Vice Taxation Isn’t ‘Free Money’ and Should Focus on Public Good

To combat ongoing revenue shortfalls, states are increasingly turning to legalization and taxation of vice industries as a potential pool of revenue—and the federal government may soon be getting in on the action. But more money in one pot comes at a cost in other areas that states must carefully consider.

In addition to marijuana, legal online sports betting is a growing source of tax revenue for 38 states that have taken the legalization and taxation route. Vices are more frequently being considered as untapped reserves of tax revenue.

The approach of considering these industries as new sources of revenue should first focus on compensating society for harm caused by decades of criminalization of those activities. It should then offset future costs caused by increased consumer use of such products and services.

Tax revenue from legalization and taxation of vices isn’t “free money”—we have existing debts to pay and more bills due.

Instant Gratification

Legalization of vice industries is proving to be a lucrative source of revenue for many states, and helps ease ongoing revenue shortfalls exacerbated by Covid-19.

The short-term financial impact can be substantial—California took in more than $160 million in cannabis tax revenue in the fourth quarter of 2023 alone, according to Census Bureau data. Each state’s success story is a potent political argument for another to pursue legalization and taxation.

The impacts are felt in direct taxation, as well as through associated economic activities and increased tourism in some cases. An influx of revenue instantly boosts state budgets, reducing fiscal deficits without politically divisive tax hikes, base expansion, or broader reforms.

Despite the immediate budgetary boost, legalization and taxation of vices should be tempered by the need to consider long-term policy goals.

Market saturation is a risk as each state legalizes such activities. There is no need for someone in Wisconsin to travel to Illinois to bet on the White Sox when they can do so from their own home. Meanwhile, let’s make sure we’ve done something responsible with the money we raised.

Long-Term Policy

Beyond economic considerations and the general question of whether vice tax revenue is sustainable, there are social costs associated with historical criminalization of these activities and the proliferation of those industries moving forward.

Health-related issues, including addiction and related increased mental health costs, are obvious potential concerns that may require substantial public health outlays and intervention strategies in addition to what is available today.

We must also consider the ethics of staking public funding on industries that have disproportionately affected lower-income communities for the worse over time. Racial disparities in incarceration rates have also persisted.

Many people are in prison or otherwise face negative judicial outcomes for engaging in behavior, such as gambling or possessing marijuana, that’s now legal in their state—industries governments are now using to compensate for state revenue shortfalls.

States should carefully consider the sustainability of these tax revenue streams and also prioritize expenditures that alleviate retrospective and prospective harms.

If governments plan to prioritize vice industries as revenue streams long-term, they should also devote at least equal attention and planning for public health and other resources that address the social harms that often result—absent intervention, social harms will continue, if not increase, as vice industries are made mainstream.

Redistribution Policies

The revenue generated by vice taxes shouldn’t be directed toward offsetting tax revenue deficits caused by failures in unrelated tax policy. No vice tax revenue should be spent to remedy state policymakers’ unwillingness to properly tax wealthy individuals or corporations—to do so would exacerbate existing social inequities.

Allocation should focus on where the most-impacted communities need funding, both at the jurisdictional and individual public service level—from social services and reintegration to public health—not where the state government needs funding.

Tax revenue from vice industries should target education, job training, and community development projects in those areas disproportionately affected by past criminalization. Remaining revenue should be set aside for public health initiatives aimed at addiction treatment and mental health services.

Some states have begun earmarking vice tax revenue for programs such as prevention initiatives and gambling addiction services, but others have directed such revenue toward unrelated shortfalls, such as state water plans.

Shuttling vice tax revenue into the general fund or unrelated projects subjects the tax revenue raised by that program to the same inequities that are inherent to the underlying policy. It hardly seems equitable to dump vice tax revenue into a fund where higher-income individuals disproportionately reap the advantages.

Vice tax revenue needs to be approached with a shift in policy perspective. It isn’t a financial boon states can use for whatever purposes they see fit—it is first a tool for enhancing social justice and equity.

Effective redistribution of this revenue is essential now, before market corrections and decreased novelty take effect. The windfall from vice taxes should produce tangible improvements to those most affected by the previous policies, with all other expenditures only being made when that debt is paid.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social

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