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"FORTUNE &amp;#8212; Thomas Doe, an analyst in the municipal bond market, was in Denver to give a speech last September when an unmistakable scent caught his attention. He\u2019d been walking down the 16th Street Mall, the city\u2019s main retail drag, \u201Cand I\u2019m smelling it in the air,\u201D says Doe, who goes by Tom. Then, completing the tableau, Doe popped into a hotel lobby and spotted three dudes wearing tie-dye and snacking on chips &amp;#8212; this just a few months before marijuana for recreational use went on sale in Colorado.\nThat\u2019s when things really started to click for the 55-year-old founder and CEO of Municipal Market Advisors, a research firm with subscribers including some 300 institutional investors, along with government regulators. Earlier last year Doe and his colleagues had joked about whether a market for medical marijuana tourism could revive the flagging finances of a place like Puerto Rico, whose bond rating has dropped in recent years.\nMORE: Obama&amp;#8217;s muted, forgettable State of the Union\nAfter Doe\u2019s trip to Denver, though, his thoughts on the matter of cannabis and credit ratings turned serious, particularly in light of certain revenue projections. The Colorado Legislative Council Staff estimated additional revenues from legalization, for example, at $100 million over two years\u00A0(PDF). In Washington State, where recreational sales will begin later this year, a fiscal impact study said tax revenue could reach up to $1.9 billion over five years, averaging nearly $400 million annually. Indeed, legalizing marijuana nationwide, to believe a 2010 report by the Cato Institute, would generate some $8.7 billion in tax revenue, in addition to billions in cost savings related to law enforcement.\nDoe believes that\u2019s enough money to help cash-strapped municipalities meet pension obligations, undertake construction projects, and lower their borrowing costs in the bond market &amp;#8212; and, therefore, enough to inspire other states to legalize marijuana, too. \u201CIt would be a real positive for states that are struggling right now,\u201D he tells Fortune. \u201CThey\u2019ve got such an infrastructure funding gap &amp;#8212; and they have challenges with funding their pensions &amp;#8212; that this is significant revenue.\u201D\nGregory Whiteley, portfolio manager for government securities at Jeffrey Gundlach\u2019s DoubleLine Capital, agrees about the potential upside. \u201CBy all accounts the legal recreational marijuana market is potentially quite large, so the impact on state and local finances could be significant,\u201D he says.\nMORE: Inequality &amp;#8211; America&amp;#8217;s great destroyer\nIt\u2019s not a totally new idea. Back in 2010, hundreds of attendees surveyed at a Bond Buyer conference in California agreed\u00A0that bonds backed by marijuana taxes would materialize were the state to legalize the recreational use. (That measure, Proposition 19, failed the same year.) A state estimate, from 2009, had put revenue potential at $1.4 billion a year\u00A0(PDF).\nThough solid data is still lacking, Whiteley says that for now the subject is \u201Cdefinitely on my radar.\u201D\nDoe, meanwhile, has been busy putting the issue on the radar of analysts and investors. He began to speak publicly last fall about the future of marijuana and public finances &amp;#8212; first to attendees at a bond market industry conference in Chicago in October, then to institutional investors at the Massachusetts Investor Conference in December. This month he told clients in a research note that \u201Ca successful experience in Colorado\u201D could result in a domino effect of legalization across the country.\n\u201CColorado\u2019s legalization of marijuana on Jan. 1 will provide hard data as to the potential revenue source from the cannabis product directly as well as ancillary products and services,\u201D according to the note provided to Fortune. \u201CShould tax revenue match projections then other states and cities are apt to follow the lead of Colorado.\u201D\nMORE: Harvard B-school dean offers unusual apology\nState budget planners aren\u2019t convinced by marijuana\u2019s potential just yet. \u201CBudget office folks are going to be very cautious until they see money coming in,\u201D says Scott Pattison, executive director of the National Association of State Budget Officers. NASBO\u2019s membership would also want to see whether any revenue gains are offset by expenditures resulting from legalization &amp;#8212; say, additional costs related to law enforcement or public health. In other words, Pattison notes, \u201CAre there extra expenses, or do we spend less in certain areas?\u201D\nBudget officers would certainly \u201Ctake notice,\u201D however, of revenue figures that exceed 2% of a state\u2019s budget. \u201CThen I think they\u2019ll start to say, Yeah, wow,\u201D Pattison says.