Tax Revenues When Substances Substitute: Marijuana, Alcohol, and Tobacco
51 Pages Posted: 25 Mar 2018 Last revised: 27 Apr 2018
Date Written: March 24, 2018
Proponents of the legalization of recreational marijuana have argued that the policy would result in increased tax revenues for states. However, if legal substances are highly substitutable, tax revenues from marijuana may crowd out pre-existing revenues. We study the change in substance tax revenues caused by legalizing marijuana in Washington state, accounting for potential substitutability and complementarity between marijuana, alcohol, and tobacco. We use a combination of detailed administrative data on retail marijuana and scanner data on alcohol and tobacco sales. By estimating a demand system for legal substances and controlling for prices, we find that substances are substitutes and the legalization of marijuana itself leads to a 12% decrease in alcohol demand and a 20% decrease in tobacco demand. 50% of state marijuana tax revenue is cannibalized by the reduction in alcohol and tobacco taxes. When those industries adjust their prices, only 18% of marijuana tax revenue comes from alcohol and tobacco. Though Washington has the highest marijuana tax rate in the country, a 1% increase in the marijuana tax results in a 1.22% increase in total revenues collected by the state.
Keywords: Marijuana, Recreational Substances, Substitution, Demand Estimation, Taxation, Industrial Organization
JEL Classification: H20, L65, L66, L00
Suggested Citation: Suggested Citation