hemp

Colorado's govenor John Hickenloper has estimated that annual sales and excise taxes on the state's legal marijuana market will bring in as much as $134 million in tax and fee revenue next year.  The figure is well above projections, and the Governor and many others in the state are happy.  Hickenloper, as well as CO Senator MIchael Bennet, both hail from Wesleyan University, my alma mater and the land of West Co. and Zonker Harris Day.  From this shared vantage point, it is easy to see how the ability to spin pot into gold, rather than just dodging the smoke clouds, is something to be celebrated.

But while Colorado may be fairly unique in terms of its approach to marijuana laws, it is hardly unique in its embedded subsidies to fossil fuels.  So why link marijuana and energy?  Sure, there is the push to make hemp biofuel (with a logo that probably had the Shell executive suite spinning), but that connection still has some ways to go before it is policy relevant. 

Rather, it is this:  there are important fiscal linkages on the tax and revenue side.  Far too many state officials (well beyond Colorado, and including my home state of Massachusetts) have failed to look at tax exemptions to fossil fuels in their quest for better policy and more state revenues.  They celebrate new sources of tax revenue without looking to see what old subsidies might be in need of review.

Some of Colorado's tax breaks to fossil fuels date back nearly a century; many more are decades old.  Often they were created during times when developing natural resources was paramount, demand-side management was not even a concept, and the environmental costs of fossil fuel extraction could be (and generally were) entirely ignored.  It is not a leap to suggest that maybe the logic that drove the creation of these policies no longer applies to the world we live in now.

Of all states, Colorado ought to be one of the first revisiting this aspect of its tax code.  CO has a very big tourism industry, driven in large part by the state's natural beauty.  And it is the home of the Rocky Mountain Institute, whose founder Amory Lovins has spent his career demonstrating that conservation and energy efficieny are big energy resources, formidable competitors to conventional supply, and often a far more competitive choice to simply producing more and more fossil energy.  It's a shame that these residual tax breaks tip markets in the opposite direction.

1) Money:  eliminating the fossil fuel subsidies will generate more state revenue than the marijuana fees do; and provide environmental gains as well

Exemptions from energy sales and use taxes have been in place for so long that people stop questioning whether they make sense and whether there are less costly ways to meet the objectives for which the exemptions were granted.  Certainly there is a humanitarian benefit and social responsiblity to ensure that the poor stay warm in winter.  But exempting all energy consumers in the state from sales and use taxes is hardly a savvy way to meet that goal.  Ensuring the poor have access to energy services can be far more efficiently achieved through narrowly targeted purchase or efficiency subsidies.  Providing special exemptions to all energy consumers simply weakens the incentives to deploy non-fuel energy resources (such as wind or solar) and to invest in energy efficiency and conservation. 

Knowing the financial trade-offs is an important part of policy change, yet Colorado was one of the last states in the country even to track tax subsidies.  Finally, in January 2013, the state released its first tax expenditure budget.  This is a very important step forward, though unfortunately came just a bit too late to assist in our review of CO fossil fuel subsidies for OECD.  The tax expenditure report, and the accounting systems behind it, should help Colorado invest its tax breaks more effectively going forward.

Marijuana taxes and fees, 2014:  $134m
CO tax breaks to fossil fuels, 2011:  $564m

The revenue cost of the state's fossil fuel subsidies is big, as shown in the table below.  While pot proceeds are expected to bring in as much as $134 million, fossil fuel subsidies cost the state Treasury more than $560 million in 2011 -- four times as much.  And that doesn't even include the increasing number of oil and gas-related Master Limited Partnerships that are bypassing not only federal corporate income taxes, but state corporate income taxes as well.  MLPs tend not to show up in tax subsidy accounting at all, though the tax-favored corporate form is dominated by firms in the fossil fuel sector.

2) Only net tax receipts, after offsetting cost increases, represent a gain to the state

There are some lessons from Colorado's tax policy with respect to fossil fuels that may be useful in evaluating the marijuana tax windfall as well.  A central one is not to focus on the top-line number of gross tax collections.  Tax revenues from pot need to be evaluated on a net, not a gross, basis because Colorado has a history of earmarking tax revenues to support industry-related activities rather than general state spending.  In some cases, they levy one tax, but then credit that amount back against another.

An interesting example is with the Colorado ad valorem tax on oil and gas, which is basically a severance tax.  For some reason, they decided it would be a good idea to allow property taxes on oil and gas operations to be credited against state severance taxes.[fn]Property taxes are levied by local governments on tangible property. Severance taxes compensate governments for the permanent loss of natural resource deposits within its geographic boundaries.  In addition to crediting property tax payments, the valuation method for tangible property used in CO also provides discounts to specific sectors, including fossil fuels.[/fn] The result has been to reduce the actual severance taxes paid into state coffers almost to zero.

With the marijuana taxes, the Governor has allocated much of the revenue to drug-related expenditures (youth use prevention, substance abuse treatment).  These are important programs and address what is a significant challenge in many states.  But to the extent the problems are made worse by the increased availability of marijuana, the reported contribution that marijuana taxes make to the core functions of running the state should be reduced accordingly.

3) Even pot markets will become more competitive, constraining tax receipts

Even with marijuana sales, one should not assume the boom times will continue indefinitely.  While the next few years may generate increased pot tax receipts due to the novelty of the policy and the lack of competitors, this is unlikely to last.  As with the early states to adopt casino gambling, there is an initial surge of activity and associated tax revenues.  However, as more and more states enter the market, the industry becomes more price-competitive and sales are spread amongst more taxing jurisdictions.  Although lower prices may prop up demand to some degree, tax take per transaction is still likely to fall with prices; and any expanded use from lower prices will be likely to drive up the social costs to which the pot tax proceeds need to be directed.  Both factors suggest net tax revenues from the industry are likely to be flat or decline over time.

If the long-term net tax from marijuana sales is subject to a variety of forces that will keep it relatively low, the benefits of fossil fuel subsidy reform look even better in comparison.  The table below highlights places to start.  A PDF version of the table is available here.

Colorado tax breaks to fossil fuels greatly exceed new revenues from marijuana sales