Recreational Marijuana Legalization Lights Up Economic Policy Considerations

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Once an untouchable issue, marijuana legalization has been gaining political momentum. Medical marijuana statutes passed the California, Oregon, Maine, and Nevada state legislatures in the 1990s. In 2012, Colorado and Washington became the first states to legalize recreational usage of marijuana, and this year, residents of four states—Alaska, Arizona, California, Oregon, and DC—may vote on marijuana legalization referendums.

American attitudes have clearly changed. For one, President Obama has been quoted as having said that marijuana is less dangerous than alcohol. In a 2014 New Yorker profile, the president said, “it’s important for [the legalization of marijuana in Colorado and Washington]to go forward for society.” National opinion echoes the president’s sentiment, with 55% of Americans agreeing that marijuana should be legalized, and 75% of Americans believing that the nationwide legalization of marijuana is inevitable, according to respective polls by CNN and USA Today.

Still, critics of recreational marijuana legalization remain. Relying on arguments of projected social harm, opponents of legalization point to marijuana as a gateway drug, whose legalization would turn the Americans into a slothful and slovenly people. On the other hand, proponents of legalization often cite that legal marijuana would be safer for consumers, reduce crime, and generate valuable tax revenue. Setting aside the ethical dimension of the issue, this article will provide an overview of the economic impacts of recreational marijuana legalization that policymakers must account for when crafting legislation.

General economic impact of increased legalization

Marijuana legalization would likely lead to a decrease in prices because the current risk premium being charged for supplying the illegal substance would vanish once legal sanctions are removed. Policymakers, however, must remember that the illegal market could resurface if government taxes are set too high, as marijuana demand is not completely elastic: Nisbet and Vakil estimate the elasticity of demand for marijuana to be in the range of -1 to -1.5, compared to tobacco, which is relatively less elastic, at -0.7.  Thus, total marijuana consumption is more responsive to price increases, which means government would be better poised to regulate the quantity of marijuana consumed to a socially optimal level, at which the revenues gained and harm inflicted from marijuana use would be balanced.

Recreational legalization of marijuana would increase the total number of users and impose costs on society. Despite a dearth of public health impact modeling, increased marijuana smoking would increase social health expenditures for lung-related ailments. In this case, government could impose a specific “harmfulness” tax that directly compensates society for the healthcare burden smokers impose.

On the other hand, greater legalization of marijuana may also result in decreased law enforcement expenses and decreased rates of violent crime due to the effects of marijuana, according to criminology scholars at the University of Texas at Dallas. The full economic impact of greater legalization of marijuana remains a mystery, but government tax revenues play a key role in the current debate about marijuana policy.

Economist Perspectives on the Potential for a Legal Market

Although economists have no way of precisely gauging the size of the marijuana market, some estimate total spending on marijuana to account for anywhere between $45 and $110 billion. These estimates assume a marijuana consumer market of 25 to 60 million, that the average cost of a cigarette is $5, and that each user consumes one cigarette per day. Some economists, like Stephen Easton of the Fraser Institute—which measures the impact of competitive markets and government interventions on society—argue that government would stand to benefit greatly from large-scale marijuana legalization.

Using figures from Canada, Easton estimates the production cost of marijuana is 33 cents per gram. Assuming the same cost of retailing and distributing marijuana as legal tobacco—ten cents per gram—then selling legal marijuana at a street value of ten dollars per gram would generate $40 to $100 billion in new government revenue, in the most optimistic case. Under such a scheme, government intervention would serve to reallocate money from criminal enterprises to public coffers.

Harvard professor Jeffrey Miron offers a more measured prediction of government tax revenues. Assuming an excise tax rate of 50%, federal, state and local governments would receive roughly $8.7 billion in revenue from the legalization of marijuana. Miron and coauthors point out that high tax rates are possible without driving a market underground, as evidenced by cigarette taxes in Europe that comprise 70% to 80% of the retail cost of cigarettes.

