Should Governments Legalize and Tax Marijuana?

Marijuana leaf on Canadian flag
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The war on drugs—no matter how you feel about it—is undoubtedly expensive. A great deal of resources go into catching those who buy and sell illegal drugs, prosecuting them in court, and housing them in jail. Critics of the war on drugs believe these costs are especially exorbitant when it comes to marijuana, a substance that is widely used and, according to numerous scientists, no more harmful than legal drugs such as tobacco and alcohol.

There's another cost to the war on drugs, too—the revenue lost by governments that cannot collect taxes on the sale of illegal drugs. In a 2010 study for the Fraser Institute, economist Stephen T. Easton attempted to calculate how much tax revenue the Canadian government could gain by legalizing marijuana. In 2018, for many of the reasons Easton outlined in his study, Canada passed the Cannabis Act, which legalized the adult use of recreational marijuana.

Revenue From Marijuana Sales

Easton's study estimated that the average price of 0.5 grams (a unit) of marijuana sold for $8.60 on the black market, while its cost of production was only $1.70. In a free market, a $6.90 profit for a unit of marijuana would not last for long. Entrepreneurs noticing the great profits to be made in the marijuana market would start their own grow operations, increasing the supply of marijuana, which would cause the street price of the drug to fall to a level much closer to the cost of production.

Of course, this doesn't happen because the product is illegal; the prospect of jail time deters many entrepreneurs and the occasional drug bust ensures that the supply stays relatively low. We can consider much of this $6.90 per unit of marijuana profit a risk-premium for participating in the underground economy. Before Canada legalized cannabis, this risk premium was making a lot of criminals, many of whom had ties to organized crime, very wealthy.

Marijuana Taxes

Easton argued that if marijuana were legalized, the excess profits produced by the risk-premium could be transferred to the government:

"If we substitute a tax on marijuana cigarettes equal to the difference between the local production cost and the street price people currently pay--that is, transfer the revenue from the current producers and marketers (many of whom work with organized crime) to the government, leaving all other marketing and transportation issues aside we would have revenue of (say) $7 per [unit]. If you could collect on every cigarette and ignore the transportation, marketing, and advertising costs, this comes to over $2 billion on Canadian sales and substantially more from an export tax, and you forego the costs of enforcement and deploy your policing assets elsewhere."

Supply and Demand

One interesting thing to note from such a scheme is that the street price of marijuana stays exactly the same, so the quantity demanded should remain the same as the price is unchanged. However, it's quite likely, in places where cannabis use is currently criminalized, that legalization would change the demand for marijuana.

We saw that there was a risk in illegally selling marijuana, but since drug laws often target both the buyer and the seller, there is also a risk (albeit smaller) to the consumer interested in buying marijuana. Legalization would eliminate this risk, causing the demand to rise. From a public policy standpoint, this is a mixed bag: Increased marijuana use can have ill effects on the health of the population, but the increased sales bring in more revenue for the government. By legalizing marijuana, governments can have some control over how much marijuana is consumed by increasing or decreasing taxes on the product. There is a limit to this, however, as setting taxes too high will cause marijuana growers to sell on the black market to avoid excessive taxation.

When considering legalizing marijuana, there are many economic, health, and social issues to analyze. Although one economic study should not be the basis for a country's public policy decisions, Easton's research does conclusively show that there are economic benefits to the legalization of marijuana. With governments scrambling to find new sources of revenue to pay for important social objectives such as health care and education, you can expect to see more leaders exploring the idea of legalization.