No one enjoys paying taxes. People in the cannabis industry enjoy paying them even less, as cannabis tends to be taxed at a much higher rate than other products. (Somewhat paradoxically, medical cannabis is taxed at a lower rate, while recreational cannabis is taxed higher than many other consumer goods.)

It’s important to understand how and why cannabis is taxed, as context can help alleviate some of the frustration. State-level cannabis tax pressure is multi-faceted and variable, with tax rates differing from state to state. Some states tax cannabis more heavily due to policy goals, tax structure choices, and local economic factors. Read on to learn why cannabis is taxed the way it is and how this can be detrimental to both the industry and, ultimately, the states that impose these taxes.

How Cannabis Is Taxed

States tax cannabis in three ways: percentage-of-price taxes, weight-based taxes, and potency-based taxes. Percentage-of-price taxes are the most common, and they tend to be set at a high rate. Rates range from as low as 6% (Missouri) to as high as 37% (Washington). Local rates — taxes imposed by sub-government entities such as cities, towns, or counties — range from 2% to 5%. In Massachusetts, municipalities can impose a 3% local tax on cannabis. Overall, 15 states adhere to percentage-of-price taxes, and five states combine this tax with other forms.

States like Alaska, Colorado, and Maine use weight-based taxes. These are levied on cultivators depending on the (you guessed it) weight of the cannabis product. Different parts of the cannabis plant are also taxed at different rates; for example, Alaska taxes flower at $50 per ounce, while Maine charges a $20-per-ounce tax on flower and a $6-per-ounce tax on leaves. According to the Institute on Taxation and Economic Policy (ITEP), taxes based on weight are more sustainable over time, as “prices are widely expected to fall as the cannabis industry matures.”

Meanwhile, states like Connecticut, Illinois, and New York tax cannabis based on potency, similar to how alcohol is taxed by alcohol content. In this case, taxes are based on the number of milligrams of THC.

The good news is that some states set lower tax rates on cannabis to help the legal market stay competitive with the illicit market and to deter consumers from purchasing from unregulated sources.

Why Is Cannabis Taxed Higher than Other Products?

Cannabis taxes are sometimes referred to as a “sin tax,” as the tax is imposed to offset the negative effects of cannabis use. A similar tax is levied on products such as alcohol and tobacco. For example, Montana dedicates a portion of its cannabis tax revenue to support substance abuse programs, while Ohio directs 25% of cannabis tax revenue to the Ohio Department of Mental Health and Addiction Services for substance abuse research.

Further, cannabis tax revenue is used for other policy objectives, including education funding, reinvesting in communities disproportionately affected by prior drug enforcement, and covering regulatory and administrative costs related to cannabis. Cannabis taxes also tend to be higher in states with tougher regulations (e.g., Alaska and its mandatory lab testing).

As the Tax Foundation points out, some states are even considering increasing their cannabis excise tax rates to compensate for budget shortfalls (or have already used this tax revenue to shore up these gaps). For example, California’s governor, Gavin Newsom, proposed allocating $100 million in cannabis tax revenue to the state’s budgetary deficit — money previously earmarked for law enforcement and public safety initiatives. Chicago has also used cannabis tax revenue to fill budget deficits.

The Consequences of State-Level Cannabis Tax Pressure

It almost goes without saying that the more taxes you have to pay, the less revenue you make. But this is far from the only consequence of tax pressure on cannabis. California just dodged the tax bullet of a proposed excise tax increase (from 15% to 19%). Illinois, for one, is unable to deduct most business expenses related to cannabis due to IRC 280E — a tax code provision that has long been another thorn in the side of the cannabis industry. IRC 280E prevents cannabis businesses from deducting otherwise established business expenses from gross income associated with the “trafficking” of Schedule I or II substances.

As frustrating as 280E is — and it’s certainly one of the biggest cannabis tax burdens — it’s also essential for cannabis businesses to understand, lest they bring the wrath of the IRS down on them like a biblical swarm of annoying insects.

Moreover, as suggested previously, the heavy cannabis tax burden can send some consumers to the illicit market. As the study “The Supply-Side Effects of Cannabis Legalization” points out, as tax rates climb, both consumers and producers are incentivized to pivot to the illicit market.

Conclusion

Yes, state-level cannabis tax burdens can unduly squeeze cannabis businesses out of much-needed profit and can motivate consumers (and producers) to turn to the dark side (the illicit market). But two things can be true at once: this state-level pressure is also used to fund educational needs and support substance abuse programs.

However, as the California cannabis industry can attest, there’s a very fine line between milking a lucrative industry and trying to milk a dead cow — as the latest proposed tax hike could very well have killed this already strained bovine. The cannabis industry, like life, is all about balance and moderation: knowing and respecting limitations, or paying the price.