The Mind Expanding Economics of Pot

Marijuana legalization my not undercut the illicit drug trade as hoped.

This is a blazing moment for American stoners. Colorado has just legalized the commercial production, sale, and recreational use of marijuana, while Washington State will begin its own pot liberalization initiative at the end of February. On Jan. 8, New York Governor Andrew Cuomo said his state would join 20 others and the District of Columbia in allowing the drug for medical purposes.

Libertarians and progressives are thrilled. Addiction specialists are anxious. And economists, well, they’re a little like undergrads lost in a bong-induced thought experiment: One moment the economics of pot seem beautifully elegant, then the real-world implications suddenly become bewilderingly complex.

In Colorado, where authorities have levied a 15 percent wholesale and 10 percent retail tax on marijuana transactions, the price of legal commercial-grade pot has doubled to $400 an ounce since the start of the year, says Aaron Smith, executive director of the National Cannabis Industry Association. That’s twice the price for medical marijuana at state dispensaries that require a doctor’s prescription. On the black market, high-grade offerings are fetching $156 to $250 an ounce, according to data compiled by Narcotic News.

“The black market is going to come back extremely strong.”

That prevailing $400-per-ounce price is no doubt inflated by limited inventory and pent-up consumer demand that may fade over time.

For policymakers, the challenge is getting the taxes right, says Kilmer at RAND. In Washington State, authorities will impose a 25 percent excise tax on every phase of the newly liberalized market: production, processing, and final sale. That’s on top of standard state sales tax of 8.75 percent.

There may be a positive net fiscal impact for states from legal marijuana. A 2010 study by the libertarian Cato Institute, co-authored by Harvard’s Miron, forecast that states could save $17.4 billion annually from reduced drug enforcement costs and increased tax revenue, assuming marijuana production and sales were legal nationwide.

Those gains could be eroded, however, if an expanded market started to displace alcohol sales, which are also taxed. A more worrisome scenario: What if more people consumed marijuana and alcohol together—and in greater amounts? The trend might contribute to more traffic accidents and other health costs.

The production, sale, and use of marijuana has been illegal at the federal level since 1937. The U.S. Department of Justice recently announced that it would not challenge state legalization laws. Who knows if the next administration will be so accommodating.

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