California cities looking to balance their books by collecting taxes on marijuana could find themselves in hazy mess.
Voters in the Golden State on Tuesday will decide whether to legalize recreational marijuana use and related commercial activities. If Proposition 19 passes, California would become the first U.S. state to legalize, regulate and tax marijuana used for nonmedicinal purposes. Local governments would get to set their own tax rates, but federal law — under which marijuana would remain illegal — could complicate local tax collectors’ jobs.
It’s unclear just how much revenue legalized pot could generate, but in an earlier study California’s state tax collector estimated marijuana sales taxes alone could generate nearly $400 million in revenue. The potential windfall has cities like San Jose, Oakland, Berkeley, Long Beach and Sacramento already asking voters to consider recreational marijuana taxes alongside Prop 19. But even if the initiatives pass, collecting taxes from businesses wary of federal prosecution could be tough.
“Historically, it has been very tough to collect taxes on criminal activity,” said Robert Mikos, a Vanderbilt University law professor who has closely studied the issue.
California’s Prop 19 would allow anyone over 21 to legally grow, posses and consume marijuana. But growing, selling and smoking pot would remain illegal under federal law, and the Department of Justice has vowed not to sit back as California lights up.
In a letter last month to former Drug Enforcement Administration officials, U.S. Attorney General Eric Holder said the DOJ would “remain firmly committed” to enforcing federal drug laws in all states.
“We will vigorously enforce the [Controlled Substances Act] against those individuals and organizations that possess, manufacture or distribute marijuana for recreational use, even if such activities are permitted under state law,” Holder wrote.
That could put California’s cash-strapped municipalities in a bind.
“As long as the federal government says “we’re going to prosecute you. We don’t care what state law says,” people are just going to remain underground,” Mikos said. “State tax collections would build paper trail to make federal government prosecution too easy.”
Current California law allows for state taxation of the medical marijuana sector anonymously. Businesses must register for a tax license but are not forced to disclose the type of business they’re in.
It’s a technique that does soften fears of federal prosecution, but “as a practical matter it is almost impossible to collect taxes that are imposed anonymously,” Mikos said.
California’s Board of Equalization, the state’s tax collector, is unsure how much revenue medical marijuana taxes have raised, but estimates the figure is somewhere between $58 million and $105 million.
California legalized medical marijuana in 1996, but it wasn’t until 2009 that Oakland became the first to approve a 1.8% tax on medical marijuana.
Oakland voters now are being asked to consider raising medical marijuana tax rates to 5% and imposing a 10% tax on recreational marijuana, moves that could add hundreds of thousands of dollars to its coffers during a time of need. Oakland has had to slash jobs, cut services and trim salaries to deal with a nearly $70 million annual drop in revenue since 2006.
While marijuana revenue might put a dent in Oakland’s budget gap, for it and other California cities the money would represent just an “incremental gain rather than a main source of new cash,” said Matt Fabian, a senior municipal finance analyst with Municipal Market Advisors.
“It would make their lives a little easier, but taxing marijuana won’t be the savior of these cities,” he said.
And any revenue generated by Prop 19 may take time to materialize. “It may not be as immediate a source of revenue as cities are potentially thinking,” said Lars Etzkorn, who focuses on municipal finance and taxation issues at the National League of Cities.
Berkeley, for example, is expecting its proposed 2.5% medical marijuana tax could generate $165,000 in revenue in 2011 and $460,000 in 2012, according to an analysis by City Attorney Zach Cowan.
Cowan said it is “impossible” to estimate the potential revenue Berkeley’s proposed 10% recreational marijuana tax could generate.
Sacramento projects it could earn $300,000 to $500,000 on its proposed 4% medical and 10% recreational marijuana taxes.
Still, Mikos said California will have to wait for a loosening of federal marijuana laws to realize the true profit potential of its largest cash crop.
“If the federal ban is lifted, it will make it a whole lot easier to collect taxes,” he said. “Until then, you’re not going to see the right market dynamic.”
Meena Thiruvengadam, Wall Street Journal Online