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Presidential election years seem to be the Super bowl for ballot initiatives. The ballot questions typically presented in the midterm election aren’t exciting enough to stir any fervent enthusiasm. Then again, like with anything else, there are always exceptions!  Superficially, it appears as if activists and lobbyists save the real blockbuster ballot questions for Presidential election years. This perception could be entirely illusory. It looks like Arizona is going to attempt to legalize recreational Marijuana once again. The first go-around in 2016, under Proposition 205 failed by a slim margin. Leading some proponents of legalization to believe that the tides are changing in the Grand Canyon state.  The opinion polls are demonstrating the popular sentiment that the majority of Americans favor legalization. Now maybe the golden opportunity for Marijuana activists and consumers to direct their efforts towards advocating for Proposition 207, The Smart and Safe Act.

While Marijuana activists are hopeful that the bill will pass, lawmakers are more concerned with the consequences of the bill passing. Legalizing Cannabis presents the herculean task of establishing all the regulations governing recreational sales. Just looking at the number of regulations in states such as Massachusetts who already allow recreational sales, it becomes apparent that regulating Marijuana is far from a perfect science. Many of these rules imposed by state governments are nothing more than a compromise. The prospect of a complete laissez-faire Marijuana market is pure fantasy. Advocates of legalization need to provide something in the bill to appease those uncomfortable with the concept of a recreational Cannabis market. Many of these burdensome regulations aim to foster public safety and provide revenue to the state government. That being said one of the most notable concessions in this exchange is in the form of taxation. Whether it is pot, tobacco, alcohol, or even sugary sodas consumers gripe at the very thought of having to pay the premium due to the excise taxes imposed on their favorite vices.

Most consumers may find these taxes to be annoyances, they play a crucial role in the legalization of recreational marijuana. For those who are fearful of the externalities that society will bear due to the use of recreational  Cannabis. The taxes levied on marijuana sales can be earmarked and allocated to a state program for substance abuse treatment or increased funding for DUI patrols on the state highways. Operating as a form of vice-specific  Pigouvian taxation meant to offset any of the harms caused by legal Marijuana consumption. Tax revenue generated from recreational sales can also be utilized more flexibly. Not being relegated to compensating for the societal costs of Marijuana. The Smart and Safe Arizona Act plans to allocate fire departments, and the “highway user fund”. Demonstrating that tax money obtained through legal sales can be more broadly applied to regular state expenditures such as emergency services. marijuana tax revenue towards community colleges, police and

Does the question become in the states that have already legalized cannabis, have the excise taxes been effective in generating state revenue? The results have been somewhat mixed. On the whole, the economic benefit has been less than promising. For example, Colorado rakes in an estimated $250 million annually from Cannabis sales, however, that is less than 1% of the state’s total budget. It is hard to speculate whether this an indictment of the prospect of legalization or the excise taxes being too high. If the goal is to generate revenue it would be prudent to avoid making the taxes confiscatory. Otherwise, consumers will not purchase from the legal market when the transaction costs of patronizing the black market are low.  Effectively derailing one of the core objectives of the legalization movement, curtailing illicit sales. It is difficult to determine when taxes become too onerous in the eyes of the consumer. There are a lot of subjective factors that influence consumer sensitivity to price elasticity, which has been estimated to be between “-0.40 and -1.51%” in the illicit market. Having the largest impact on the purchasing behavior of moderate users more so than heavy and light users. However, parallels can be drawn between the taxation of marijuana and other legal vices such as tobacco and alcohol. New York has arguably had one of the highest tax rates for cigarettes in the country and simultaneously has a thriving illicit smuggling market. Resulting in “..30% to 45% of all cigarettes..” having been “… illegally smuggled across state borders”. Smuggling efforts to avoid excessive taxes are not limited to merely tobacco, but also alcohol. One sobering statistic (no pun intended) is that globally 20 % of all alcohol consumed is acquired through illegal sources.  The rate of direct taxation does not include the costs of regulatory compliance on the part of producers which is passed to the consumers in the retail price. Merely nothing more than another form of implied taxation.  This is a fact that regulators need to thoroughly contemplate when proposing a tax rate. Is the purpose of the tax to generate revenue or deter people from consuming the product?

