The Pot of Gold
May 21, 2019Taxes
The Federal Government is Losing Billions in Potential Tax Revenue by Refusing to Legalize Marijuana
The Feds won’t do it, but smart state governments are cashing in, and have collected hundreds of millions in marijuana taxes. Medical marijuana is now legal in 33 states, and recreational marijuana use is legal in nine; (Washington, Oregon, California, Nevada, Colorado, Alaska, Michigan, Vermont, and Maine).
Ironically, recreational pot is also legal in our nation’s capital, Washington D.C., although it is still prohibited under federal law. There is no denying the revenue potential. Nevada legalized recreational use in 2017, and raked in almost $70 million in taxes that year. Oregon collected $80 million last year. Oddly enough, although pot is legal in Michigan, Vermont, Maine and Washington D.C., they have no tax system in place.
The marijuana business is booming, but has some unusual restrictions. Because marijuana is still classified as a “Schedule 1” drug (in the same class as heroin or cocaine) and is illegal under federal law, cannabis businesses have difficulty opening bank accounts. Most banks refuse to work with marijuana dispensaries, because the Department of Justice could technically prosecute them for money laundering.
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A Tax Collection Nightmare
Though federal law says it is illegal, marijuana growers and distributors are still required to pay federal taxes on their gross income. The law forbids them from taking any deductions or credits for business expenses, which can mean an effective federal tax rate as high as 90%.
Since it is primarily a cash business, collecting taxes is a challenge. The U.S. government collected an estimated $4.7 billion in taxes from cannabis companies in 2017, on nearly $13 billion in revenue. Cash payments are a nightmare for the IRS, and for the individual businesses that must pay them. For a cannabis company to pay their federal taxes, they have to schedule an appointment, and go to a local IRS office to make the payment. Because of the amount of cash involved, the business owners will frequently hire armed guards to accompany them. When they get to the IRS office, a secure room is set aside to count the money, and two IRS agents have to be in the room at all times.
The IRS used to assess a 10% penalty to businesses that paid in cash. In 2014, one of these businesses sued them over this policy. After that, the IRS revised the policy for legal pot businesses who could show that they had tried to open an account, but were rejected by the bank.
Of course, the IRS would still prefer payment by electronic deposit, credit card or check, but usually have to accept bags of cash that smell like the product.
The Department of the Treasury recently awarded a $1.7 million contract to a Virginia based company called the Mitre Corporation, for the sole purpose of processing large cash payments from the cannabis industry. (Our tax dollars at work, folks).
A study done by a data analytics firm called New Frontier Data estimates that if marijuana was legalized nationwide, the IRS would collect over $132 billion in tax revenue, and create more than a million new jobs over the next decade.
Beau Whitney is a senior economist at New Frontier Data. He thinks it makes good sense for marijuana to be legalized on the federal level. “When there are budget deficits and the like, everybody wants to know where is there an additional revenue stream, and one of the most logical places is to go after cannabis and cannabis taxes,” he said.
Whitney predicts that the illegal marijuana market would shrink if the legal marketplace was allowed to flourish, and was not overly taxed. “Consumers want to do things legally in general, but they don’t want to do it at too much of a price,” he said. “If they go to 7-11 to pick up cannabis, they’re willing to pay 10 to 15 percent on top of what they get on the street. Once they get above that, it slows the transition and makes the consumer think twice about making that legal purchase.”
Federal Prohibition is Likely to Continue
Although there has been bipartisan support in Congress to legalize marijuana nationally, it probably won’t happen with the current administration. Attorney General Jeff Sessions has clouded the issue in the states where marijuana is legal, making it easier for U.S. Attorneys to enforce federal law, and reversing Obama-era discouragement of overriding state laws.
There is legislation being pushed by both Democrats and Republicans to end the federal prohibition on marijuana. Democrats are in control of the House, and many of their new freshman members are pro-cannabis. They will try to pressure Senate Majority Leader Mitch McConnell to stop blocking pro-marijuana legislation in the upper chamber. McConnell has made it clear, however, that he does not support cannabis legalization. He has called it “hemp’s illicit cousin.”