THE HIGH PRICE OF GETTING HIGH

Let me get to the point / Let's roll another joint / Turn the radio loud / I'm too alone to be proud. ~ Tom Petty 

State marijuana markets are becoming white as well as black. More states are passing laws or propositions that legalize recreational and/or medical marijuana; creating legal white, regulated markets. Currently, 29 states and the District of Columbia have laws broadly legalizing marijuana in some form.

Despite characterizations by advocates, there is no national market for marijuana because of strict federal rules and regulations from the Justice Department’s Drug Enforcement Administration (DEA). According to federal statute, no marijuana (not even a single preroll) can be legally transported across state lines. All markets for medical or recreational marijuana are thus legally confined to individual states. Each state has its own rules and regulations for cultivation, production, sale and use of marijuana.

The Department of Justice Secretary Jeffrey Beauregard Sessions has clearly expressed his distaste for marijuana of any sort. As Alabama Attorney General he strongly supported an Alabama law that would have established mandatory death sentences for a second drug trafficking conviction, including for dealing marijuana. It was never enacted. Other cannibas-related statements by Mr. Sessions include: “Good people don't smoke marijuana;” marijuana reform is a "very real danger;" and it is “not the kind of thing that ought to be legalized.” I’d say Mr. Sessions is the kettle calling the pot black.  

According to federal statute, marijuana remains classified as a Schedule I drug, along with heroin and peyote. Schedule I drugs are those that have “no accepted medical purpose and a high potential for abuse” according to the DEA. Classifying marijuana as a Schedule 1 drug is a farce. If Mr. Sessions believes marijuana’s Schedule I designation is correct, then alcohol should be added to the list of Schedule I drugs, because its “high potential for abuse” is a matter of demonstrable knowledge (just ask one of the 2 million AA members). Oops, then he’d be battling the alcoholic beverage industry  that had sales totaling $223.2 billion in 2016. Not gonna happen. Like all too many of the president’s cabinet who play follow the leader, Mr. Sessions espouses his faith in inconsistent, misbegotten policies. States’ rights are fine and dandy when they “enhance” religious freedom or school choice, but nasty when they relax outmoded federal policy.

I believe marijuana/cannibas legalization for recreational and medical use is worthy and worthwhile. There are several useful objectives that can be met with legalization. The potential benefits from shelving prohibition and establishing publicly-regulated (white) marijuana markets – that The Economist terms “reeferegulation” – include: protecting consumers, promoting improved health, reducing penal sentencing of non-violent (mostly black) youth, saving the police money, raising tax revenues and putting criminal black markets out of business, as well as extending personal liberty. Beyond direct marijuana sales are benefits involving increased property values and more jobs (both in government and in marijuana production and distribution). Hey Mr. President, perhaps you should provide training and travel vouchers for former coal miners from WV and WY to head for states that have already legalized weed, where jobs are budding.

I highlight in this blog how stakeholders in legalized marijuana markets – producers/distributors, consumers and particularly state regulators – have affected its white market price.

Marijuana’s market price is a crucial factor and serves as a foundation for several available policy choices to achieve the above-cited benefits, especially dousing criminal black-markets and raising tax revenue. Despite the lengthy and expensive War on Drugs conducted by the DEA, the black-market supply of marijuana has never been acutely compromised. Curiously, pro-legalization advocates now echo the same benefits – lower criminal activity and increased tax revenue – that champions of Prohibition repeal proclaimed over 80 years ago with passage of the 21st  Amendment.

As mentioned above, legalized marijuana markets continue to expand across the US and beyond. This coming January, California expects to begin establishing the nation’s largest recreational marijuana market alongside those already operating in Colorado, Washington State, Oregon, Alaska and Nevada. In these states the legalized market for marijuana operates proximate to the traditional, illegal black market.

One of the important, repeatedly-mentioned goals of legalization is to eliminate black market marijuana supplied by criminal enterprises, a crucial goal that states need to achieve if they want to avoid federal intervention under the 2013 Cole Memo. It is a basic policy challenge for the regulated white market price to reflect this goal.

Public agency intervention with taxing and regulating white-market marijuana is a balancing act. This involves both interceding with the demand of legalized marijuana and its supply. Public authorities in each of the eight states now dealing with white market marijuana have confronted this challenge differently. If the tax rate is set too high, thus escalating the retail price, demand for white-market marijuana may be stunted. If growers and distributors believe that authorities have imposed too many or too stringent licensing and related regulations and not permitted sufficient numbers of retail dispensaries, then the supply of legalized marijuana may be inadequate. In either case, post-legalization customers can return (or remain) where they were before, in the underground black market. Also, if the price of the newly-legalized marijuana is much higher than the black market “street weed,” marijuana consumers may stay with their traditional sources rather than switch to the white market. If this happens, optimistically-forecast marijuana tax revenues won’t be collected, as happened in Washington State.

