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Lawmakers wary of taxing recreational marijuana too much, losing to illegal market

Taxes on newly legalized recreational cannabis in Maryland could be phased in over time as the state seeks to replace an illicit market with a regulated one.

Between now and July, lawmakers will have to wrestle with a number of issues. Legislators will ultimately have to decide on how to tax the new industry and at what level. Taxes that are too high can bolster black market sales and make it tougher for a legal market in its infancy to establish a beachhead.

“I’ve always been under the impression — because we’re talking about the illicit market — that people are willing to pay more for a legal product than an illegal product but not necessarily double,” said Sen. Brian Feldman, D-Montgomery and vice chair of the Senate Finance Committee.

“You don’t want to lose to the illicit market too quickly,” he said during a recent briefing of the House Cannabis Referendum and Legalization Work Group. “You want to have a competitive product early and then as the legal market matures, then you can ratchet up (taxes) over time, a graduated system.”

Currently, New Jersey and New Mexico have opted for a phased-in approach to taxing the substance.

“I can’t say that that’s the right way to do it, but that is the approach that several states have taken and it seems to be the effective way to do it,” said Jackson Brainerd, who covers tax and economic development issues for the National Conference of State Legislatures.

RELATED: Maryland voters approve recreational marijuana legalization

The association Brainerd represents provides research and data to state legislatures but does not take positions on which policies those bodies should adopt.

Voters earlier this month approved an amendment to Maryland’s constitution legalizing adult-use recreational marijuana by a 2-to-1 margin.

Starting July 1, adults 21 and older may possess up to 1.5 ounces of the drug. The law would also allow for up to two plants to be grown at home — regardless of the number of adults in the residence. Sharing among adults of legal age would also be permitted.

Currently, 21 states, the District of Columbia, Guam and the Northern Mariana Islands have legalized adult-use cannabis, though not all are selling to the public yet.

“When it comes to taxing marijuana, states have not coalesced around a uniform approach. There are still a lot of uncertainties around the best design, the type of tax, who it’s collected from, ultimate tax rate,” Brainerd said.

All states that have legalized the substance have an excise tax, though they differ on rates and whether taxes are imposed on growers, processors or consumers — or all three.

Tax revenues from the product can run in the tens to hundreds of millions of dollars.

Even so, the amount often is only about 1% of a state’s budget, according to Brainerd.

And there are costs associated with moving to a legal market that can be broad and overlooked. Some states have included the cost of replacing drug sniffing dogs because they cannot be retrained to perform other duties. And some states have also seen reductions in court fees tied to legalization.

“When all applicable taxes are combined, the effective rate on marijuana in many states can be pretty high, between 20% and 40% in most cases,” Brainerd said.

A 2019 study of the California market found that illicit cannabis sellers outnumbered legal, regulated businesses by a 3-to-1 ratio. In Colorado, it’s estimated that only 60% of the marijuana consumed in the state is sold legally. In Oregon, about 15% of the market is illicit, according to Brainerd.

California recently revised its excise rates and eliminated taxes on growers and processors. 

Del. C.T Wilson, D-Charles, a chairman of the House Economic Matters Committee and a member of the work group, said increases don’t have to be established in the coming year. Instead, the legislature could revisit the issue as the industry matures.

“If we at some point want to make this a money-making scheme where we’re actually bringing income into the state, that’s something that doesn’t have to be done right away,” Wilson said.

“We don’t have a lot of people buying moonshine anymore because we made it affordable to begin with,” Wilson said. “Many states including Maryland have enacted a sin tax since but that was done after we were able to diminish the illegal market. I hope that’s the goal of most of the people, to not make money as much as diminish that illegal market.”