New Jersey marijuana legalization passage no game changer for state finances

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New Jersey voters approved the legalization of recreational marijuana setting the stage for revenue growth, but future tax gains may be limited if neighboring states pass similar measures, according to analysts.

The referendum, which passed overwhelmingly in voting that concluded Tuesday, calls for a 6.625% state tax on marijuana sales to customers 21 or older and permits municipalities to charge an extra 2% tax. The legalization is projected to generate around $120 million for the fiscally stressed state once the market gets established, which won’t be for another two to three years as state legislators adopt regulations and legal dispensaries open.

Massachusetts marijuana dispensaries debuted in November 2018 two years after the state passed a cannabis legalization bill. New Jersey is looking at a similar time frame.

New Jersey lawmakers opted to place the marijuana question on the November ballot after previous failed attempts to legalize cannabis through the legislative process. Neighboring New York and Pennsylvania have made recent attempts at marijuana legalization.

Ballot measures to legalize recreational marijuana were also approved Tuesday in Arizona, Montana and South Dakota Tuesday making 15 states that now tax the drug.

“The legalization of recreational marijuana in New Jersey will ultimately be a modest, but not game-changing, positive for the state’s finances,” said Lisa Washburn, managing director of Municipal Market Analytics. "The estimate is also at risk of coming in lower if nearby states ultimately legalize. Similar to what we have seen over the years with gaming revenues, I’d expect that any hypothetical expansion of the legalized industry to New York and Pennsylvania would cannibalize some of New Jersey’s aspirational revenues.”

Moody’s Investors Service analyst Baye Larsen also cautioned that New Jersey’s future revenue growth would be hampered if New York and Pennsylvania ultimately pass similar measures. She also noted that tax collections will take a few years to materialize.

“While the additional revenue will be a credit positive for the state and any participating municipalities, the impact will be limited by the relatively small size of potential marijuana tax revenues compared to New Jersey’s total general fund,” Larsen said.

Rising pension liabilities and past structurally imbalanced budgets triggered 12 credit downgrades to New Jersey general obligation bonds during the past nine years to the second-lowest ratings of the 50 U.S. states. The Garden State’s GO debt is rated higher than only Illinois at A3 by Moody’s, A-minus by S&P Global Ratings, A-minus by Fitch Ratings and A by Kroll Bond Rating Agency.

Voters approved legalized marijuana in New Jersey two months after Gov. Phil Murphy and state lawmakers struck a deal for an income tax hike on millionaires to 10.75% from 8.97% in an effort to address revenue losses driven by the ongoing COVID-19 pandemic. The millionaire’s tax is projected to raise $390 million of new annual revenue, but it will be largely offset by an estimated $340 million cost of the rebates.

“[Marijuana legalization] is an unlikely to be material panacea for future state budgets” said Fitch analyst Douglas Offerman of New Jersey’s estimated revenues from the drug, which would equate to about 0.3% of the state’s overall spending plan. “It is part of the overall picture but part of that overall picture several years from now potentially.”

Offerman added other states that have enacted marijuana legalization have faced obstacles setting up necessary infrastructure to sell the product. He noted that Massachusetts, which passed a marijuana legalization referendum in November 2016, didn’t open its first legal dispensaries for another two years. The Bay State collected $150 million of tax revenue from marijauna sales as of early August, according to the Commonwealth Dispensary Association.

“It has been a time-consuming process for other states who have pursued legalization of recreational marijuana, and it will be no different in New Jersey,” Offerman said, “There is a lot of regulation to be written and there are a lot of decisions to be made on how distribution will work.”

The increasing number of states legalizing marijuana has prompted some in the municipal bond industry to pursue issuing bonds backed by cannabis taxes. However, the federal government continuing to classify marijuana as a controlled substance have hampered momentum for marijuana revenue bonds on the state level.

“Unless this inconsistency is resolved, I think it will likely be a deterrent to the involvement of companies in the financial services sector, which are needed in a variety of capacities in a bond issuance,” said Washburn of the disconnect between state and federal laws. “I think it will be a while before we see bond deals backed by marijuana revenues.”

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