The state of Washington, which has finally approved rules for its legal cannabis industry, expects to reap billions from legal cannabis sales. The amount of tax revenue is dependent on how much cannabis is sold - Washington state has capped the total amount to be produced and distributed - and the level of tax that's levied. The legal market has to be economically viable - that is, retailers (334 pot shops throughout the state have been approved) need to make enough to survive, and the prices need to be low enough to be competitive with the illegal market.
And there's the rub. The concern is that taxes, and greed, may make Washington's legal cannabis system unworkable. (Colorado has a much different and lower set of taxes and no limit on production, so for the purposes of this blog post we'll focus on Washington.)
Jacob Sullum, an editor at libertarian-leaning Reason, recently wrote at forbes.com: "The dilemma is especially clear in Washington, where I-502 specified a 25% excise tax at three levels: sales between producers and processors, between processors and retailers, and between retailers and consumers. That’s in addition to the standard state sales tax of 8.75%." According to calculations by BOTEC, Mark Kleiman’s consulting firm, which was hired to advise the State Liquor Board on how to proceed with creating the new industry, "These taxes will make the retail cost of cannabis 58% higher than it would otherwise be, accounting for 37 percent of the price paid by consumers. One BOTEC projection, based on a production cost of $2 per gram, indicates the after-tax retail price will be $17 per gram, or $482 per ounce. Another projection, based on a production cost of $3 per gram, puts the retail price at $25.50 per gram, or $723 per ounce. That’s a lot more than pot smokers in Washington currently pay. According priceofweed.com, which collects reports from marijuana consumers across the country, the average price for high-quality cannabis in Washington is $239 per ounce.“
It's madness. No one pays that much for marijuana, right? Well, kind of. It depends on where, and who, you are. Sure, these days there are medical patients in some states paying only $150-$300 per ounce of high-quality cannabis. On the other hand, friends back in the small Iowa town where I grew up currently pay that much for mediocre imported commercial-grade cannabis.
When I worked for NORML in Washington, DC, back in the late '80s, bad weed, almost always brown and moldy, used to cost $160-$200 per ounce. Real high-grade sinsemilla grown in the U.S. went for upwards of $400-$500 an ounce retail. I recall newspaper reports at the time that said in New York, some professionals were shelling out as much as $800 an ounce for top-shelf delivery service weed.
Here's the kicker: I know that the sinsemilla which friends were paying $400 an ounce for in 1990 only cost about $2,000-$2,400 per pound from the grower (that's $125-$150 per ounce). Pretty good profit margin; then again it was illegal so you expected a fairly hefty mark-up. That's the same mark-up I used to see at dispensaries in the Bay Area – pounds purchased from vendors for $2.000-$2,400 broken down into eighths and sold for $360-$400 per ounce.
Legal dispensaries have more overhead, such as employee salaries, health insurance, rent, utilities and business taxes. That hasn't stopped owners of some of these dispensaries with which I'm intimately familiar from taking six-figure salaries in addition to lavish expense accounts, first-class international travel and entertainment paid for by the company, and pot perks like access to as much free cannabis as they and their friends can consume. Even with all that, those dispensaries were still able to manage a profit margin of at least 35% after taxes.
That was California. Things are definitely different in the Pacific Northwest, where I live. In Oregon, currently operating medical cannabis dispensaries (illegal at the moment; the state is putting together a regulatory system to be in place by Mar. 1) charge anywhere from $160-$280 an ounce, similar to retail prices in Washington.
Kleiman, the academic drug policy expert who runs BOTEC, argues that "virtually anyone can get marijuana for recreational use through the current system. Critically, there is no tax, meaning that it will likely underprice the legal recreational market. If you are trying to maximize state tax revenue, that hits you right in the pocketbook. The state has an available solution, which is to close the medical system. Recreational users currently in the medical system would thus have to start paying tax to use their drug (entirely consistent with the initiative’s concept of regulating pot like alcohol). The small proportion of medical marijuana users with AIDS, cancer, terminal illnesses etc. could be issued a license that allowed them to purchase marijuana tax free within the legal recreational market.“
He also points out an obvious move which Washington's law allows: integration of the producer and processor. That is, the grower also processes the cannabis – basically manicuring and bagging – then directly sells to the retailer, cutting out the middleman. The state's 25% excise tax is levied at each stage, so by cutting out the middle stage, a hefty chunk of the tax burden is eliminated.
It comes down to the simple question: What premium will people pay in order to legally acquire their cannabis? In other words, what is the cost of risk? Washington is gambling that its citizens will pay – possibly not happily – very high prices in exchange for the reassurance of knowing that they're not going to get arrested.
Yet there's also a more basic question: Is the $2 per gram cost posited in the Washington analysis realistic? There is some evidence that production could be much cheaper. The RAND Corporation, whose analysts have also been working with Washington State, released a report in 2010 estimating the cost to produce legal cannabis at "$200-$400 per pound, plus another $20-$35 per pound for harvesting and processing. Such costs are roughly comparable to current prices per ounce, and are about a factor of 10 lower than the current pound price for sinsemilla in the U.S.“
The low-end price, which the BOTEC analysis used, of $2 per gram presumes a mark-up of 100%, which means that they assume a cost of production of about $1 per gram, or $454 per pound. That's a big difference.
It must be noted that the RAND analysis was based on cultivation in a 5' x 5' space. Outdoor production may be limited by climate to one crop per year, yet there's no electricity cost. Greenhouses do need some electricity to allow for year-round cropping, yet they also use sunlight part of the year, so costs are less than in an indoor operation. Larger production capacity indoor or out should allow for economies of scale. That RAND estimate could actually be too high, but in any case it's much less than the BOTEC/Washington State estimates. That means projections of consumer prices based on the BOTEC analysis are too high.
Who's right? We'll eventually find out. Only in a legal, regulated system can we have the transparency that will let us know how much is actually being produced and how much that level of production actually costs. Until then, it's nothing but guesswork. Ultimately, just as with the assumption that people would rationally choose cannabis over alcohol, if the former were also legal, the proof will be in the pudding. We can try to look at the experiences of The Netherlands and Portugal, yet they haven't actually legalized and regulated cannabis. This is new. We are heading into uncharted territory, and Washington and Colorado are leading the way.