Are Potency Taxes the Future?

When Illinois launched its market in 2020, it became the first state to tax cannabis based on cannabinoid content. However, it is unlikely to be the last. The fact that no other state taxes cannabis based on potency might seem odd to anyone familiar with alcohol taxes. Distilled spirits (liquor), with a much higher alcohol content than wine or beer, are taxed at a much higher rate per gallon. Why isn’t this the norm for cannabis?

Let’s look at how alcohol is taxed, starting with federal excise taxes, which are imposed when the product leaves the brewery, winery, or distillery or is imported into the country. Most beer is federally taxed at around 50 cents per gallon, regardless of its alcohol content (usually 5–8 percent). The wine excise tax, by contrast, varies dramatically based on strength. For medium-sized producers/importers, the federal tax per gallon jumps from 17 cents to 67 cents to over 2 dollars as alcohol content rises from under 16 percent to 21–24 percent. Liquor is taxed per “proof gallon,” meaning that the federal tax is adjusted percentagewise based on alcohol content. For medium-sized producers, liquor is taxed at $10.67 per gallon of 80-proof liquor (40 percent alcohol) or $13.34 per gallon of 100-proof liquor.

Additionally, states have their own taxes on alcohol, including sales taxes based on price and other taxes based on volume and alcohol content. According to the Tax Foundation, 16 states have beer taxes that vary based on alcohol content, and numerous states also follow the federal approach of basing wine and liquor taxes on alcohol content.

From a public health standpoint, basing taxes on alcohol content makes sense. Generally, as prices increase, use decreases, reducing the public health burden from chronic disease, accidents, and other negative effects of excessive alcohol consumption. If a beer with 5 percent alcohol, a wine with 17 percent alcohol, and a liquor with 50 percent alcohol were taxed at the same rate per gallon, it would incentivize the production and sale of liquor over lower-alcohol products.

Theoretically, in states such as California and Alaska, which tax marijuana production by weight, growers would benefit by producing higher-THC strains.

It is too early to know the effects of taxes on cannabis consumption, particularly because illicit markets continue to thrive even in states with easy access to regulated cannabis. Theoretically, in states such as California and Alaska, which tax marijuana production by weight, growers would benefit by producing higher-THC strains, which would generally sell for a higher price without a higher tax. In states such as Colorado and Nevada, where the excise tax is based on the sales price from grower to distributor, it might make more sense to produce lower-THC cannabis than it would in California or Alaska. However, many costs, such as fertilizer and lighting, are the same for low-THC products as high-THC products, which would temper any benefits to the lower excise tax. Also, as Priceonomics points out, other factors such as regulatory requirements and growing conditions affect prices.

Of course, we are not comparing apples to apples. While excessive THC intake might be associated with emergency department visits and impaired driving, we don’t have good data on how higher-THC cannabis increases overall health risk. Having to smoke more low-THC cannabis to produce the same effects might increase respiratory inflammation, for example. Further, having to grow more cannabis to produce the same number of edibles may have negative environmental consequences. Finally, raising taxes too much could have the effect of driving people to the illicit market.

It is too early to know which states’ approach to cannabis taxation is the most effective, but in coming years this will surely be an important issue for states and, perhaps, the federal government. The data from Illinois will be particularly helpful to state legislatures because so many public health concerns are linked to high-potency products.

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