Legal recreational marijuana sales may raise hundreds of millions of tax dollars for Illinois within five years but the nascent industry isn’t likely to deliver enough of a windfall to solve the budget woes of the worst-rated U.S. state.

Starting Jan. 1, adults who are 21 and older can purchase cannabis as Illinois becomes the 11th state to legalize recreational pot. With nearly 13 million residents and more than 100 million tourists a year, the state will be the largest adult-use market in the Midwest and annual sales could reach $4 billion when the market matures, according to Cresco Labs Inc., the largest cannabis operator by capacity in the state.

The growing industry arrives as Illinois faces $6.7 billion of unpaid bills and $137 billion of pension debt. Tax collections on legal pot are forecast to jump from $34 million in the coming year to $375.5 million in 2024, according to the Illinois Department of Revenue.

Still, rating companies and watchdog groups caution that the revenue can be uncertain. Supply constraints, a persistent illegal market and a patchwork of localities restricting sales may slow development.

“Illinois has had a bad history of claiming various legalization of vices -- video gaming, marijuana or casino expansion -- would provide significant financial windfall,” said Laurence Msall, president of the Civic Federation, a watchdog group that analyzes government finances. “What we have seen is sin taxes are traditionally unreliable sources of revenue.”

Illinois was wise not to use cannabis taxes to balance its fiscal 2020 budget, Msall said. Lack of data on use, demand, price and length of time until market maturity make revenue difficult to project, according to a Civic Federation report released Thursday.

State and local governments should “budget conservatively for cannabis revenues and prepare for much volatility,” according to the report.

Governor J.B. Pritzker, who made legalization a key platform during his campaign, will deliver his second budget address on Feb. 19.

The experience of places like California, which fell short of its initial tax collection forecast for pot sales, suggests that the revenue shouldn’t be relied on as a key fiscal source, said Eric Kim, a Fitch Ratings analyst.

“This is not going to be what saves the state’s budget,” Kim said.

California had projected revenue of $630 million from its cannabis excise tax in the 2018 to 2019 fiscal year, but that forecast was later lowered, according to state budget documents. The spending plan for the 2019 to 2020 fiscal year estimated $359 million in cannabis excise tax revenue.

And New Jersey Governor Phil Murphy has rolled back expectations for how much his state will collect from marijuana sales. Murphy’s most recent estimate was $60 million for the first six months of legal pot sales. That’s much less than the $300 million a year he had estimated when he was running for election in 2017. The state’s voters will decide if they want to legalize sales in November.

Illinois is deliberately taking a phased-in, slow approach that “doesn’t allow the industry to grow very quickly,” said Toi Hutchinson, Pritzker’s senior adviser for cannabis control. Hutchinson added that she’s trying to temper expectations about revenue.

In other states that legalized sales, the tax revenue generated amounted to less than 2% of state taxes, with Colorado at the highest with 1.8% and California the lowest at 0.1% in fiscal 2018, according to Lucy Dadayan, a senior research associate at the Urban Institute Tax Policy Center.

In Illinois, where taxes on tobacco, alcohol and gambling make up about 5.5% of revenue, marijuana is expected to provide less than 1% for fiscal 2020, Dadayan said.

Even though revenue from legalized marijuana can’t cover the cost of big-ticket items such as education or infrastructure, state officials are drawn to so-called sin taxes, she said.

“Each single million counts in the budget,” Dadayan said.

Chicago is projecting $4 million in tax revenue from legalized marijuana in 2020. During her recent campaign, Mayor Lori Lightfoot cited legalization as part of her plan to address the city’s financial problems.

Illinois plans to impose a 7% cultivator excise tax on legal pot, according to the Civic Federation’s report. Other states such as Massachusetts, Michigan and Oregon don’t do that. Illinois will also levy a 6.25% general sales tax, as well as a retail excise tax that will range from 10% to 25%, based on the level of THC, tetrahydrocannabinol, the chemical in marijuana that produces a high. Local governments are also allowed to add additional taxes.

Opt Out

Another challenge to the growth of revenue from legal marijuana is the patchwork of local rules. Some Chicago suburbs, including Mount Prospect, Arlington Heights and Naperville, have voted to ban the recreational sales, so-called “opting out.”
Even though illicit sales are projected to dip in Illinois, they will outpace the legal share through 2024, according to projections by BDS Analytics and Arcview Market Research.

“Any money coming into the state is welcome,” said Howard Cure, director of municipal bond research for Evercore Wealth Management, LLC in New York. Illinois has “a load of several billion in unpaid liabilities putting aside pensions. There is no shortage of uses.”

This article was provided by Bloomberg News.