Taxation and Market Power in the Legal Marijuana Industry

44 Pages Posted: 23 Sep 2018 Last revised: 2 Dec 2018

See all articles by Brett Hollenbeck

Brett Hollenbeck

University of California, Los Angeles (UCLA) - Anderson School of Management

Kosuke Uetake

Yale School of Management

Date Written: August 23, 2018

Abstract

In 2012 the state of Washington created a legal framework for production and retail sales of marijuana. Nine other U.S. states and Canada have followed. These states hope to generate tax revenue for their state budgets while limiting harms associated with marijuana sales and consumption. We use a unique administrative dataset containing all transactions in the history of the industry in Washington to evaluate the effectiveness of different tax and regulatory policies under consideration by policymakers and study the role of imperfect competition in determining these results. We use both a reduced form sufficient statistic approach and structural methods to show a number of results. First, Washington's strict cap on firm entry has resulted in retailers with substantial market power. This market power has immediate consequences for both state tax revenue and consumer welfare. Second, because these entry restrictions have caused retailers to behave like local monopolists, the state could substantially increase revenue generated from marijuana legalization by acting as the retailer itself, as it did for alcohol sales until 2012, without a large increase in prices. Third, despite have the nation's highest tax rate at 37%, marijuana in Washington is not overtaxed as many policymakers in other states have argued. The high taxes do not result in lower revenue or a substantial black market. Instead Washington is still on the upward sloping portion of the Laffer curve and the amount of revenue generated by a tax increase is significantly larger due to retailer market power than it would be under perfect competition. Our results suggest there is not widely available black market marijuana competing with legal retail sales. Finally, the high excise tax is primarily borne by consumers and not by firms, and there is a large social cost associated with each dollar raised.

Keywords: marijuana, pass-through, tax incidence, excise taxes, market structure, cannabis

JEL Classification: H22, H21, L13

Suggested Citation

Hollenbeck, Brett and Uetake, Kosuke, Taxation and Market Power in the Legal Marijuana Industry (August 23, 2018). Available at SSRN: https://ssrn.com/abstract=3237729 or http://dx.doi.org/10.2139/ssrn.3237729

Brett Hollenbeck

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Kosuke Uetake (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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