Coming from a different angle, Dale Gieringer, co-founder of the California Drug Policy Reform Coalition, concludes that government stands to gain greatly from more widespread marijuana legalization. Under a regime where marijuana use is legal, the price of marijuana would drop roughly to cost of its production—a mere six cents per joint. Given that one joint has roughly the intoxicating effect of 1 to 2 ounces of alcohol, many consumers would choose marijuana over alcohol, assuming a degree of substitutability between the two intoxicants.  In response, large-scale breweries and distilleries would undoubtedly lobby legislatures to protect their own market share, meaning the price per joint of marijuana would be held above production price. Government taxes here could serve to sustain the alcohol industry, while generating public revenue at the same time. Because the margin between production and consumer price of a joint is six cents to six dollars, government has serious room to maneuver in setting a tax rate that would yield substantial tax revenue, cover the social harm from marijuana use and still allow dispensaries to profit. Even if prices were to fall to half of their current value, the spread would still be significant enough to provide government revenue and private sector profit.

Harmfulness tax

Though marijuana arguably imposes less individual harm than other drugs, its use certainly burdens non-users in society. The primary harm from marijuana use comes from respiratory-related illnesses due to smoking. These additional healthcare costs are often borne by individuals and can also raise group insurance rates, affecting non-users as well. The National Organization for the Reform of Marijuana Laws calculates the cost of marijuana to be somewhere between 40 and 95 cents per joint, the sum of additional costs from health care and accidents from mental impairment. These costs could easily be factored into government tax policies, given immense spread between the cost of legal production and price consumers would pay.

An Example of Unforeseen consequences: Decrease in police budgets

Although proponents of legalization often cite reduced law enforcement costs near 8.7 billion, dropping legal sanctions against marijuana has reduced police budgets. States that have legalized marijuana can no longer seize the assets of marijuana growers. Historically, marijuana growers have proven lucrative for police budgets, because police can more easily shut down growing operations. “The advantage with marijuana is that it’s one location, and you can make a lot of money off of one grow,” according to an NPR interview with Matthew York, an attorney who works on drug forfeiture cases in Washington, a state that has legalized recreational use of marijuana.

In some municipalities, funds from marijuana property seizures accounted for 15% of police budgets, which went to pay for police overtime and equipment upgrades. For this reason, some police officers are vociferous opponents of marijuana legalization. Though legalization would yield significant tax revenues, the haul would be distributed to other government expenditures, such as infrastructure, education, and health, leaving few funds for police departments. That said, many argue marijuana legalization makes sense from a law enforcement standpoint because it would leave officers to focus on more serious crimes. Already, drug task forces in areas of the country have turned their attention to the heroin and cocaine trade, drugs that arguably pose a greater threat to society due to their more addictive nature.

Conclusion

Though marijuana legalization initiatives have gained significant traction in the past years, the debate is far from settled, especially considering recent research showing that marijuana use led to abnormalities in the brain structure of its users. The health effects from marijuana are not fully known, making it difficult to accurately gauge its costs to society. Nonetheless, numerous analyses have shown marijuana will yield a significantly positive fiscal impact on government balance sheets. The spread between cost of legal marijuana production and consumer price—propped up by fears of making the drug too accessible, as well as powerful tobacco and alcohol lobbies—means government has the opportunity to devise tax policies that can simultaneously generate significant revenue without driving the market underground.

Marijuana legalization has many economic impacts beyond tax revenue. Studies have proved that marijuana legalization correlates with decreased rates of violent crime, a result that should be included in the social calculus to determine the optimal tax rate. Moreover, recreational legalization will spawn a new industry of growers and dispensaries that can revitalize economically depressed areas. Spinoff industries, such as those that specialize in devising marijuana packaging, as well as labs to test the chemical properties of marijuana, ensuring consumers a pure and adequately potent product, can contribute to economic development.

Still, marijuana legalization has unforeseen consequences—such as decreasing public budgets—and will require societal adaptation. Many studies cite decreased enforcement costs as a benefit to marijuana legalization, but this would entail layoffs in the law enforcement sector. That said, streamlining law enforcement priorities would be societally beneficial, allowing officers to pursue higher-priority crimes. Proponents of marijuana legalization do not address how organized crime behind marijuana distribution and supply networks will disappear. Drug cartels obviously have vested interests in maintaining their current profit streams, and it remains to be seen how they will respond to widespread recreational legalization.

Devising an optimal tax policy for legalized marijuana is undoubtedly difficult. Policymakers have to consider the external costs of marijuana consumption, as well as a substitution effect that would occur between marijuana and substances like tobacco and alcohol. Though government must take care not to tax at a level that would support the black market, empirical evidence suggests an opportunity for the collection of significant tax revenues.

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Melody Wang

Melody Wang is an associate editor of Yale Economic Review. Contact her at melody.wang@yale.edu.

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