\nBy Doe&amp;#8217;s reckoning,\u00A0$400 million is enough to fund, hypothetically, 10 social service programs that cost $40 million each, or to finance major construction. \u201C$400 million of new tax revenue would be material,\u201D he says, adding, \u201CI\u2019ve seen states borrow $400 million to help fund infrastructure projects.\u201D\nMORE: Shadow banking &amp;#8211; China&amp;#8217;s wobbly house of cards\nThat said, skeptics list a host of reasons why marijuana sales won\u2019t ultimately make a dent in state finances, or the bond market for that matter. Craig Mauermann is managing director and senior portfolio manager at BMO Global Asset Management U.S. He does think that other states will be enticed to follow the lead of Colorado and Washington &amp;#8212; but that doing so will only dilute the revenue stream in the end. \u201CThe so-called boon is pretty much going to be spread out,\u201D he says.\nMauermann questions, too, whether marijuana sales will end up eating into consumers\u2019 \u201Cdisposable vice income\u201D for products like cigarettes and alcohol, which also generate sales tax revenue for states.\nThen there\u2019s the illegal competition. Mark Tenenhaus, director of municipal research at RSW Investments, doubts that high-priced legal pot could steal substantial market share from the underground economy. In Colorado, retailers have been peddling marijuana at around $400 an ounce, according to media reports. \u201CI don\u2019t think you\u2019re ever going to get rid of the black market,\u201D says Tenenhaus.\nLike their lawbreaker competitors, legal purveyors of recreational and medical marijuana (permitted in 20 states and in Washington, D.C.) have another challenge to confront: the feds. Marijuana remains an illegal substance under federal law. If a municipality wanted to back a bond offering, in part, with revenue from marijuana sales, bondholders would have to be advised of the risk that sales could be shut down. \u201CIn this environment, it\u2019s a pretty strong risk,\u201D says attorney Robert Christmas, a partner at Nixon Peabody who specializes in bankruptcy and government insolvencies.\nMORE: Why low inflation hurts the 99%\nTom Doe agrees that federal prohibitions, particularly banking restrictions, pose a big impediment to the growth of a legal marketplace. Right now banks won\u2019t touch the transactions or proceeds from sales, forcing merchants to deal in cash, including when they pay taxes. &amp;#8220;The banking laws will have to be adjusted,\u201D Doe says.\nBut Doe also believes the political sentiment is already shifting. Polls by Pew Research Center and Gallup\u00A0have found that a majority of Americans favor\u00A0legalizing marijuana.\u00A0Just this month, states including New York, New Hampshire, and Florida have made moves in favor of some form of legalization.\nEven President Obama appeared to have softened his tone on pot, when he told The\u00A0New Yorker that he thinks the drug is less dangerous than alcohol \u201Cin terms of its impact on the individual consumer.\u201D\nHis administration is working on guidance so that marijuana businesses can make better use of the banking system and not have to deal solely in cash,\u00A0Attorney General Eric Holder said\u00A0at an event at the University of Virginia last week.\n\u201CIf the electorate is supportive then I think the politicians go with it,\u201D Doe says.\nSimilarly, long-time advocates of marijuana reform say interest in \u201Ccannabis commerce\u201D is having an effect on the political climate, too. Allen St. Pierre has worked at the National Organization for the Reform of Marijuana Laws (NORML) since 1991. Two decades later, St. Pierre, now executive director, is suddenly hearing from people like Doe, along with reps from \u201Chedge funds, angel investors &amp;#8230; and big, big law firms that are wondering whether or not to put a toe in the water.\u201D\n\u201CThose folks have the ear and the sway of those politicians far more than we do,\u201D he says.\nAging Baby Boomers may prove another pressure point on pols. \u201CThey want health care options,\u201D says Doe. He envisions a future in which Boomers become strong advocates for medical marijuana because it \u201Cmay be a less expensive and a more desired therapy for diseases\u201D that are impacting them.\nBut the money may talk soon enough. Colorado\u2019s new pot businesses will report their first round of sales tax revenue on Feb. 20, and the state\u2019s Department of Revenue will post the numbers. \u201CBottom line,\u201D says Doe, \u201Cyou\u2019ve got a state that\u2019s going to provide real data, and we\u2019ll see where all of this ends up.\u201D"^^<http://www.w3.org/2001/XMLSchema#string>
<http://fortune.com/2014/01/30/how-marijuana-munis-could-save-the-states/?iid=SF_F_River/>