The growth of legalized medical and recreational marijuana sales has been impressive. In 1996, California became the first state to legalize medical marijuana when voters approved Proposition 215. Five years ago recreational marijuana wasn't legal anywhere in the US. Yet in 2016, sales of legal weed grew to $6.6 billion (B), according to New Frontier Data that includes $4.7B for sales of medicinal marijuana (in 29 states and Washington DC) and $1.9B for recreational weed (in Colorado, Washington, Oregon and Alaska).

The table below presents several facets of the 8 state recreational marijuana markets where it’s been legalized so far. The table lists states in chronological order of legalization. Cannibas shops that sell legal recreational marijuana and “edibles” have been open for business in Colorado and Washington since 2014, in Oregon since 2015, in Alaska since Oct. 2016 and in Nevada since July. The industry as a whole is projected to exceed $24B in sales by 2025, an annual growth rate of 16%. Despite its widening legality, if you show up for work and flunk a drug test due to marijuana use in these states, you still can be fired.

The State of State Recreational Marijuana Markets

State	When Legalized	First Month Sales ($M)	Aver. Mkt. Price* ($/oz.)	Sales Tax Rate
Colorado	2014	$15	$242	22%
Washington	2014	$3.8	$324	37%
Washington DC	2014	NY	$600	0%**
Oregon	2015	$15	$210	17%
Alaska	2016	$0.75	$298	$50/oz.
Nevada	2016	$27.1	$270	15%
California	2016	NY	$250	15%
Massachusetts	2016	NY	$340	3.75%
Maine	2016	NY	$297	10%

Sources: Priceofweed.com, The Cannabist, Tax Foundation. NY: Not Yet.

*Price of “high-quality” marijuana. **Federal law prohibits DC from taxing weed.

From the table, first-month sales of marijuana and related products have varied quite a bit for the 5 states where legal retailing has occurred. Nevada’s first-month revenues are the largest so far, by a wide margin. Because only Nevada-grown marijuana can be legally sold there, many dispensaries soon closed their doors after opening them. They had no product to sell because demand had far outstripped supply. After July, legal supply has become more available for the increased number of dispensaries.

The last column shows each state’s tax rate on marijuana as of January 2017. These rates can include either retail sales or excise taxes on marijuana, but don’t include wholesale taxes, optional local taxes or standard sales tax.

Washington DC’s rate, 0%, an obvious outlier, was set by Congress. After DC voters approved legalization in a 2014 an initiative, conservative members of Congress, who at times seem to work in DC, were upset, especially Rep. Andy Harris (R-MD). Medical marijuana has been available in DC for almost two decades. Rep. Harris did not want legal recreational marijuana on the streets around or beyond his Longworth Building office. Luckily for him, the House of Representative holds complete fiscal power over DC’s budget. Republicans have passed annual spending bills since 2015 that contain a rider written by Rep. Harris that prohibits the DC Council from using any appropriated funds for taxing or regulating marijuana. If you come to or live in Washington DC, anyone over 21 can legally possess up to 2 oz. of marijuana, but you cannot legally buy or sell it anywhere in the District. So it goes.

Beyond DC, state sales taxes vary considerably. Washington State’s marijuana tax remains the highest (37%), even though it was reduced in 2016. Massachusetts’ 3.75% is the lowest. States’ marijuana tax rates have tended to diminish after the first two states – Colorado and Washington – allowed legal sales.

Looking at Colorado and Washington illustrates the trade-offs and consequences arising from “more lenient” versus ”stricter” regulation. Colorado initially set its marijuana taxes fairly low, at 28%. It also took a somewhat lenient approach to licensing sellers, meaning there were many of them. In 2016 there were 698 storefronts in Colorado that sold medical or retail marijuana, more than triple the number of Starbucks in the state. Colorado has more than 2.5 times the marijuana dispensaries than Washington State initially had, after accounting for the population of each state.

First-month total revenue in Colorado was $15M, four times higher than Washington State’s. Perhaps not surprisingly, Colorado is now the most popular spring vacation destination for US college students; the Colorado Cannibas Chamber of Commerce (yes!) has done its job. Beyond spring, almost one-quarter of Colorado’s 77M yearly visitors, and one-third of those between 25-34 years, said that availability of recreational marijuana was a reason they chose to visit the state.

