help stabilize the legal industry and overhaul its regulation. Lindsay Robinson, the executive director of a marijuana trade group, the California Cannabis Industry Association, praised the legislation, saying that the “survival of the regulated industry is vital to providing ongoing tax revenues for the State and the advancement of public health and safety.”9
In addition to eliminating the cultivation tax, the bill also created new tax credits for some marijuana businesses and transferred responsibility for collecting the cannabis excise tax from distributors to retailers. A.B. 195 also lowered to 10 the number of workers a business can employ before triggering requirements to create a labor peace agreement, which can lead to unionization by the company’s employees.
Strange Days Indeed
California wasn’t alone in seeing declines in its marijuana-related revenue in 2022. TaxVox reported declines in Colorado, Nevada, Oregon, and Washington as well.
In Colorado, one of the country’s most established markets, sales in June 2022 decreased 11.4 percent from June 2021 after rising by 25.8 percent between March 2020 and March 2021. In large part, that was a result of both lower prices and falling demand. In July 2022, for example, people spent an average of $55.21 per visit at the median Colorado store. That was about $4 less than the average of $59.73 in July 2021, according to Headset.
“Retailers are discounting in a time of high inflation because they’re trying to move product from the shelves,” Walsh told CNBC, adding that businesses are also facing intense competition from a “thriving” illegal market that isn’t taxed. CPR, in its report, noted that “starting in July 2021, the industry has logged 17 straight months of decline” in sales and that the prices for recreational flower had dropped 23 percent over the last 12 months, and “they don’t look likely to rebound anytime soon.”
About $1.5 billion worth of cannabis was sold through October in Colorado in 2022, down 21 percent from the same period in 2021, a decline of more than $400 million. “Black Friday used to be a big day for us,” said Christopher Stefan, who specializes in cannabis real estate in Colorado. “And it hit with a thud this year. We’ve talked to multiple retailers,” and they just aren’t seeing customers materialize, he said.10
Colorado tax collections were down by $90 million in 2022 and were on target to be down $100 million for the year, a significant drop. In 2021 the state took in about $423.5 million in tax revenue from medical and adult-use marijuana sales of $2.22 billion, a record.11
Elsewhere, the story is the same. Nevada taxable sales were off 4 percent in 2022. Oregon cannabis sales in 2022 were down 16.4 percent through November compared with the same period in 2021. Washington’s cannabis sales declined by 8 percent in 2022, the first decline since the state began legal adult-use marijuana sales in 2014.
A report from the Urban-Brookings Tax Policy Center that examined cannabis tax policy across the country noted that it was too early to fix a definitive explanation for the declines in 2022, but it speculated that the pandemic and its aftermath played a major role: “In particular, all aspects of state and local finance were affected by the COVID-19 pandemic and the federal government’s response to it in fiscal years 2021 and 2022. Specifically, for cannabis tax revenue, collections may have spiked in 2021 when consumers had disposable income (i.e., stimulus checks and reduced spending options) and a desire to substitute marijuana purchases for more public activities like going to a bar or restaurant. If true, the 2022 cannabis tax collections in these states could merely represent a return to more normal consumptions patterns.”12
Each state where revenue declined has its own explanations for what happened, which generally boil down to a decline in sales following the pandemic spike, abundant supplies as a result of more competitors entering the market, a thriving illegal market, and recent inflationary trends that have pushed consumers to spend their dollars on other types of purchases.
In Colorado, for example, CPR noted that during the pandemic, investment rushed into the industry, particularly into new production and grow houses. “I think like everyone saw the lines around the corner, Cannabis is pandemic-proof, right?” said Matt Huron, the owner of Good Chemistry Nurseries, which grows and sells cannabis. “Well, it takes a good year and a half to build one of these things,” he said. “It takes probably at least two years if you know what you’re doing to build it, get through the inspections, get open.” The timing was bad because while marijuana sales did prove to be pandemic-proof, they fared less well once people were free to move around in public again, he added.
Weapons, Violence, and Lethal Chemicals
Perhaps befitting the world’s largest marijuana market, California also has the world’s biggest marijuana headaches. When Prop. 64 legalizing adult-use marijuana for recreational purposes was put on the ballot, it was sold to the voters on the notion that a legal market would cripple the drug’s black market, which was associated in the minds of many Californians with violence and environmental damage. But the tax and regulatory structure put in place following Prop. 64’s approval undercut the economics of the legal market, critics say.
