The Other Green Economy: An Estimate of the Potential Tax Revenue Generated by a Legally Taxed and Regulated Marijuana

1. The Other Green Economy: An Estimate of the Potential Tax Revenue Generated by a Legally Taxed and Regulated Marijuana Market Copyright Max Chaiken, May 5, 2009 0

2. Acknowledgements There are a great number of people who I would like to thank for their assistance, both personal and academic, in conceiving, writing and editing this report. First and foremost, I am extremely grateful for the help and advice of Professor Brian Knight, without whom I may not have finished this undertaking. Additionally, I would like to thank a number of other influential professors of mine in the Economics Department�Rachel Friedberg, Kenneth Chay, Pedro Dal Bo, and Anna Aizer. To Debra, who helped me format this report so meticulously, I am indebted. To Jesse, who sent me links on nearly any topic pertaining to Medical Marijuana regulations, laws and advocacy, as well as helping me to copy edit, your support has been invaluable. And to all of my family and friends who have supported me in this endeavor, from Providence, Teaneck and all other avenues of life, to my fraternity brothers and my A Capella group, and especially to Chaz, Aaron, Toby, Lynn, and Steve�thank you. I could not have done this without you. Copyright Max Chaiken, May 5, 2009 1

3. Introduction Drug war very expensive�human costs, costs of enforcement, lost taxable revenue and income � variable of interest is federal tax revenue Calculating these figures is complex, but critically important for policy, especially in a time of cultural change Prohibition is premised on preventing use and thereby preventing costs of use and abuse�data show that it hasn�t worked Tens of millions of Americans report using marijuana annually, including youth, who consistently report marijuana as readily available and relatively inexpensive Copyright Max Chaiken, May 5, 2009 2

4. Caveat Perhaps the most legitimate criticism of my study is that this question itself is hypothetical The economic case for ending prohibition can be made without answering this question This particular moment in American history is like no other, however, and there may be opportunities in the next several years to seriously think about changing American drug policy at the federal and state level Copyright Max Chaiken, May 5, 2009 3

5. Other Estimates Two other major studies estimating precisely this question � funded largely by advocates for marijuana law reform: Miron, estimates roughly $14 billion/year in �savings� Gettman, estimates $31 billion/year in �lost taxes� My study seeks to improve this literature Miron more concerned with savings from enforcement than revenue Gettman does not attempt to account for changes in policy � only for current scope of market These estimates are very strong floors for the potential revenue generated but are too conservative Copyright Max Chaiken, May 5, 2009 4

6. Domestic Political Context Movement at the state-level, particularly recently, particularly with regard to medical Obama has indicated that he will leave medical regulations to states Copyright Max Chaiken, May 5, 2009 5

7. Policy Spectrum Copyright Max Chaiken, May 5, 2009 6

8. Market Equilibrium Effects We expect wide-ranging effects from any such change in policy Look at expected effects in a simple supply and demand model Understanding these effects shapes the estimation methodology Copyright Max Chaiken, May 5, 2009 7

9. Initial Shift in Supply Copyright Max Chaiken, May 5, 2009 8

10. Secondary Shift in Supply Copyright Max Chaiken, May 5, 2009 9

11. Shifts in Demand Copyright Max Chaiken, May 5, 2009 10

12. Role of Elasticity In addition to shifts in supply and demand we have to know something about the price elasticity to estimate revenue The amount by which the price changes with respect to a given tax is determined by the elasticity Copyright Max Chaiken, May 5, 2009 11

13. Price Elasticity of Demand For marijuana this has a lot to do with the literature on addiction and dependence, and the degree to which marijuana exhibits these characteristics Price elasticity of demand should be correlated with age of initiation, frequency and quantity of use, etc Copyright Max Chaiken, May 5, 2009 12

