On May 10, the Alaska House of Representatives passed House Bill 119, which would substantially reduce taxes on legal marijuana if it becomes law. Alaska currently imposes one of the highest tax rates on legal marijuana in the nation and has struggled to transition buyers and sellers to the legal market. A drastic tax cut is warranted to place legal products on a more even playing field with illicit alternatives.
When Alaska voters approved an adult-use recreational market for marijuana in 2014, the initiative they approved included a wholesale excise tax of $50 per ounce, or $800 per pound, which places Alaska among the highest taxed states for legal marijuana. As originally proposed, HB 119 would have reduced this tax rate by 75%, down to $12.50 per ounce and imposed a new 3% retail sales tax on marijuana products. An amendment adopted on the House floor prior to passage increased the proposed retail sales tax to 7%.
The amended bill garnered overwhelming support in the House, passing with a vote of 36-3, and has been assigned to the Senate Finance Committee. The legislation reflects the recommendations of a task force convened by Gov. Mike Dunleavy in 2022 to study the state of the industry and recommend improvements. Brandon Emmett, a task force member who works in the industry, told the House Labor and Commerce Committee:
I can tell you with a high degree of certainty that [marijuana] is still much cheaper on the black market. Alaska’s taxes and the burden on businesses from the Marijuana Control Board is causing prices to stay high and businesses to be uncompetitive.
Emmett went on the say he believes 40 to 50 percent of marijuana sold in Alaska is from unlicensed vendors because the illicit market offers better prices.
A legislative aide also told committee members that marijuana tax revenue is declining in Alaska and that lower tax rates could eventually result in greater tax revenue as a greater proportion of transactions migrate to the legal market in response to lower prices and become subject to taxation.
These observations highlight two common, but conflicting, goals of marijuana legalization. Legalization advocates aim to displace an unregulated and potentially dangerous illicit market with an orderly legal market. Many policymakers are focused instead on generating substantial new tax revenues on legal marijuana sales. To the extent that the cost of taxes and regulations raise the price of legal marijuana goods relative to competing illicit goods, however, consumers and producers may choose to remain in the illicit market, undermining legalization entirely.
A recent large-scale survey published in the Journal of Studies on Alcohol and Drugs of consumers across the United States and Canada found that marijuana users prefer legal products when prices are comparable to those in the illicit market. However, if the price of legal products increases above that of illegal products, consumers tend to revert to the illicit market. Among 50,000 respondents, 17,000 had purchased marijuana in the past year, and 12,000 of these had bought illegal marijuana, citing price as the primary reason.
In 2022, Reason Foundation analyzed the impact of state and local cannabis taxes in California on the decisions of producers and consumers to participate in the legal market. The analysis revealed that the total effective tax per pound of cannabis ranged from $677 to $1,440, depending on the jurisdiction. These taxes exceeded the estimated wholesale production cost of $564 per pound, pushing two-thirds of marijuana transactions in California to the illicit market in 2021, resulting in no tax revenue from these transactions. Our modeling indicated that eliminating California’s statewide cultivation tax would accelerate market growth for legal retailers, increasing transactions subject to retail excise and sales taxes. By December 2024, we projected that cannabis tax revenues would grow to 223% of their March 2022 levels, even without the cultivation tax. California adopted this change, eliminating the cultivation tax in June 2022.
A key lesson is that taxes influence behavior and excessive taxes can lead to reduced revenues by encouraging individuals to avoid the taxed behavior altogether. In the case of marijuana, individuals may simply choose not to buy legal goods.
Reason Foundation acquired proprietary data from market analytics firm New Frontier Data that estimates the size of the legal versus illicit market in Alaska. This data, plotted below, shows that illicit sales in Alaska still account for 62% of the state’s overall marijuana market. Roughly $200 million in illicit sales are forecast to occur in 2024 compared to only $125 million in legal sales.
Alaska has a long way to go for its orderly and legal marijuana market to displace the illicit market. A critical plank in its strategy should be to reduce the tax-induced price disparity between legal and illicit goods. Legislative staff has recognized this reality, affirming testimony submitted by Reason Foundation. It’s encouraging that Dunleavy and House lawmakers have supported the effort to reduce Alaska’s punitive taxes on legal marijuana.