The Effect of Cannabis Legalization on Substance Demand and Optimal Taxes
51 Pages Posted: 25 Mar 2018 Last revised: 14 Oct 2019
Date Written: March 24, 2018
Cannabis advocates argue legalization will increase tax revenues. However, if legal substances are substitutes, cannabis revenues may crowd out other taxes. We document substitution between legal cannabis products and alcohol and tobacco products using detailed administrative and scanner data from Washington state. We estimate a flexible demand system for legal substances and find legalizing cannabis leads to a 9% decrease in alcohol and a 12% decrease in tobacco demand. We find the revenue-maximizing tax rates for cannabis products are above the current rates. Without considering substitution between substances the government would lose 33% of available revenue.
Keywords: Marijuana, Recreational Substances, Substitution, Demand Estimation, Taxation, Industrial Organization
JEL Classification: H20, L65, L66, L00
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