A Principled Approach to Taxing Marijuana:PRESERVING PRAGMATISM


Unfortunately, Congress has not proved itself capable of smoothly adjusting taxes to adapt to changing circumstances. Take federal alcohol taxes. They are not even indexed for inflation, so year by year, they erode in real terms. The federal tax rate on medium-potency still wine (14% to 21% alcohol) was $0.67 per gallon in 1951. That was still the rate 40 years later, by which time inflation had reduced it in real terms by over 80%, to the equivalent of $0.12 per gallon in 1951 dollars. If the rate was correct back in 1951, then it was much too low in 1991, and vice versa. Furthermore, when Congress finally acted, it increased the rate (to $1.57 per gallon) but failed again to index it for inflation. That is a bit like giving a blood transfusion to a trauma victim without bothering to suture the wound.

There is no mystery as to why this happens. Tax increases focus pain on a well-defined, often well-organized, and typically well-heeled constituency, whereas the benefits are diffuse. Even today, Congress fails to tax many things that need taxing. It can’t summon the nerve to tax the income that Apple shifts to tax havens — leaving that to the European Union — or even to close the gaping carried-interest loophole that lets hedge-fund promoters turn ordinary income into low-taxed capital gains.

Even when the total benefits outweigh the costs, it is hard to build political coalitions to implement tax increases. So we should expect marijuana-industry lobbyists to block even rational increases in marijuana taxes as production costs fall.

But there are reasons why it might be politically easier for Congress to launch federal legalization with a plan for robust revenues than it would be to raise taxes later. For one, the marijuana industry is currently at a strategic disadvantage. Interested players want legalization more than they want low taxes. That puts Congress in an unusually strong position.

he industry is also still fragmented, with few firms’ annual revenues exceeding tens of millions of dollars. (The federal prohibition on marijuana blocks participation by tobacco and other national consumer-goods giants, and prevents the issuing of publicly traded stock.) In addition, anti-tax guru Grover Norquist has said marijuana taxes don’t violate his “taxpayer-protection pledge,” and advocates of supply-side economics would probably prefer marijuana taxes to income taxes.

Congress also has extra leverage over marijuana taxes because of an obscure 1982 law that limits those selling certain illegal drugs to deducting only the “cost of goods sold” — that is, money spent to grow or buy the product, but not on advertising or other costs of distribution and selling. This law was enacted after a taxpaying drug dealer deducted those expenses (remember, Al Capone was taken down on tax charges). Since all marijuana sales are banned under federal statute, this rule applies to state-legal marijuana businesses. Having this tax on the books, generating current revenue, makes the political climb of creating a new tax plan a little less steep.

At the moment of legalization, Congress will have some legislative options that would allow marijuana revenue to increase over time while maintaining flexibility. One potential plan would hardwire in tax increases to be phased in over time, but would deliberately err on the side of increasing taxes too much and too quickly. That way, all the adjustments would be in the downward direction relative to that initial trajectory. After one difficult act at the time of legalization, Congress might look forward to a series of easier votes, lowering tax rates that were set high initially as a safety factor. That safety factor won’t prevent industry lobbyists from working to make taxes too low at every opportunity. But the burden of changing the law would be on the industry lobbyists; Congress would be in a position of strength.

Another option — indeed a better one if Congress and the Constitution allowed — would be for Congress to delegate tactical control to some independent or semi-independent commission. While such delegation of tax authority is unprecedented, there are precedents for Congress delegating important and politically sensitive decisions. The Defense Base Closure and Realignment Act authorized an independent, nine-member body of presidential appointees to choose which military bases to close, subject to congressional override. Another example is granting the president fast-track authority to negotiate trade agreements that Congress can then only approve or reject but not amend.

The institutional-design question is both important and complicated. Presumably the rate-setting body’s actions would be subject to congressional override, and it would be structured to give primary weight to public-health considerations, secondary weight to tax-revenue generation, and no particular deference to the narrow profit interests of the marijuana industry.

Inspiration might be drawn from government institutions that do manage to continuously adjust crucial economic variables in ways that are substantially insulated from lobbying pressure. The Federal Reserve’s process for adjusting interest rates comes to mind. Other examples include the Postal Regulatory Commission’s oversight of postage-rate increases; state public-utility commissions’ oversight of utility rates; the Federal Communications Commission’s sale of segments of the electromagnetic spectrum via auction rather than fixed prices; and indexing aspects of income taxes for inflation. These reasonably successful examples contrast with failed attempts by Congress to adjust government-set rates for grazing and mining rights, or to adjust gasoline excise taxes in response to changes in oil supply and to changing understandings about environmental externalities.

However desirable, this option undeniably involves serious political challenges and constitutional questions (especially concerning the origination clause). And the principle of taxation with representation is not to be abandoned lightly.





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