The 4 Things Many States Get Wrong When They Legalize Marijuana

Politicians and bureaucrats in legal states still struggle with the temptation to over-tax and over-regulate their legal marijuana markets.

Marijuana legalization has gone mainstream. In November, voters in four states approved recreational cannabis, and legislators in Virginia, New Mexico, and New York followed suit in early 2021, sending bills to all three governors' desks.

But the term legalization obscures vast differences in how states regulate marijuana businesses and consumption. Oklahoma arguably passed the most free market medical marijuana rules among the states. Michigan's recreational marijuana regulations largely embrace free and open markets, while Colorado's have steadily liberalized since legalization. Unfortunately, most other states are choosing highly restrictive market structures that undercut their ability to foster economic growth and quash the black market (we're looking at you, California!).

Wielding statutes such as possession limits, allowance for home growing, tax levels, licensing regimes, and testing and labeling requirements, states are targeting real political problems or imagined market ones. But such wrangling ensures that legal markets lose out to black markets. Even in polite Canada, only 28 percent of cannabis consumers buy legally, possibly beating out some U.S. states. Here are the four biggest mistakes states make, time after time, when creating legal marijuana markets.

1. Caps on Licenses

Most states where marijuana has been legalized arbitrarily cap how many businesses can be licensed to grow, manufacture, or sell. Advocates justify these caps to limit excess supply from bleeding into black markets, despite every recreational marijuana program's extensive state-monitored inventory tracking, which uses radio frequency identification on every plant or package and mandatory continuous video surveillance. If each product from every licensed facility is tracked, why cap licenses? 

A more pernicious motivation may lurk under the surface: excluding aspiring competitors. In Nevada, which permits only 120 dispensaries statewide, regulators accepted bribes from applicants, then manipulated the application process in those applicants' favor. In Illinois, which permits only 30 cultivators in a state with more than 11 million residents, license caps created systemic shortages, raising prices well beyond those found on the black market.

2. High Taxes

Studies show consumers react to even small price changes of legal marijuana, retaining readily available black market substitutes if those prices range too high. Following basic supply and demand, high tax rates end up fostering the black market, shrinking the very tax revenues that government bureaucrats seek. In California, where state and local taxes comprise 30 to 40 percent of legal market prices, illegal sellers were projected to rake in $8.7 billion in 2019 sales while legal sellers reported only $3 billion. No wonder California has fallen vastly short of its forecast revenues, leading legislative analysts to advocate reducing tax rates down to 15 percent.

3. Local Opt-Outs

Legislation that blocks access to legal marijuana within a reasonable distance of residential areas denies voters real access to what they voted to legalize. In California, four out of five local governments prohibit dispensaries within their jurisdictions, with some consumers living over 100 miles from one. Such NIMBY ("not in my backyard") attitudes ensure there will be rampant black market alternatives. More reasonable efforts, like New Mexico's, would allow local governments to set some restrictions on zoning and hours of operation, but don't outright prohibit sales.

4. Imagined Market Failures

Policy makers preemptively "solve" marijuana market failures without waiting to see if they occur. For example, many states weirdly don't allow food or drink sales at marijuana dispensaries or stores (because we've all seen the horrors that occur at Walgreens where they sell food and drink along with prescription meds).

Government bureaucrats and regulators also seem obsessed with THC levels in legal marijuana products. Florida lawmakers are in their third year of trying to impose a 10 mg THC cap per dose of legal medical marijuana flower, over the objections of doctors, with no scientific or medical basis for picking that nice round number. Oregon limits THC in edibles to no more than a total of 50 mg per package.

Legalization recognizes Americans' increasingly strong and widely shared opposition to marijuana prohibition. But, unwilling to get out of their own way, states that insist on over-taxing and over-regulating could foolishly reverse all gains.