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Pot tax rate key to driving down illegal market in CT

April 14, 2019

Yale University professor Kosuke Uetake studies economics for a living, but on Thursday afternoon he was stumped.

Name another consumer product for which states, in recent history, have created and regulated new legal markets.

The economist thought for a minute. Maybe e-cigarettes? Facebook?

Bottom line: it’s extremely rare, he concluded.

So the potential legalization of recreational marijuana gives Connecticut, and other states, a unique opportunity. It’s a chance to protect public health, shape consumer behavior, reduce an illegal market and increase state revenue, economists agree.

One decision by Connecticut lawmakers will be crucial to the state’s success in all these areas: setting the tax rate on recreational cannabis.

Connecticut Democrats, most of whom support legalization, are still making up their minds on how to tax the new product. They haven’t finished drafting this part of the cannabis legislation.

On Monday, Rep. Jason Rojas, D-East Hartford, who chairs the Finance, Revenue and Bonding Committee, which is writing this part of the law, said its proposed legislation would set an effective 20 percent tax rate on pot, comprised of a 9.35 percent sales tax and an excise tax of $45 per ounce on cannabis buds and $13.50 per ounce on the rest of the plant.

This is similar to Massachusetts’ 20 percent tax rate on recreational marijuana and a moderate rate compared to the six other states that have legalized the drug for recreational use.

But by Friday, Rojas said lawmakers would likely revise the excise tax down to about $30 to $35 per ounce for cannabis buds, out of concern that too high a tax would fail to grab buyers from the black market. Even this rate could change later if the full House and Senate get the chance to weigh in.

Economists who have studied other states’ legal weed markets say the weight-based excise tax Connecticut is eyeing is good — but a potency-based tax could be better.

“We have been trying to encourage either a tax per unit or, in our minds more appropriate, a tax per unit THC (tetrahyrocannabinol, the principal psychoactive chemical in cannabis), which would be more akin to how we treat alcohol,” said Rosalie Pacula, co-director of the RAND Drug Policy Research Center.

By taxing the amount of THC in the cannabis product sold, Connecticut could ensure a steady revenue stream even as the price of marijuana varies and disincentivize dispensaries from selling stronger and stronger weed products to raise prices, Pacula said.

But potency-based taxation requires good laboratories and technology to accurately test THC levels, said Uetake who teaches marketing at Yale’s School of Management.

“Reliability and replicability of testing remain problematic,” wrote Carl Davis, Misha E. Hill and Richard Phillips of the Institute on Taxation and Economic Policy in a 2019 policy paper. “Cannabis testing laboratories lack the regulation and oversight that most other public health and safety labs require. Thus, there is not yet an industry standard and testing results may vary.”

Economists also recommended Connecticut be prepared to raise its tax rate later.

“Usually marijuana prices are initially high, so taxing a lot on top of that leads to consumers going to the black market or not going to the legal market,” said Uetake. “Eventually, prices go down due to competition or other factors. Then maybe we can charge higher taxes. At that point, people get used to the legal market, they love going to the legal market and they don’t go back to the black market.”

To decide when to raise the rate and by how much, Connecticut needs good sales data, said Keaton Miller, an economics assistant professor at the University of Oregon. That might require Connecticut to purchase and implement a seed-to-sale tracking system — which proposed legislation passed by the General Law Committee currently does not allot for.

“It’s hard to make good decisions in the future unless you are collecting good data today,” Miller said.

Washington state is heavily studied by economists because of its extensive, publicly accessible data on cannabis sales and revenue. The state also has the nation’s highest tax rate on recreational marijuana with a 37 percent excise tax plus a 6.5 percent state sales tax.

Uetake’s research finds Washington could raise its tax rate even higher — perhaps as high as 50 percent — with little dropoff in sales.

If Connecticut adopted Washington’s current tax scheme, the state could see annual revenues of over $151 million, Davis, Hill and Phillips estimate. That’s higher than Connecticut politicians’ current predictions of $80 million to $140 million with a 20 percent effective tax rate.

Connecticut could also see higher cannabis revenues if it beats New Jersey and New York to legalization, economists observed.

“I think there is a big opportunity in the short-run for Connecticut to take advantage of uncertainty in New York and New Jersey,” said Miller. “If you can go to Stamford from Grand Central station and the price is competitive to what you would see in Providence or Boston, you are going to see a lot of business in Stamford — a lot.”

But revenue will also vary based on the market Connecticut creates: how many licenses to grow, manufacture and sell marijuana products it permits, who runs them, what products those vendors are allowed to sell, how cannabis is marketed and the overlaps between medical and recreational marijuana.

And like taxation, most of those details, said Rep. Michael D’Agostino, D-Hamden, are still being sorted out.

emunson@hearstmediact.com; Twitter: @emiliemunson