State Tax Revenue is Down – Can Cannabis Revenue Fill the Gap?

by Mary Briggs,

Cannabis tax revenues offer an easy boost to counter pandemic-impacted tax revenues.

The economic effects of the COVID-19 pandemic will ripple through American society for years to come.

One of the areas where a sudden disruption will cause long-lasting impact is tax revenue. Statewide economic shutdowns have disrupted many of the ways states fill their coffers with taxpayer money.

As of July 2020, the full extent of this fiscal damage is unknown. The aftershock effects are likely to impact state budgets for years, even if no new shutdown orders occur in the meantime.

States that embrace cannabis legalization may be able to keep important services running without having to go into debt to do so. This move can have wide-ranging effects on everything from the quality of roads and bridges to the ability to raise teacher salaries and more. 

If the tax situation gets particularly bad, states may be forced to furlough workers or take other drastic measures. However, this situation will impact different states in different ways.

Different States Have Different Revenue Portfolios

Taxes make up about half of the money that state governments use to provide services to residents. Every state has a unique economy, leading to different levels of impact from the COVID-19 pandemic. Nevada, for instance, lost about $2 million per day in gaming taxes when it closed its casinos. Hawaii reported losing $250 million in tax revenues due to a drop in tourism.

Most states get the majority of their tax money either from personal income taxes or general sales taxes. The COVID-19 pandemic affects both of these tax structures in different ways.

Personal Income Taxes

Personal income taxes are usually one of the most reliable revenue sources for state coffers. Although only 41 states impose personal income tax, it tends to be a significant revenue generator. In 30 of those 41 states, personal income taxes bring in more money than any other kind. Oregon reports the highest share of personal income taxes for its state budget, at 70.5%. It is followed by New York and Virginia, with 59.3% and 56.6%, respectively.

When unemployment rises, personal income tax revenues decline. People begin to spend less, leading to a general freeze in public expenditures. Cannabis has shown itself to be resilient to this kind of fiscal damage, which makes it a reliable source for much-needed tax revenue, along with food, home services, and pharmaceuticals.

General Sales Taxes

General sales tax revenues have been deeply impacted by the closure of restaurants, bars, retail stores, and other businesses. As consumer spending declined, so too did states’ ability to pay for critical services. Forty-five states levy a general sales tax; it is the largest tax source in one-third of those states. Florida is the top-earner, with 62.5%, followed by Texas with 60.2%, and Washington with 59.5%.

Since cannabis spending has shown itself to continue even through periods of intense difficulty and economic hardship, legalization stands a good chance of improving day-to-day spending. Unlike sales tax sources with volatile value fluctuations – like capital gains taxes and oil-related taxes – cannabis keeps its value relatively constant even in the face of economic challenges.

Where Does Tax Money Go?

Every state has its own plans for cannabis tax revenue, but states with legal cannabis industries share broad patterns in their spending. Ballot initiatives tend to earmark funding for drug abuse prevention, public safety, and economic development – in some cases, specifically for communities disproportionately impacted by drug enforcement laws.

In practice, much of the money goes to paying for the state regulatory program, with a portion dedicated to funding grants to study cannabis further. Social issues like drug abuse prevention and public safety are often realized at the local level instead of throughout the entire state.

What About Federal Funding?

The federal government also contributes heavily to state budgets. Before the pandemic began, federal funding was the biggest revenue source in six states: 

  • Louisiana (45.1%)
  • Montana (44.4%)
  • Mississippi (42.6%) 
  • Alaska (42.3%)
  • Wyoming (42.1%)
  • New Mexico (41.4%)

While it may seem like states that rely on federal funding may be unwilling to dedicate time and energy to cannabis legalization, that’s not quite the case. While the President has threatened to cut off funding to states that with policies he does not agree with, that power ultimately does not rest with the executive branch.

Congress could withhold federal funds in theory but is extremely unlikely to do so. Democratic lawmakers are virtually guaranteed to oppose legislation that punishes states for legalizing cannabis, while Republican lawmakers are loath to curtail states’ rights and give the federal government more power than it already has.

The bottom line with regard to federal funding is that states can reasonably rely on passing whatever cannabis legalization laws they wish to without fearing a negative federal response. This has shown itself to be the case already in all of the states that have successfully legalized cannabis and began collecting taxes on cannabis sales.

Even the Federal Government Relies on Cannabis Tax Dollars

In fact, the federal government is already making significant tax income from the fact that marijuana products are legal at the state level but scheduled at the federal level. Provision 280E of the federal tax code prevents cannabis dispensaries from claiming federal tax deductions – meaning they pay their full tax liability without taking any tax credits (with the exception of Costs of Goods Sold)

Cannabis dispensary owners who are unable to make tax deductions the way any other business would end up paying more in federal taxes than any other kind of business. In effect, this means that the federal government makes more in taxes from illegal cannabis than it would from legal cannabis, and the Internal Revenue Service is happy to collect.

Despite these challenges, the cannabis industry continues to flourish due to incredible consumer demand. This ensures that government institutions in need of funding will be able to find the money they need to keep infrastructure running and critical citizen services open if they only look for the appropriate opportunity.