According to the critics’ line of reasoning, the state saw a potential cash cow in taxing legal weed, and lawmakers, including Gov. Gavin Newsom (D), supported legalizing the drug despite the minimally enforced federal prohibition on marijuana sales. But once it was legal, critics say they set about strangling the goose that potentially could lay the golden egg. By requiring licenses to grow and transport pot, permits to sell it retail, and taxes to buy it, the state effectively imposed a 70 percent tax on legally purchased marijuana. As a result, as the Los Angeles Times reported in an investigation last year, “the law triggered a surge in illegal cannabis on a scale California has never before witnessed.”13 California taxed about $5.8 billion in pot sales last year, but police estimate illegal sales are twice that — with 10 illegal farms for every one that has a state permit.
What the Times investigation found wasn’t a pretty picture. “Rogue cultivation centers like Mount Shasta Vista now engulf rural communities scattered across the state, as far afield as the Mojave Desert, the steep mountains on the North Coast, and the high desert and timberlands of the Sierra Nevada,” the article reported. “Residents in these places describe living in fear next to heavily armed camps. Criminal enterprises operate with near impunity, leasing private land and rapidly building out complexes of as many as 100 greenhouses. Police are overwhelmed, able to raid only a fraction of the farms, and even those are often back in business in days.”
“The illegal industry is competing with the legal industry and essentially putting them out of business,” Sgt. James Roy, head of the Riverside County Sheriff’s Department’s 12-person marijuana eradication team, told Fox News. “This place is no different than thousands of others we hit this year confiscating about a half-million plants in Riverside County alone.”14
And the byproducts of illegal grow operations are nothing short of terrifying for many residents. “With the surge in illegal cultivation came heavy-duty weapons, violence and lethal chemicals,” according to the Times report. “On one 2021 raid, deputies found bottles of Metrifos, with ‘peligroso’ — dangerous — and a skull and crossbones on the label. The nerve poison, taken off the U.S. market in 2009, is still sold in Mexico to protect crops from rodents. The sheriff said one deputy became ill after the raid and was hospitalized with poisoning symptoms.”15
The illegal activity inevitably seeped down to street level as well. “The price of everything in Los Angeles is going up except pot, it’s everywhere,” said Detective Mike Boylls of the Los Angeles Police Department’s Gang and Narcotics Division. “The state legalized pot and was hoping to make it a legitimate market. But the problem is these illegal shops are coming in and they’re undercutting all the legal shops. They’re selling product for almost half the price. So, our job as law enforcement has actually gotten harder.”16
The state has taken steps to choke off the illegal market by boosting the legal market, including passing A.B. 195. Also, Newsom in October 2022 said a newly formed Unified Cannabis Enforcement Task Force was taking aggressive action to crack down on illegal cannabis. The task force, led by the Department of Cannabis Control’s (DCC’s) Law Enforcement Division and the California Department of Fish and Wildlife, began expanding eradication operations in Tuolumne County on October 4, targeting unlicensed outdoor cultivation operations. Nine search warrants were served, and 11,260 illegal cannabis plants were eradicated. The task force also destroyed 5,237 pounds of illegal processed cannabis flower, worth an estimated retail value of more than $15 million, according to the DCC.
“California is taking immediate and aggressive action to stop illegal cannabis and strengthen the burgeoning legal market throughout the state,” Newsom said. “By shutting down illegal grow sites and applying serious consequences to offenders, we are working to curtail the criminal organizations that are undercutting the regulated cannabis market in California.” The question is whether it will be enough in a state the size of California.
As if that wasn’t enough, small marijuana businesses say the industry is feeding on itself, aided and abetted by the state. As Rolling Stone noted in a February 2022 article: “But in Nov. 2017, two months before Prop. 64 was set to go into effect, cannabis industry lobbyists persuaded the California Department of Food and Agriculture to [remove] the limit on the number of quarter-acre licenses available to individuals or companies, creating a loophole that opened the door to multi-acre farms through bundling or ‘stacking’ licenses. This meant that a business that could afford to purchase multiple licenses could grow exponentially more cannabis than a small farm. The protective period that would have ostensibly allowed small farms to get a foothold in the legal market before facing off with big agriculture was gone.”17 Small operators have accused the state, and particularly the DCC, of “bureaucratic overreach” ever since, claiming it is shrinking the number of small farms in the state.