In 2015 Washington initially set its taxes much higher, at an effective rate of 44%, and was much stricter with licenses for growers and retailers. Only 334 retail shops across the state were approved by the State Liquor and Cannibas Board. First-month sales were $3.8M. The Board hastily increased the total licensed retailers to 556 after it became obvious that there were too few outlets (and tax revenue). Given supply and demand and all that, Washington State’s legal marijuana prices were 67% higher than Colorado’s in 2014. Washington’s Board has since reduced the effective tax rate but it’s still the highest of any state. The legal white market marijuana price in the state is often higher than the black market price.

As a consequence, Washington’s legal sales accounted for only about 30% of the state’s total estimated cannibas market (both the white and black markets), whereas Colorado’s legal sales met about 70% of total estimated demand in Colorado. Hence, a strong majority of Washington marijuana users continued to buy from existing black market sellers after legalization. This outcome was not only due to Washington State’s early higher prices but because there were fewer licensed sellers, especially when compared to Colorado. Price differences remain; Colorado’s current average market price is $82/oz. less expensive than Washington’s.

Lower marijuana tax rates may reduce overall tax revenues, but essentially can increase the market share of legal marijuana relative to the total demand, and make life harder for black market suppliers.

The crowd-sourced average market price for “high-quality” marijuana, posted by priceofweed.com, also varies considerably. The table shows that Oregon has the lowest market price, $210/oz. Washington DC’s price of $600/oz. stands out as the highest, but remember DC as yet has no legalized recreational marijuana sales due to Congress’ restrictions. It’s a fair assumption that in DC the quantity of marijuana demanded strongly exceeds the quantity supplied, hence high market prices.

In general, market prices in eastern states exceed those in western states. The average market price in northeastern states – DC, DE, MA, ME, NY, PA and VT – is $376/oz. The average price in western states – AK, AZ, CA, CO, NV, OR and WA – is $270/oz. A fair amount of premium-priced California marijuana ends up on the East Coast as well as points in between.

The chart below shows how US wholesale prices have dropped between April 2015 and June 2017, as state-legalized marijuana sales have dramatically expanded. 

Source: Cannabis Benchmarks. Wholesale price in dollars per pound.

The marijuana harvest usually occurs each fall, as shown with price decreases on the chart for the latter part 2015 and 2016. The expanding legal markets in Oregon, Colorado and Nevada contributed to the dramatic reduction in the 2016 fourth quarter price according to Cannabis Benchmarks. Wholesale cannabis prices dropped 18.6% in the first half of 2017.

The “biggest Kahuna” California market for legalized recreational marijuana is to begin in less than three months. But all is not going smoothly in the Golden State. Taxing white market marijuana is not likely an issue – the prospective marijuana tax rate for consumers is 15%. One concern centers on the long-time existence of a sizable black market whose suppliers have been loath to adopt new supply-side regulations. Another problem is that localities have important responsibilities for establishing rules and licensing retail dispensaries, but local and county governments are behind schedule in these essential duties.

Voter approval of Proposition 64 legalized recreational marijuana last November. It also decriminalized the possession of certain amounts of marijuana (it’s now a misdemeanor, not a felony), allowed individuals to grow six plants at home, set rules for the sale and cultivation of regulated plants, and sought to better manage the largely unregulated medical cannabis system. Unlike other states that embarked on creating a white market for marijuana, California has had a well-known, substantial black market that produces high-grade weed. California’s newly-enfranchised marijuana regulators face a unique conundrum that can be summed up in two words: Emerald Triangle.

Growers in Northern California’s Emerald Triangle region have produced large amounts of mostly outdoor, superior marijuana for decades. It’s the largest cannibas-producing area in the US. According to Arcview, its market value is about $7B. Many connoisseurs believe it’s the best in the world and are quite willing to pay high prices. California produces seven times more marijuana than it consumes, according to one estimate. Because the potential rewards are so significant, the Emerald Triangle along with the rest of California is almost certain to remain a major (illegal) exporter to other states even after the white market becomes established. However, the huge wildfires in Northern California aren't just destroying homes and vineyards; cannibas cropland is also going up in flames. For cultivators whose crop hasn't been directly destroyed, the fires' heavy smoke will reduce the value of their crop.  

