How did this legend start?

Here's the best theory I've heard. Other people disagree, saying that they believe these flyers were circulating before 1980.

In 1980, the Narcotics Bureau of the New Jersey State Police sent out a memo including pictures of blotter acid decorated with small pictures of Mickey Mouse. The photo showed foil packaging with a ziploc bag and a red cardboard box with a picture of Mickey Mouse on it (these details weave their way into some versions of the fliers). The memo uses the word "stamps" to refer to the pictures stamped on the blotter paper and warns that "children may be susceptible to this type of cartoon stamp believing it a tattoo transfer."

The double-meaning of "stamp" in english (both an image that is stamped on to a surface as with blotter acid images, and a lickable adhesive-backed image such as a postage stamp) led to some of the initial confusion regarding the nature of bootleg LSD.

A Seventh-Day Adventist church community wrote and propagated a flier in 1980 using information from the police memo, and the legend was on a roll. Like a successful virus, this flier was highly contagious and subject to mutations that would make it more virulent.

Fear and ignorance about psychedelic drugs have led to a whole host of urban legends surrounding them. You've probably heard about the students who took LSD and then stared at the sun until they went blind; or the babysitter who took acid and put the turkey in the crib and the baby in the oven (I remember a speaker coming to my school to speak about the dangers of drugs who trotted that one out!); or that if you take LSD enough times you are considered legally insane; or that LSD crystalizes in the spinal column and is visible on x-rays.

It was Timothy Leary who noted that "psychedelic drugs have been shown to cause paranoia, confusion, and total loss of reality - in [people] who have never taken them." For many people, myths and legends constitute a primary source of information about LSD. Stories about drug dealers trying to hook children on drugs with "free samples" and other nefarious means have been around for a long time, and it was natural that there would be some cross-fertilization.

The legend builds up its own momentum. Someone receives a copy and makes several more for their day-care center or workplace. The process continues, with new copies being typed up (with occasional changes) as the multiply-photocopied versions become less readable.

The news media in towns hit by an outbreak of the flyers tend to take them seriously in page A1 headlines, and then to admit their urban-legend status a week later in page A-12 retractions. (The retractions, oddly, are often as full of nonsense as the original articles). Elements of the legend become part of the consensus background-knowledge about LSD and statements like "LSD is commonly disguised as children's stickers or tattoos" or "...the cartoon pictures, designed to attract children to the drug..." or "...police say they found several LSD 'tattoos' last year..." become part even of news stories that were not directly prompted by the flyers.

By 1987, the fliers include references to "Blue Star," Bart Simpson, butterflies, clowns, red pyramids, and colored microdots. LSD is now alleged to be able to cause "a fatal `trip'" and strychnine is said to be included in some stamps. Details about the ziplock bag, red box and foil are rarely seen on versions of the flyer found after the mid-1980s.

Most versions of the warning that are being found these days attribute the warning to a "J. O'Donnel" from Danbury Community Hospital's Outpatient Chemical Dependency Treatment Service. Danbury Hospital (in Connecticut) has told reporters that it receives several calls each week asking for information, but does not have an employee by that name and knows nothing about any LSD Tattoo outbreak. (I wonder if the fact that "O'Donnel" can be read as "O.D. on 'L'" - or, "overdose on LSD" - might have significance. Perhaps this was planted by someone who was deliberately perpetuating the hoax? Or maybe it just means that Paul McCartney hass really been dead all this time.)

More recent versions of the flyer are including the ominous warning: "Young lives have already been taken!" (and the adjective "many" quickly attached itself to this phrase).

The flyers have hit several continents and have been translated into several languages - lately, they've hit the infobahn, appearing in usenet newsgroups, on web pages and in mailing lists.