The Rolling Stone article describes many of the travails of small growers in detail, including their mounting frustration. The article says that “the overwhelming sense amongst the so-called ‘legacy growers’ is that they’re at a breaking point, exhausted by the regulations of the industry that they largely created.”
Finding the ‘Sweet Spot’
The legal marijuana business in this country really still is in its infancy. Many of the states that have legalized recreational marijuana are still in the process of creating the regulatory framework necessary for the operation of a legitimate industry. And always looming in the background is the question of what the federal government may do at some point, not to mention the long shadow of the illicit market.
What’s happening in the industry now is what happens in many new industries early on and in most industries at some point — disruption and realignment. It takes time to get the alignment right and to build a lasting industry. Supply chains and business structures have to be built where none existed before. And as is the case with just about every sin product taxed by government, from cigarettes to liquor, the black market must be dealt with — and even then, it probably never goes away entirely, particularly when the monetary rewards to some people appear to outweigh the risks.
The market should stabilize and eventually find its footing. With the number of states that have legalized weed in one form or another, the marijuana business isn’t going away — it’s never been gone. From Reefer Madness to Woodstock, pot has been around longer than any of us.
The legal side of the business, though, is likely to change as it matures. In the CPR interview, Huron takes the long view, comparing the marijuana business as it is maturing with the restaurant industry. He said he hopes to set apart his marijuana by focusing on the quality of strains he grows.
The trick for the industry will be to find the right balance. “It hit that boom after Covid, and I think too many people got into it,” Roy Elliott, a Crowley County, Colorado, commissioner, told CPR. “And like any other new industry, when it first shows up, they gotta find that sweet spot.”
1 Joseph Palamar, Austin Le, and Benjamin Han, “Quarterly Trends in Past-Month Cannabis Use in the United States, 2015-2019,” 219 Drug and Alcohol Dependence 108494 (Feb. 1, 2021).
2 “Where Marijuana Is Legal in the United States,” Marijuana Business Daily, Dec. 2022.
3 Stefan Sykes, “Marijuana Industry Sales Slow Down After Pandemic Surge,” CNBC, Dec. 9, 2022.
4 Ben Markus, “The Cannabis Industry Is Facing Its Longest Downturn Yet, With No End in Sight,” Colorado Public Radio, Dec. 22, 2022.
5 “An Analysis of Declining Growth in Recent US Cannabis Sales,” Headset (Aug. 4, 2022).
6 Kristine Owram, “Cash Dwindles, ‘Extinction-Level Event’ Looms: Cannabis Weekly,” Bloomberg, Apr. 12, 2020.
7 Tony Lange, “California Cannabis Sales Hit 9-Quarter Low,” Cannabis Business Times, Nov. 21. 2022.
8 Richard Auxier, “Cannabis Tax Revenue Is Down in Some States — And Maybe That’s Okay,” TaxVox blog, Sept. 29, 2022.
9 A.J. Herrington, “California Eliminates Cannabis Cultivation Tax,” Forbes, July 5, 2022.
10 Markus, supra note 4.
11 Kyle Jaeger, “Colorado Set a Marijuana Sales Record in 2021, State Officials Report,” Marijuana Moment, Feb. 10, 2022.
12 Auxier and Nikhita Airi, “The Pros and Cons of Cannabis Taxes,” Urban-Brookings Tax Policy Center (Sept. 28, 2022).
13 Paige St. John, “The Reality of Legal Weed in California: Huge Illegal Grows, Violence, Worker Exploitation and Deaths,” Los Angeles Times, Sept. 8, 2022.
14 William La Jeunesse, “California’s Illegal Pot Business Is Booming,” Fox News, Nov. 23, 2022.
15 St. John, supra note 13.
16 La Jeunesse, supra note 14.
17 Alexandra Hootnick, “Inside California’s Cannabis Crisis,” Rolling Stone, Feb. 21, 2022.
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Tax Notes State, Jan. 16, 2023, p. 265
107 Tax Notes State 265 (Jan. 16, 2023)
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