Potential tax revenue from a regulated marijuana market: a meaningful revenue source

American Journal of Economics and Sociology, The,  Oct, 1994  by Michael R. Caputo,  Brian J. Ostrom

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The price of marijuana to the consumer under regulation is almost certain to drop from its current black market level. The Law of Demand asserts that the quantity demanded will therefore increase. But what are the relative changes? The price elasticity of demand must be estimated to determine the effect that changing prices might have on government tax revenue.

D. Elasticity and Other Determinants of Tax Revenue

An attempt (possibly the only one) to estimate the price elasticity of demand for marijuana was made in 1972 by Nisbet and Vakil. Their estimates of price elasticity ranged from -0.40 to -1.51, which suggests that total revenue may rise, fall, or remain constant in response to deviations from current black market prices. Again, considerable uncertainty exists.

Nisbet and Vakil suggested that their methodology gives downward biased estimates, and concluded that it is quite likely that a price elasticity slightly greater than one would be a reasonable estimate. Since the price of marijuana will most likely fall after regulation, as noted above, the conservative nature of the analysis is maintained by assuming a price elasticity of -1.0, so that a fall in the retail price of marijuana will leave total potential tax revenue unchanged.

Becker and Murphy (1988) and Becker et al. (1991) discussed the effects of temporary and permanent changes in the price of addictive goods on the quantities demanded of such goods. Becker et al. (1991) argued that the long-run price elasticity for drugs is around -.7 to -.8, and the short-run price elasticity is around -.3 to -.4. The argument, however, is based upon the econometric work of others on the demand for cigarettes, heavy alcohol consumption, and gambling, not on the demand for marijuana. Even so, some credence must be given to these elasticity estimates since the range of values occurs with some regularity. For example, Miron and Zwiebel (1991) looked at alcohol consumption during Prohibition and suggested that the price elasticity of demand was around -.1, while Chaloupka (1991) estimated that the long-run price elasticity of demand for cigarettes by current smokers ranged from -.46 to -.35. If, in fact, the demand for marijuana is price inelastic, then the fall in the price of marijuana that may occur after regulation will lead to a fall in tax revenue.(5) Thus the unitary elasticity assumption may overstate potential tax revenue from a regulated marijuana market. Therefore the tax revenue estimates below are adjusted to account for the uncertainty over the price elasticity of demand for marijuana.

At least three other factors are likely to reduce the government's eventual tax revenue and reflect individuals' different reactions to taxation: Home cultivation of marijuana outside the regulated industry, continuing purchases made from the current, well-established, black market, and interstate smuggling.

Regarding home cultivation, the closest parallel to be drawn is with the repeal of prohibition. While it was undoubtedly cheaper to produce home-brewed liquor, it seems that an insignificant proportion of total alcohol consumption was produced in this manner. The cultivation of marijuana is quite simple and inexpensive, and considering the substantial mark-up involved, it is likely that a larger proportion of marijuana will be grown at home than the proportion of alcohol produced in homes in the 1930s.