There are 19 states that have legal retail markets for recreational cannabis as of the spring of 2023, and Maryland will become the 20th as of July 1. That leaves another 31 states (including D.C.) who are leaving billions in weed tax revenue on the table. Twelve of those states have already either decriminalized pot or allowed its medical use. Nineteen have yet to legalize cannabis in any form. These other states know they could enhance their state revenues with full legalization and an accompanying sale tax and licensure system. But, politics of one form or another has delayed the inevitable.
So here’s an idea that is certain to break through the political weeds in all of those states without any controversy: legalize pot and use the tax money to stabilize state and local pension funds.
Okay, well, maybe there would be some political controversy. Pot for pensions will sound like a half baked idea to plenty of legislators. But in the context of growing investment volatility risk for public pensions staring down the prospects of a recession and tax revenue reductions, all ideas should be on the table for finding ways to improve pension funding.
Getting into the Weeds of Public Pension Funding
State and local governments spent around $150 billion last year in contributions to their public pension plans. Most of that spending was to pay down persistent pension debt. Those contributions were between 5% and 10% of state general funds for most states — and in a few states were nearly 25% of the state budget.
To put that number in context, it is about 50x the budget of the Drug Enforcement Agency, more than three times what the Feds spend on all drug control policies, and is approaching the annual budget for the Department of Homeland Security.
The driving cost for all of this pension fund spending is pension debt (formally “unfunded liabilities”).
In 2004, the funding shortfall for state and local pensions was $420 billion. (Well, it was actually $412 billion, but that’s not as much fun.) This wasn’t great, but it was preferable to how bad things have gotten since then. State and local governments had $1.4 trillion in unfunded pension liabilities in 2022, with a 77.3% funded ratio. Those numbers are likely going to look worse in 2023 based on muted investment returns.
The additional $1 trillion in pension debt over the past twenty years is due to a combination of unrealistic investment assumptions, losses during the financial crisis, and contribution policies that have allowed tens of billions in interest on the pension debt to accumulate. State pension funds have tried to solve for these problems, in part, by expanding their portfolio of high risk, high reward investments. Twenty years ago public retirement systems had less than 10% invested in private equity, hedge funds, and other alternative investments. By 2022 these risky or non-transparent investments had increased to 25% of pension fund portfolios.
Some state pension funds have even invested in real estate companies who do business with cannabis companies—which basically makes them weed dealers themselves.
State governments could continue to effectively direct their pension funds to take high risk bets and hope they pay off to avoid extra costs. But that sounds like a strategy cooked up while high.
A more sober approach would be to address growing costs with additional streams of on-going revenue. For some states that might mean adjusting property taxes (like modifying Prop 13 in California) or income taxes (like Illinois progressive income tax proposal that was voted down in 2020). For other states this might mean taking a pause on reductions in tax revenue (which have been a priority for states like Texas in recent sessions). And for those who’ve yet to legalize all uses of pot, the cannabis plant might be a place to look.
Harvesting the Pension Pot (of Funds)
The case for creating a dedicated stream of revenue from pot legalization is straightforward. The War on Drugs not only has failed, but has caused harm in many parts of society. So it is little surprise that a majority of voters from across the political spectrum either support or somewhat support the legalization of marijuana. Some of these individuals support legalization on the grounds of individual freedom, while others can accept that even if they preferred no drug use that there’s no stopping the flowering weed economy. Better to regulate the weed industry and leverage tax dollars into some helpful public good.
Arizona already kind of has a pot for pensions law on the books. In 2020, Arizona voters approved Prop 207 which fully legalized sales of cannabis with a 16% sales tax. Roughly one-third of that revenue is sent to municipal police and fire departments to help them pay for their pension debt costs.
States with legal weed sales in 2021 generated over $10 billion in tax revenue from cannabis specific excise taxes (e.g. not including normal sales taxes or medical related tax revenue). California generated $1.2 billion in tax sales for 2021 alone, according to Tax Foundation data.
State governments are each leaving tens of millions on the table — or hundreds of millions for larger states like Florida, Georgia, or Ohio. And it just so happens that all three of those states don’t fully have their arms around unfunded pension liabilities.
Georgia’s Teacher Retirement System alone has over $20 billion in pension debt. Florida’s state pension fund reported nearly $40 billion in unfunded liabilities for 2022, and is almost certain to face higher pension fund contributions in coming years. Ohio’s four large statewide retirement systems have a combined $50 billion in unfunded liabilities.
When state and local governments just let pension debt fester its like ignoring an off-balance sheet debt. They are letting interest on their pension debt grow at a faster rate than contributions and/or taking a puff and hoping that investment returns will save the day. This is fiscally irresponsible.
Legalizing cannabis certainly mixes together all kinds of political strains that create for complicated discussions. Against the backdrop of fentanyl and opioid crises there is no reason to be cynical toward those who pause at legalizing another drug. But in a world where pot legalization is just a matter of time, the fiscally responsible thing to do is start generating revenue now and putting that money to good use. Passing the bowl to state pension funds to help reduce their funding mess is as good of a place to start as any other.