So far only about 3,500 marijuana growers in the Emerald Triangle have applied for permits to farm within the white market. This number sounds like a lot of cultivators and would be in virtually any other region. But it represents just 11% of all growers in the Emerald Triangle. Many cultivators/growers have been dissuaded by what they consider significant effort needed to obtain a permit, as well as the fees, taxes and enduring regulatory requirements. If they stay beyond the new, white market system, these growers probably face lighter punishments and avoid paying taxes, fees and the costs of meeting environmental standards. The way one local grower put it, “Why do I have to get permits? My parents didn’t have to and my grandparents certainly didn’t have to.” Confirming this reluctance, Bruce Smith, a lieutenant with the Mendocino County Sheriff’s Office who leads the county’s efforts to shut down illegal marijuana farms stated, “The vast majority aren’t permitted.”

If these trifling levels of white-market participation continue through January, California may face the ironic circumstance of producing an insufficient amount of legal marijuana, despite being the nation’s largest domestic producer. That situation won’t reflect much balance between demand and supply; legal prices will likely spike and make the task of slaying the black market marijuana dragon difficult.

Can California sufficiently merge its large, existing black market with its nascent white market? It’s the key question that will influence the success of California’s initial foray into legal recreational marijuana. This issue hopefully can be resolved through discussions with growers, regulators, sellers and consumers before the New Year. Paraphrasing the late, great Tom Petty, I doubt if these discussion participants will be too alone, but they may be too proud. 
A Coda on Greedy Weed Bureaucrats.

New information became available on Halloween about the expected total taxes to be charged on California's legalized, recreational marijuana. One knowledgeable policy analyst said that high marijuana tax rates "will prevent the minimization of the black market,” a clear policy goal of marijuana legalization. Minimizing California's sizeable black market for marijuana is not likely.

The expected price of California’s recreational marijuana sold legally after January 1st keeps growing. Why? In large part because marijuana is California’s single biggest cash crop. Cannibas’ production value is roughly 50% greater than that of grapes, the state’s second most lucrative crop. Thus, local authorities see legalization as a big new revenue-enhancement opportunity. They are proposing multiple large taxes on marijuana consumers, distributors and growers. Revenue-hungry municipal and state agencies will, in effect, feed the black market by increasing the tax-inclusive price of legal, recreational marijuana. The price of getting high in the Golden State is getting higher.

The fundamental economic relationship that tax authorities may have forgotten is this: high prices of legal marijuana will reduce its sales and will allow California’s existing, large black market weed to prosper. This is in spite of the relatively price inelastic nature of the demand for cannibas.

A new study issued by Fitch Ratings and reported by CNN on Halloween notes the breadth and height of these expected taxes on California recreational marijuana. They are shown in the table below.

California’s Proposed Taxes and Costs for Recreational Marijuana

Tax Type	Tax Rate or Level
Consumer sales tax	22.25% to 24.25% (includes 15% state excise tax)
Local business/distributor tax	1% to 20% of gross receipts or $1 to $50 per square foot of plants
Grower’s tax	$9.25/oz. flowers and $2.75/oz. leaves
Grower’s cost for registration and environmental compliance	$100,000 (est.)

Source: Fitch Ratings and CNN

These proposed consumer and distributor tax rates may total 45%. Notice also the hefty potential costs of growers registering and complying with the state’s environmental regulations. Such substantial “entrance fees” for the thousands of California’s illegal growers will act as a large disincentive for them to enter the legal market.

These sizable tax rates have a familiar ring to them. My experience with public authorities in several states’ municipalities is few have any systematic sense about how consumers or businesses may respond to their tax increases. They seem to believe that if for example they increase a tax by 10%, then tax revenues will also increase by 10%. This is a naïve expectation, especially when there is a substitute good not subject to the tax, Emerald Triangle cannibas.

The authorities appear to believe businesses and consumers have virtually no sensitivity to high taxes; they will supply and buy the same amount of marijuana regardless of the taxes’ rate. This is a mistaken belief.

The tax-induced high prices of legal recreational marijuana in California will be good news for growers of black market weed. There will certainly be new buyers of marijuana after the New Year who will pay the high legal price because it’s legal and a less risky transaction. However, it’s also likely that other consumers (including many existing buyers of Emerald Triangle marijuana) or price-sensitive shoppers will buy from black-market suppliers and doubtlessly enjoy lower prices, just like happened in Washington State.

California’s marijuana policy-makers should learn about and/or remember Washington State’s, Oregon’s and Colorado’s early legalization experiences that forced these states to lower their initial,-uncompetitive, high tax rates. Given their fiscal greediness, I’m not sanguine that California’s marijuana tax authorities will remember basic economics or other states’ experiences. Time will tell as January 1st approaches.