Drug Policy

Should the Benefits of Legalizing Pot Be Measured by Tax Revenue?

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Jacob Sullum

According to a new report by researchers at Colorado State University, the tax revenue generated by marijuana legalization won't be the windfall some people may have been expecting. The report, produced by the university's Colorado Futures Center (CFC), estimates that annual excise tax revenue will fall far short of the $40 million for school construction anticipated by Amendment 64, the initiative that made marijuana legal for recreational use. They estimate that the 15 percent excise tax authorized by Amendment 64 would instead yield something like $22 million a year, while a special sales tax of 15 percent, as contemplated in a bill the state legislature is considering, would produce $91 million in revenue, on top of $18 million from the regular state sales tax of 2.9 percent. The total of $130 million or so (which does not include revenue from local sales taxes) obviously would not have much of an impact on Colorado's overall budget, which totals more than $20 billion a year. "After meeting the obligations for BEST [the school construction program] and funding the regulatory and other public health and safety budget demands," the report concludes, "revenue from marijuana taxes will contribute little or nothing to the state's general fund."

That conclusion does not trouble me, since I have never been a big fan of the tax-revenue argument for legalization. The ban on marijuana (and other drugs) should be repealed because the government has no business trying to dictate what people put into their bodies, not because prohibition represents a missed opportunity to take people's hard-earned money. In fact, to the extent that revenue comes from special "sin" taxes on marijuana, as opposed to the standard sales and income taxes, I think the right target is zero, since this is just a milder way of punishing people for behavior that violates no one's rights. Still, the assumptions that went into this fiscal analysis, several of which are questionable, raise some interesting issues.

To begin with, I think the CFC researchers may have erred in the way they calculated the revenue from the excise tax, which they applied to the "wholesale cost" of marijuana, by which they mean "the cost of growing marijuana." Based on a RAND Corporation estimate for marijuana cultivation in California, they assume that it costs $600 to produce a pound of marijuana. Applying the 15 percent excise tax to that amount, they get $90 in revenue. Yet H.B. 1318, the marijuana tax bill, says the excise tax would be applied to "the average market rate" for wholesale marijuana, which includes the grower's distribution costs and markup. Using the CFC's figures for those, the excise tax revenue per pound would be $120 instead of $90, or one-third more, in which case the annual revenue would be around $29 million rather than $22 million. Applying the excise tax to the wholesale price rather than the production cost also would boost the sales tax revenue a bit, since it is partly a function of the excise tax.

Changing the assumptions about marijuana sales could have a much bigger impact on revenue projections. The researchers start with numbers from surveys on marijuana use, which they inflate by 20 percent to account for underreporting and apply to Colorado's population. They take into account the impact of lower prices on consumption, but their estimate of the difference in prices between the black market and the legal market seems way too low: just 10 percent. Partly that reflects the impact of taxes, which by their calculation would add about $34 to the retail price of an ounce, making it about 23 percent higher than it would otherwise be. But the low estimate of the price gap between the legal and illegal markets is mostly due to using $206 as the black-market price for an ounce. That is "the average price of an ounce of marijuana of all qualities," as reported on the website The Price of Weed, based on numbers submitted by consumers, as of April 10.

But the black-market price of high-quality cannabis, which is what Colorado's medical marijuana centers (MMCs) sell and what the state-licensed pot shops will offer, is typically between $300 and $400 in the U.S. (as reported on the same site). The current Price of Weed average for high-quality pot in Colorado is substantially lower, just $238, but that figure likely includes marijuana bought at MMCs, which typically charge $25 for an eighth of an ounce, close to the CFC's $185-per-ounce estimate of the after-tax retail price in state-licensed pot stores. Kayvan Khalatbari, co-owner of an MMC in Denver, estimates that black-market prices in Colorado are roughly twice what businesses like his charge. By contrast, the CFC researchers are assuming almost no difference in price. If Khalatbari is closer to the mark, legalization would bring a much bigger drop in price, implying a bigger increase in consumption and more tax revenue. A further boost would come from pot purchases by visitors to Colorado, which the researchers do not include in their analysis because the extent of that market segment is hard to estimate.

In addition to lower prices, legalization itself may have an impact on consumption, since people may be more inclined to buy and consume marijuana when doing so is legal and convenient. That possibility does not figure into the CFC analysis, because the researchers assume any such effect would be canceled out by the elimination of marijuana's "forbidden fruit" appeal. If they are wrong about that, consumption and tax revenue will be higher than they anticipate.

The CFC's numbers imply that roughly 18 percent of Colorado adults will be marijuana consumers after state-licensed pot shops open, compared to a nationwide average of around 14 percent (including the CFC's 20 percent adjustment for underreporting). If the increase in consumption proves to be that modest, it will undercut not only extravagant promises of new tax revenue but also hyperbolic warnings about the dire consequences of treating marijuana more like alcohol. Although opponents of the war on drugs often respond to such warnings by minimizing the extent to which the consumption of currently illegal drugs would rise if they were legal, increased consumption generally should be counted as a benefit. It means that people are getting more enjoyment for their money than they otherwise would, because prohibition either deterred them from using marijuana or kept them from consuming as much as they would have liked. At the same time, lower marijuana prices free up money to spend on other things people value.

An increase in consumption may also raise the costs associated with inappropriate or excessive marijuana use, but even a pure utilitarian has to weigh those costs against the benefits, which include avoiding the harm caused by prohibition. It is therefore telling that The Denver Post sums up the CFC study this way: "Legal marijuana in Colorado may not bring in enough money to cover the societal costs of legalization." In reality, the study makes no attempt to measure "the societal costs of legalization." Even if it did, putting "societal costs" on one side of the ledger and tax revenue on the other would exclude almost all the ways that people benefit when the government stops treating marijuana suppliers and consumers as criminals.

You can download the CFC report here. In case you wonder how fiddling with its underlying assumptions affects the tax revenue projections, the authors provide a handy interactive calculator here.