Step by Step, Pot-Legalizing States Free Their Marijuana Markets

Officials learn the hard way that high taxes and red tape just encourage black markets to continue

Even as they embarked on a deliberate experiment in legalizing marijuana for recreational use, the states taking the plunge unintentionally (we can only hope) initiated a second experiment. In dropping overt bans on the stuff while appeasing critics with reams of regulation, could they so bind the marijuana trade in red tape and taxes that they retained all the flaws of prohibition and gained few of the advantages of legalized status?

The answer was very quickly a big "yup." But officials may just be learning from the experience and fixing their early mistakes. A little.

Last summer I wrote that federal financial restrictions, as well as restrictive state rules and high taxes, had conspired to keep the marijuana black market alive and profitable in Alaska, Colorado, Oregon, Washington, and Washington, D.C., the four jurisdictions with nominally legal recreational marijuana. My conclusions weren't a stretch—I quoted local publications and pot vendors pointing out the advantages illegal dealers retained in terms of service and pricing. The rules hobbled legal businesses by hiking prices and preventing consumer-friendly offerings. Long-established illegal dealers were already in place to take advantage of that hobbling.

So officials ruefully revisited the issue and changed their ways, right? Well, some. They're in no apparent rush, but they are slowly loosening the screws.

Last month, Washington's Liquor and Cannabis Board reported that, one and a half years after recreational marijuana was legalized in the state, the "best estimate on the breakdown" of the marijuana market is: "$480M medical (37 percent of market), $460M state-licensed recreational stores (35 percent of market) and $390M illicit (28 percent of the market)."

That is, the rules have been so restrictive in the "legal" Washington market for marijuana that people remain willing to risk arrest and imprisonment while trading hundreds of millions of dollars of the stuff in ways that violate the law.

The market breakdown from the Liquor and Cannabis Board came at the end of the announcement of rescinded residency requirements on who can fund marijuana businesses, looser testing requirements for products, and looser restrictions on ingredients in products, among other changes. Those adjustments should make the industry more accessible to legal would-be participants and more able to respond to market pressure.

At the same time, state lawmakers and Seattle officials are pushing for legal home delivery of marijuana in an effort to counter consumer demand that's currently being satisfied by underground vendors.

Of course, City Attorney Pete Holmes couldn't admit the need for deregulation without throwing in some tough-guy posturing.

"I support our proposals to legalize and regulate marijuana delivery, but businesses that currently deliver marijuana undermine our efforts to demonstrate that there is a regulatory alternative to marijuana prohibition. All current delivery services are engaged in nothing less than the felony distribution of a controlled substance and must be closed."

Whatever, Pete. Just get out of the way.

In a similar spirit, Rep. Christopher Hurst (D-Enumclaw) proposes to lower the excise tax on marijuana sales from 37 to 25 percent in an effort to make legal weed more competitive price-wise with tax-free black market alternatives. "The criminals love the tax rate being high, because they don't pay it, and it makes it so the legal people can't compete with them," he noted, with unusual perspicacity for a lawmaker.

Unfortunately, Hurst's bill appears to have stalled in the House Finance Committee.

Oregon is having its own problems with marijuana taxes, through a process seemingly designed to confuse and discourage anybody delving into the legal market. The state just concluded a marijuana tax holiday with a temporary sales tax hike to 25 percent before the permanent 17 percent rate kicks in later this year.

According to The Oregonian: "Matt Price, who owns a chain of dispensaries called Cannabliss, said some customers have shrugged off the tax. 'And then,' he said, 'we have people that say they would rather go back to their 'guy,' so to speak, and walk out.'"

A huge tax hike drives people to illegal vendors? Who could have guessed?

Still, the permanent rate to come is set well below the extortionate take in Washington, and may well prove more consumer-friendly in the long run.

But Oregon has other restrictive rules in place. Edible cannabis products, which have proven very popular among medical marijuana patients, aren't yet available to recreational customers while the Liquor Control Commission, which has no authority over the medical market, puzzles over its preferred grab-bag of regulations.

Medical marijuana also remains untaxed, meaning that recreational buyers often see a wider range of cheaper products to which they have no access in the same establishments in which they're expected to make legal purchases. As a result, reports The Oregonian, "recreational shoppers at [one] store spend, on average, $38 to $45 per transaction, compared with $100 to $110 among medical marijuana patients."

Black market vendors, it should be noted, continue to sell a full line of untaxed goods. As in Washington, lowered taxes—already in the works—and loosened rules may allow Oregon's legal marijuana businesses to better compete in the future.

Colorado is experiencing "a wave of illicit marijuana cultivation in violation of federal law and operating outside Colorado's marijuana regulatory structure," according to the U.S. Attorney's Office for the District of Colorado. Strictly speaking, even if true that's not the state's fault, since it's spurred by the opportunity to satisfy demand in neighboring states suffering under federal prohibition and restrictive local laws of their own creation.

The state has arguably been a bit more proactive than Oregon and Washington in responding to people's desire for competitive prices and services. When the state's black market remained healthy after legalization, state officials reduced one of the taxes on the stuff from 10 percent to 8 percent (though this small measure of relief doesn't kick in until 2017).

The state also allows sales of edible marijuana products to recreational users. Munchies that give you the munchies have proven popular enough to gobble up close to half the market (attention Oregon regulators). Perhaps inevitably, that popularity led to new regulations—but it's also evidence of a huge trade that would have been left to illicit vendors if the state had been more restrictive.

Even so, Colorado Drug Investigators Association Vice President Jim Gerhardt approvingly tells people that marijuana is the "most highly regulated industry in the entire state."

Which, inevitably, leaves an opening for people to meet demand that can't be fulfilled within the law.

Alaska and Washington, D.C., are still hashing out what "legal" means in the context of marijuana—and the nation's capital needs federal permission to do pretty much anything beyond looking the other way. Whether the results succeed in replacing vast underground markets with legal businesses that can function in the open depends on the lessons they draw from the experiences of Colorado, Oregon, and Washington. That lawmakers and regulators in those state appear willing to adjust to reality, even a little, may be a positive sign for the future.

Should lawmakers in states with legal-ish marijuana markets be doing more to reduce taxes and restrictions? Of course. But the repeal of prohibition in those states was the first step in recognizing that black markets are the inevitable result of bans on popular goods and services. Incremental reductions in taxes and steps toward deregulation since then—however grudging--are further evidence that officials aren't completely immune to messages sent to them by the world in which they live. It's not just bans, they're learning, but unreasonable restrictions that have to be done away with if you want to eliminate underground markets.

If they keep it up, we might just embark on a new experiment to see what a legal and free market in marijuana looks like.