Why Marijuana Taxes Could Decide the Fate of Pot Stocks

Marijuana Taxes Could Decide the Fate of Pot Stocks Here's How
iStock.com/bluebay2014

Impact of Marijuana Taxes on Pot Industry

The legal marijuana industry is not a simple one, so marijuana stock predictions are difficult. There is a dizzying array of factors that complicate cannabis sales and, therefore, the growth of pot stocks. It can be easy to overlook some developments that are occurring out of sight of the mainstream media.

And that brings us to marijuana taxes.

One of the big issues facing the cannabis industry right now is political: how does the newly legalized market compete with the established marijuana black market, which has the advantage of far lower production costs?

Think about it. For decades, cannabis consumers have been buying their pot from illegal dealers. Legal marijuana—even medical marijuana—is a fairly new development in the vast majority of U.S. states and in countries around the world.

Advertisement

Years of relying on the black market have established trust between consumers and illegal dealers.

When you add marijuana taxes and other regulatory burdens into the mix, the result is that legal marijuana is more expensive than its illegal counterpart, without being much better in terms of quality (or at least not in the eyes of the consumer).

This has, as you would imagine, had a disastrous impact on marijuana stocks. The marijuana black market has siphoned billions of dollars in revenue from the legal market, often eclipsing the legal markets.

An audit by the United Cannabis Business Association found that there are about 2,835 unlicensed weed dispensaries and delivery services in California, the largest marijuana market on Earth. That number easily puts to shame the 873 licensed sellers. (Source: “Nearly 3,000 illegal marijuana businesses found in California audit, dwarfing legal trade,” Los Angeles Times, September 11, 2019.)

As you’d expect, that massive disparity in availability has played itself out in a glaring revenue deficit. Another industry-backed audit found that about $8.7 billion will be spent on unregulated cannabis in California this year. In the same period, it’s expected that there will only be about $3.1 billion spent on cannabis sold by legal operators in the state.

In order to help curb this massive migration of consumer dollars to the black market, governments can do a number of things.

Meanwhile, investors can watch for important markers that will help them choose the pot stocks best suited to weather the storm.

Marijuana taxes are a big reason why the black market is outselling the legal market. Taxes, after all, drive prices higher and drive revenue lower. Considering that the illegal operators pay zero dollars in taxes, it gives them a competitive advantage that the legal businesses can’t hope to match.

Of course, I’m not advocating for zero cannabis taxes. In fact, I’m generally in favor of taxes for a number of reasons, but most pertinent to this issue is pragmatism. It’s easier to sell marijuana legalization to skeptics when you tell them that legal pot will help pay for things like schools and roads.

Instead, I’d like to just see a reduction in marijuana taxes in order to help the legal market defeat the black market.

Until that happens, marijuana investors are best served by carefully monitoring the taxation disparities across markets in order to predict which pot stocks will have a step up on the competition.

Another new study focused on Oregon and the effect that its 25% cannabis tax has had on the behavior of consumers. The study found that this tax garnered $60.2 million for Oregon in 2016 alone (a score for pro-pot arguments). (Source: “It’s high time someone studied marijuana taxes – so we did,” The Conversation, September 20, 2019.)

But as new taxes are imposed, the research suggests that this will alter consumer behavior. Namely, consumers will increase their marijuana purchases in the lead-up to a tax hike. Think of it as stockpiling.

As a result, if you see that a new marijuana tax is to be implemented in a certain jurisdiction, expect to see a jolt in sales, followed by a fall-off in the next quarter.

Another behavioral shift that the research found was that consumers may hop over to other states (or provinces in Canada) with lower taxes to do their marijuana shopping.

That, of course, necessitates two legal markets being relatively close together, but a higher marijuana tax in one state can be a huge boon to the neighboring legal market.

Another indirect impact of higher cannabis taxes is that consumers will likely shift to medical marijuana, which is often taxed differently (or sometimes not at all). The research found that applications to get medical marijuana increased post-taxation.

Investors would do well to research marijuana stocks that currently operate in states anticipating a marijuana tax hike.

They could then plan accordingly by seeking out competitors in neighboring jurisdictions, looking into the medical marijuana sector, and otherwise preparing for a spike then dip in sales in the states with a tax increase.

It’s yet another way that a well-informed investor can keep ahead of the marijuana market and possibly make larger gains than otherwise possible.

Analyst Take

The rollout of pot legalization is not going to be without its obstacles. Nobody thought it would be an entirely painless process. We’re seeing those growing pains right now across the industry in the form of onerous regulations and burdensome taxation.

When it comes to marijuana taxes, being able to accurately predict how political changes will have an impact on pot stocks can be very lucrative indeed.