Will Legal Pot Cost More Than Black-Market Pot?

High marijuana taxes could derail legalization in Washington and Colorado.

When Congress banned marijuana in 1937, it did so in the guise of taxation, imposing a prohibitive levy on cannabis and created criminal penalties for those who failed to pay it. Marijuana taxes also played a prominent role in what may be the beginning of the end for pot prohibition: the legalization measures that voters in Colorado and Washington approved last fall.

Supporters of Washington's I-502 and Colorado's Amendment 64 emphasized the revenue that the government could reap by recognizing cannabis production and distribution as a legitimate business. The tricky part, as officials in both states will soon discover, is balancing the desire for tax revenue against the desire to eliminate the black market created by prohibition. Or as UCLA drug policy expert Mark Kleiman, an adviser to Washington's marijuana regulators, puts it: "What if we gave a pot legalization and nobody came?"

The dilemma is especially clear in Washington, where I-502 specified a 25 percent excise tax at three levels: sales between producers and processors, between processors and retailers, and between retailers and consumers. That's in addition to the standard state sales tax of 8.75 percent.

According to calculations by BOTEC, Kleiman's consulting firm, these taxes will make the retail cost of cannabis 58 percent higher than it would otherwise be, accounting for 37 percent of the price paid by consumers. One BOTEC projection, based on a production cost of $2 per gram, indicates the after-tax retail price will be $17 per gram, or $482 per ounce. Another projection, based on a production cost of $3 per gram, puts the retail price at $25.50 per gram, or $723 per ounce.

That's a lot more than pot smokers in Washington currently pay. According to the website Price of Weed, which collects reports from marijuana consumers across the country, the average price for high-quality cannabis in Washington is $239 per ounce.

Some of those purchases may be from medical marijuana dispensaries, which are not explicitly authorized by state law but operate as patient and provider cooperatives. Washington's medical marijuana rules are relatively permissive, allowing cultivation and possession by patients with a wide variety of conditions, as long as they have a doctor's recommendation. Dispensaries in Seattle currently charge $250 or so per ounce, and medical marijuana sales remain untaxed under I-502.

In short, BOTEC's projections indicate that the after-tax price for marijuana sold by state-licensed outlets will be something like two to three times as high as prices charged by black-market dealers or dispensaries. "That's a big problem," Kleiman says. "The legal market is going to have a hard time competing with the illegal market, but a particularly hard time competing with the untaxed, unregulated sort-of-legal market."

Colorado's constitution, unlike Washington's, requires separate voter approval for new taxes. The price of legal marijuana in Colorado therefore will depend on the fate of Proposition AA, an initiative on next month's ballot that would authorize not only the 15 percent excise tax mentioned in Amendment 64 but also a special sales tax of up to 15 percent. That's on top of the standard state and local sales taxes, which in Denver total 8 percent. Meanwhile, voters in Denver, where most pot stores will be located, will decide whether to approve an additional municipal marijuana tax of up to 15 percent.

Supporters of the marijuana taxes, including Amendment 64 co-author Brian Vicente and the Medical Marijuana Industry Group, argue that they are necessary to fund an effective regulatory system, which in turn will help discourage federal interference. Opponents, led by Rob Corry, a Denver attorney and longtime marijuana activist, argue that excessively high taxes will undermine regulation by preserving the black market. "Over-taxation creates a marijuana market ripe for takeover by the unregulated, untaxed, underground market," Corry says.

The Proposition AA campaign deems that prospect "unlikely," saying "the combined taxes on retail marijuana sales will add about 22 percent to the retail cost of marijuana products"—less than half the impact of Washington's taxes. That estimate does not include local taxes, which could make a big difference given Denver's important role in the marijuana industry.

Washington and Colorado legislators will have the power to adjust tax rates. But they may be tempted to keep taxes high in the hope of generating more revenue, even when reducing rates might actually boost revenue by allowing licensed sellers to attract more business. The backers of hefty marijuana taxes are putting a lot of trust in legislators' ability to anticipate unintended consequences and learn from experience—skills that do not come naturally to politicians.

Note: Kleiman recently has taken a more optimistic view of the legal marijuana industry's ability to compete with other sources in Washington.

This article originally appeared at Forbes.