Legalizing and Taxing Commerce in Marijuana

On Thursday July 28th, I testified at the Indiana State House in front of a panel of legislators considering revisions to the marijuana laws. It was an interesting experience. The complete text of my presentation is below. I should add that I was addressing a group of very conservative gray-haired white men (the members of that legislative panel). So I tried to present arguments that they could understand and maybe even accept. Other arguments also have validity. For example the most libertarian among us would argue that it's not the government's role to tell people what they can and cannot do in their own homes as long as they are not hurting anyone else. Other people made that argument and I sympathize with it, but I did not mention it because I did not think that the panel would be receptive to it. Instead, I spoke from the paternalistic point of view of someone who wishes to discourage marijuana consumption. As a parent, I would like to encourage my children to always keep a clear head and I would try my best to discourage them from using marijuana or any other mind-altering drugs. But I would not want them to be sent to jail if they do not follow my advice. There are better ways, and that's the message I gave to the panel.

Legalizing and Taxing Commerce in Marijuana:
A More Efficient Policy Designed to Reduce Both Consumption and Crime

Whether we like it or not, there is a market for marijuana in Indiana. It’s been estimated that about half a million people in Indiana have used marijuana during the last year. I take it for granted that the State Assembly’s objective is to reduce the quantity of Marijuana consumed in Indiana. I happen to agree with this objective, except for people suffering from chronic pain, for whom marijuana could be an effective and less addictive natural alternative to synthetic opiates like oxycodone. Where economists can be of use, is in helping to sort out what kind of policies would best achieve this objective.

There are two ways to reduce consumption of any good: reduce supply, or reduce demand. The criminalization of marijuana acts on the supply side: seizures and the threat of prosecution drive up the cost of supplying marijuana. However, a supply restriction policy is doomed to failure because it is going against market forces. The following Supply and Demand diagram illustrates why:

An analogy would be someone in a boat rowing upstream against a very strong current. Exerting a lot of effort does not get him very far. In other words, all the money that is being spent on drug interdiction is hardly making a dent in consumption; and could not make more than a dent because the reality is that as long as there is a demand for marijuana, someone will supply it. For every drug dealer put in jail, another will step forward to replace him because high priced drugs mean high profit margins. The more we try to restrict supply, the more lucrative is the business of the remaining suppliers, and the more newcomers are attracted to this business. The “war on drugs” cannot be won this way.

Attempts to restrict supply also have undesirable side effects: since it drives up the price of drugs, many drug users resort to crime to finance their habit. Thefts, burglaries, prostitution, and gang violence are often indirectly drug related even though they do not appear in criminal statistics as drug offences.

An effective policy would try to reduce consumption through the demand side.

As you can see, demand reduction through treatment, prevention and education does not fight against the market. When demand is lower, the price of drugs goes down. You don’t need to imprison drug dealers because they couldn’t make enough money trying to sell drugs, so they would drop out. Since marijuana would be less expensive, property crimes to finance drug habits would also decrease.

But we can do even better to reduce consumption: combine efforts to reduce demand with legalization and taxation, by taking advantage of the fact that the demand for drugs tends to not be very responsive to price. I don’t know the current street price of marijuana in Indianapolis because I have never bought marijuana. If the price of marijuana fell by half, I still would not buy any, and I expect that very few among the 90% of Hoosiers who never use it would see a lower price as a long awaited opportunity to become users. That’s what economists mean by an inelastic demand, a demand that is not very sensitive to price.

As you can see, legalization would allow supply to increase since the State would no longer be spending law enforcement resources to restrict it. As a result the price of marijuana would fall. But because demand is not very sensitive to price, consumption would not increase by much. Now consumption could still increase a little, something that neither you nor I want. However, if commerce in marijuana is legal, it can also be taxed, just like tobacco or alcohol. The tax would push the price back up and ensure that consumption does not increase. If at least some of the revenue from taxation is devoted to demand reduction, even larger decreases in consumption would be possible.

Legalization plus taxation is a win-win-win-win policy. The State would gain three ways: (i) lower law enforcement costs; (ii) additional tax revenue; (iii) all this while managing consumption at the current or lower level. This is an opportunity that should not be passed up.

In closing, I want to add that this is not a left versus right issue. The number one champion of such a legalization plus taxation scheme was the late Milton Friedman, the Nobel Prize winning University of Chicago economist, and long-time conservative icon. This is about adopting policies that work, and there is a rare consensus among economists on both the left and the right that legalization plus taxation would be such a policy. I hope the Indiana State Assembly will have the far-sightedness to adopt and implement it.