Superficially, the tax has purposed for the Smart and Safe Arizona Act mirrors the present excise tax on alcohol and tobacco. The proposal is aiming for a 16 % excise tax, which has done little to hamper alcohol consumption in Arizona. Potentially the tax as purposed may help in assisting the state drawn in more revenue to fill its coffers. It is important to try to have realistic expectations of the impact of legalization on tax revenue. It can be stated with confidence that if the taxes are excessive, it will only benefit the black market. Regardless of what is being taxed if it is exorbitant people will find ways to circumvent the tax.  If we consider the inferences implied in the model of a Laffer Curve heavy taxation reduces tax revenue. Creating something of a paradox. When the tax burden is high, the productive output will decrease because the incentive to produce is greatly reduced. Hypothetically this could lead to not only diminished output but also reductions in investments.  

                                                    (Image from the Foundation For Economic Education)

Needless to say, if the transaction cost of avoiding a tax is low, determining the tax rate is a precarious balancing act. It could be safe to say that there are proponents of taxing marijuana at a high rate, but for various reasons. Once again, we encounter a Bootleggers and Baptists coalition. In this scenario, the Baptists are the individual who naively believes that a higher tax rate will automatically equal more money for government services. In a static model or a perfect world, this may be the case. Such an assumption ignores human nature, which has the proclivity to exploit any possible loopholes. Those in the coalition possessing the naivete of a moral do-gooder exhibited the laudable goal of wanting to collect money to improve infrastructure and services.  The Bootleggers are the individuals supporting a high tax rate and fully understanding it will prevent people from buying legal Marijuana. There are two subgroups among the Bootleggers. There are two-dimensional and obvious beneficiaries who sell or distribute marijuana on the black market. Their incentives model is transparent and due to the illegality of their businesses, they operate as silent beneficiaries. I highly doubt even the Mexican Drug cartels could get away with forming a lobbying organization in the United States. Despite their political clout and economic power just south of the border.

The second subject of Bootleggers is not quite so obvious. They are individuals who oppose recreational marijuana use. They are fully hopeful that high taxes will serve a confiscatory function. Due to popular sentiment growing increasingly in favor of legalization, the fight to keep pot illegal is becoming significantly more difficult. The next best thing you can do is influence consumer behavior by making it prohibitively more expensive to purchase the intoxicant. This perspective could be a naïve one if the individual actor does not account for the black market. Those in favor may also want marijuana sellers and users to experience the legal consequence of doing business on the black market. Even if the fallout is less severe than it was during prohibition. The self-serving motive behind this logic stems from the prejudice the members of the subgroup hold against Marijuana consumption. Whether justified or unreasonable this would be the impetus. It could be feasible that such actors are dual-role agents.  Not only do they personally dislike Marijuana, but they also truly believe it is a dangerous plant and the public needs to be shielded from the adverse consequences of its consumption.

7 thoughts on “Bootleggers and Baptists X: Marijuana and Taxes

  1. Excellent Post! I especailly like how the focus is on the difficult task of figuring out what the optimal level of a tax should be. (Does it depend on the “elasticity of demand” for legal marijuana?) Also, if I recall my reading of Cheryl Misak’s new biography of the great Frank Ramsey, Ramsey may have written a paper on finding the optimal level of taxes.

    Liked by 1 person

    1. Thank you. I will have to check out Ramsey’s paper at some point.

      My first inclination is to react with opposition to taxes. I did exercise quite a bit of restraint in this essay. It is unrealistic to believe that any vice will go untaxed. That being said, I would rather figure out how to make it work than outright dismiss it if it is an inevitability.

      The complexity of finding that golden mean is way above my pay-grade.

      Liked by 1 person

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