Federal Marijuana Tax Bill from Congressman Blumenauer — Is the tax burden just right?

February 5, 2013 § Leave a comment

Any marijuana tax needs to be low enough to drive trade into legal channels.  That may happen under a bill from Oregon Congressman Earl Blumenauer, which would “create a federal marijuana excise tax of 50 percent on the ‘first sale’ of marijuana – typically, from a grower to a processor or retailer.”  http://apnews.myway.com/article/20130204/DA482F300.html

Here’s a preliminary look at how that tax would interact with state taxes in Washington (whose taxes are higher than Colorado’s)  – with the tentative conclusion that the tax burden might not be prohibitive.

1.  High markups:   if margins are 100 percent at each step of the supply chain:

Case 1:  WA High markups
Pre-tax price per unit Washington excise tax Federal excise tax State and local sales tax After-tax price
Producer sells to processor $1.00 $0.25 $0.50 $1.75
Processor sells to retailer $3.50 $0.88 $4.38
Retailer sells to consumer $8.75 $2.19 $0.97 $11.90

With those high markups, taxes would be $3.81 of the total retail price — that’s 32 percent.

2.  Low markups:  if margins are 50 percent at each step of the supply chain:

Case 2:  WA Low markups
Pre-tax price per unit Washington excise tax Federal excise tax State and local sales tax After-tax price
Producer sells to processor $1.00 $0.25 $0.50 $1.75
Processor sells to retailer $2.63 $0.66 $3.28
Retailer sells to consumer $4.92 $1.23 $0.54 $6.70

With those low  markups, taxes would be $2.64  – that’s 39 percent of the total retail price.  With legal businesses operating in the open and benefitting from economies of scale, that might be low enough to keep the bootleggers out of business.

Now taxes on cigarettes in Europe can reach 80 percent of retail price — but marijuana is easier to bootleg than tobacco.  All this is covered in “Laws To Tax Marijuana,” 59 State Tax Notes 251-280 (January 24, 2011), downloadable at http://ssrn.com/abstract=1741735 and http://newtax.files.wordpress.com/2011/01/20-may-2011-taxing-marijuana4.pdf.

And there’s another standard:  Tax writers in years gone by looked at alcohol excise tax rates as a percentage of cost of manufacture, which did not include distribution and selling costs.  When a $2.00 per gallon tax amounted to eight to 12 times the “average cost of manufacture” of whiskey in the Civil War, bootlegging ran rampant.[1]  A reduction in that tax by 75 percent in 1868, to two or three times the cost of manufacture, “practically stopped illicit distillation” and more than doubled revenues from the tax.[2]  Two times the cost of manufacture was a rough standard used in the re-imposition of tax after passage of the 21st Amendment, too.  Whiskey then thought to cost $1.00 or a little more per proof gallon to produce[3] bore a federal tax of $2.00[4] with the understanding that state taxes would add to the final price to the consumer.  That “two times” standard turned out to be low:  The federal tax increased 450 percent, to $9.00, 10 years later.

Looking at first cost of manufacture, the total tax take (2.64 or 3.81 times the cost of manufacture or producer price) in Washington is not far out of line with alcohol rates that held up.

If the 50-percent Federal excise is low enough when combined with Washington’s tax, it’s a fortiori low enough when combined with Colorado’s:

Case 3:  Colorado Low markups
Pre-tax price per unit Colorado excise tax Federal excise tax State and local sales tax After-tax price
Producer sells to processor $1.00 $0.15 $0.50 $1.65
Processor sells to retailer $2.48 $2.48
Retailer sells to consumer $3.71 $0.28 $3.99

Total taxes in this case 3 are 93 cents per unit, 23 percent of the retail price, and just over twice the first cost of production.

(For Washington, this analysis assumes an average local sales tax rate of 2.23 percent in addition to the 6.5 percent state sales tax. http://taxfoundation.org/sites/taxfoundation.org/files/docs/ff323.pdf.  For Colorado, it assumes an average local sales tax rate of 4.52 percent in addition to the 2.9 percent state sales tax.  http://taxfoundation.org/article/new-data-state-and-local-sales-taxes-tax-foundation)

Lots to think about.  More to come.  A low tax on marijuana is essential to beat bootleggers — and I think a high tax  is essential to legalization.  There are huge “ifs,” but Congressman Blumenauer’s 50 percent excise might land in Goldilocks territory.


[1] Hu, Tun Yuan Hu, The Liquor Tax in the United States, 1791-1947: A History of the Internal Revenue Taxes Imposed on Distilled Spirits by the Federal Government (New York: Columbia University, Graduate School of Business 1950), at 42.

[2] Id.  States in that era imposed license fees rather than gallonage taxes.

[3] That was the statement of Lovell H. Parker, Chief of Staff of the Joint Committee on Internal Revenue Taxation, about the price of good quality, 100 proof whisky.  Tax on Intoxicating Liquor, Hearings Before the Committee on Ways and Means, House of Representatives and the Committee on Finance, United States Senate, 73d Congress, Interim, 1st and 2d Sessions 124 (Dec. 11-14, 1933),  at 11.  Various witnesses had different estimates of the average cost of production; $1.20 was the figure supplied by a Mr. Lourie of the Tariff Commission.  Id. at 83.

[4]Thomas B. Ripy, “Federal Excise Taxes on Alcoholic Beverages: A Summary of Present Law and a Brief History” Congressional Research Service Report RL30238 14 Appendix B (June 15, 1999), available at http://stuff.mit.edu/afs/sipb/contrib/wkileaks-crs/wikileaks-crs-reports/RL30238.pdf [hereinafter “Ripy].

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