The Substitutability of Recreational Substances: Marijuana, Alcohol, and Tobacco
45 Pages Posted: 25 Mar 2018 Last revised: 10 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 interaction between the marijuana, alcohol, and tobacco industries in Washington state using a combination of detailed administrative data on the marijuana industry and scanner data on alcohol and tobacco sales. We estimate a demand system and find that alcohol and marijuana are substitutes, with the legalization of marijuana in isolation leading to a 12% decrease in alcohol demand, and a marginal cross price elasticity of demand of .16. Marijuana legalization results in a 20% decrease in tobacco demand, but the marginal relationship is unclear. When prices are held fixed, 50% of marijuana tax revenue comes from cannibalizing alcohol and tobacco taxes. When those industries adjust their prices, only 22% 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 1.01% 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