14. Fundamental Assumptions Demand does not shift � quantity consumed may increase � but assume no shift in demand Long-run quite possibly true; short-run might expect an outward shift Supply will be perfectly elastic in the long run Consumers pay entire tax burden Similar to other agricultural crops in that farmers/producers have no price-setting power, P=MC Use a constant elasticity of demand Data is not sophisticated enough to differentiate Copyright Max Chaiken, May 5, 2009 13

15. Estimation Strategy R = tL * QL tL is defined by policy makers � can be set to create �optimal� tax QL = f(PL, PC, eD, QC) Copyright Max Chaiken, May 5, 2009 14 Label variables slightly differently in report as I discuss this in greater detailLabel variables slightly differently in report as I discuss this in greater detail

16. Tax and Regulatory Structure Unit Tax versus Ad-valorem Tax With perfectly elastic supply, makes little difference except for how much revenue is generated and how to calculate R When you relax this assumption, unit tax is sounder because of the uncertainty with regard to how much price falls Estimate unit taxes of $2-$7/g; roughly equivalent to current tax and regulate bills in CA, MA Estimate ad-valorem taxes between 30% - 90% Copyright Max Chaiken, May 5, 2009 15

17. Compliance Policy-makers� goal, short-run, is to maximize compliance with the legal market regulations established � age restrictions, fees, etc. Fundamental issue of incentives for both consumers and suppliers Home growing confounds on demand side Supply-side we can envision, theoretically, model in which even if price increases producers comply (Becker-Grossman-Murphy model) Inevitably a question of price � comparison to cigarette tax compliance Copyright Max Chaiken, May 5, 2009 16

18. Price of Marijuana Three primary sources for Pc STRIDE, NSDUH, High Times Magazine quotations Combine these into overall price index, weighted by source, PC of $11.12 per gram Interested more in how price changes under legalization; how costs to producers change Several ways to think about this: Miron suggests price shouldn�t fall more than 50%, could fall less If price falls to �wholesale� level, could fall to roughly $3.00/gram Copyright Max Chaiken, May 5, 2009 17

19. Price Elasticity of Demand Very little literature on eD for marijuana, other drugs, Nisbet and Vakil (1972) estimate between -0.5 and -1.0, with �slightly greater than -1.0� being ideal Cigarettes offer a good comparison Complements Both (potentially) addictive, causing dependence Copyright Max Chaiken, May 5, 2009 18

20. Quantity of Marijuana Two general techniques for estimating this Supply-side techniques: seizures of processed marijuana (foreign imports) and plant eradication data (domestic production) Demand-side techniques: demand models based on NSDUH data I only utilize the supply-side method Take federal seizure statistics for a 10-year period and use a wide range for various parameters to estimate maximum, minimum and best-guess quantities available in the market Only utilizing supply-side estimates of quantity is one of very few assumptions that should bias revenue upwards Copyright Max Chaiken, May 5, 2009 19

21. Estimation Strategy, cont. QL = f(PL, PC, eD, QC) eD = (%?Q)/(%?P) eD = ((QL-QC)/QC) / ((PL-PC)/PC) Unit: PL = P0 + t Ad-valorem: PL = P0(1 + t) Copyright Max Chaiken, May 5, 2009 20

22. Copyright Max Chaiken, May 5, 2009 21

23. Scope Finding that there is a minimum of $72 billion, and perhaps greater than $200 billion in annual tax revenue from marijuana is astounding in the context of current U.S. federal budget situation Approximately the cost of Medicaid or 20 months in Iraq Not quite economic �stimulus� per se, but recognizing and attempting to bring the marijuana market into the mainstream economy could generate critical revenue Copyright Max Chaiken, May 5, 2009 22

24. Conclusions and Caveats A great number of issues are not covered in the scope of my research Labor market effects Health effects Effects on international trade and regional economies Effects on crime, criminal justice savings It is possible that future research in these areas will reveal serious costs to society from marijuana use But in the current policy environment all of the negative externalities of use are present in society while all of the economic activity associated with this vast market is effectively ignored This is only one part of a multi-faceted, complex policy debate Copyright Max Chaiken, May 5, 2009 23