420 Magazine Background

The Budgetary Implications of Marijuana Prohibition

Smokin Moose

Fallen Cannabis Warrior
The Marijuana Policy Project provided funding for the research discussed in this report. Daniel Egan provided excellent research assistance.
Executive Summary

* Government prohibition of marijuana is the subject of ongoing debate.

* One issue in this debate is the effect of marijuana prohibition on government budgets. Prohibition entails direct enforcement costs and prevents taxation of marijuana production and sale.

* This report examines the budgetary implications of legalizing marijuana — taxing and regulating it like other goods — in all fifty states and at the federal level.

* The report estimates that legalizing marijuana would save $7.7 billion per year in government expenditure on enforcement of prohibition. $5.3 billion of this savings would accrue to state and local governments, while $2.4 billion would accrue to the federal government.

* The report also estimates that marijuana legalization would yield tax revenue of $2.4 billion annually if marijuana were taxed like all other goods and $6.2 billion annually if marijuana were taxed at rates comparable to those on alcohol and tobacco.

* Whether marijuana legalization is a desirable policy depends on many factors other than the budgetary impacts discussed here. But these impacts should be included in a rational debate about marijuana policy.

I. Introduction

Government prohibition of marijuana is the subject of ongoing debate. Advocates believe prohibition reduces marijuana trafficking and use, thereby discouraging crime, improving productivity and increasing health. Critics believe prohibition has only modest effects on trafficking and use while causing many problems typically attributed to marijuana itself.

One issue in this debate is the effect of marijuana prohibition on government budgets. Prohibition entails direct enforcement costs, and prohibition prevents taxation of marijuana production and sale. If marijuana were legal, enforcement costs would be negligible and governments could levy taxes on the production and sale of marijuana. Thus, government expenditure would decline and tax revenue would increase.

This report estimates the savings in government expenditure and the gains in tax revenue that would result from replacing marijuana prohibition with a regime in which marijuana is legal but taxed and regulated like other goods. The report is not an overall evaluation of marijuana prohibition; the magnitude of any budgetary impact does not by itself determine the wisdom of prohibition. But the costs required to enforce prohibition, and the transfers that occur because income in a prohibited sector is not taxed, are relevant to rational discussion of this policy.

The policy change considered in this report, marijuana legalization, is more substantial than marijuana decriminalization, which means repealing criminal penalties against possession but retaining them against trafficking. The budgetary implications of legalization exceed those of decriminalization for three reasons.[1] First, legalization eliminates arrests for trafficking in addition to eliminating arrests for possession. Second, legalization saves prosecutorial, judicial, and incarceration expenses; these savings are minimal in the case of decriminalization. Third, legalization allows taxation of marijuana production and sale.

This report concludes that marijuana legalization would reduce government expenditure by $7.7 billion annually. Marijuana legalization would also generate tax revenue of $2.4 billion annually if marijuana were taxed like all other goods and $6.2 billion annually if marijuana were taxed at rates comparable to those on alcohol and tobacco. These budgetary impacts rely on a range of assumptions, but these probably bias the estimated expenditure reductions and tax revenues downward.

The remainder of the report proceeds as follows. Section II estimates state and local expenditure on marijuana prohibition. Section III estimates federal expenditure on marijuana prohibition. Section IV estimates the tax revenue that would accrue from legalized marijuana. Section V discusses caveats and implications.
II. State and Local Expenditure for Drug Prohibition Enforcement

The savings in state and local government expenditure that would result from marijuana legalization consists of three main components: the reduction in police resources from elimination of marijuana arrests; the reduction in prosecutorial and judicial resources from elimination of marijuana prosecutions; and the reduction in correctional resources from elimination of marijuana incarcerations.[2] There are other possible savings in government expenditure from legalization, but these are minor or difficult to estimate with existing data.[3] The omission of these items biases the estimated savings downward.

To estimate the state savings in criminal justice resources, this report uses the following procedure. It estimates the percentage of arrests in a state for marijuana violations and multiplies this by the budget for police. It estimates the percentage of prosecutions in a state for marijuana violations and multiplies this by the budget for prosecutors and judges. It estimates the percentage of incarcerations in a state for marijuana violations and multiplies this by the budget for prisons. It then sums these components to estimate the overall reduction in government expenditure. Under plausible assumptions, this procedure yields a reasonable estimate of the cost savings from marijuana legalization.[4]
The Police Budget Due to Marijuana Prohibition

The first cost of marijuana prohibition is the portion of state police budgets devoted to marijuana arrests.

Table 1 calculates the fraction of arrests in each state due to marijuana prohibition. Column 1 gives the total number of arrests for the year 2000.[5] Column 2 gives the number of arrests for marijuana possession violations. Column 3 gives the number of arrests for marijuana sale/manufacturing violations. Columns 4 and 5 give the ratio of Column 2 to Column 1 and Column 3 to Column 1, respectively; these are the percentages of arrests for possession and sale/manufacture of marijuana, respectively.

The information in Columns 4 and 5 is what is required in the subsequent calculations, subject to one modification. Some arrests for marijuana violations, especially those for possession, occur because the arrestee is under suspicion for a non-drug crime but possesses marijuana that is discovered by police during a routine search. This means an arrest for marijuana possession is recorded, along with, or instead of, an arrest on the other charge. If marijuana possession were not a criminal offense, the suspects in such cases would still be arrested on the charge that led to the search, and police resources would be used to approximately the same extent as when marijuana possession is criminal.[6]

In determining which arrests represents a cost of marijuana prohibition, therefore, it is appropriate to count only those that are "stand-alone," meaning those in which a marijuana violation rather than some other charge is the reason for the arrest. This issue arises mainly for possession rather than for trafficking. There are few hard data on the fraction of "stand-alone" possession arrests, but the information in Miron (2002) and Reuter, Hirschfield and Davies (2001) suggests it is between 33% and 85%.[7] To err on the conservative side, this report assumes that 50% of possession arrests are due solely to marijuana possession rather than being incidental to some other crime. Thus, the resources utilized in making these arrests would be available for other purposes if marijuana possession were legal. Column 6 of Table 1 therefore indicates the fraction of possession arrests attributable to marijuana prohibition, taking this adjustment into account.[8]

The first portion of Table 2 uses this information to calculate the police budget due to marijuana prohibition in each state. Column 1 gives the total expenditure in 2000 on police, by state. Column 2 gives the product of Column 1 with the sum of Columns 5 and 6 from Table 1. This is the amount spent on arrests for marijuana violations. For 2000, the amount is $1.71 billion.
The Judicial and Legal Budget Due to Marijuana Prohibition

The second main cost of marijuana prohibition is the portion of the prosecutorial and judicial budget devoted to marijuana prosecutions. A reasonable indicator of this percentage is the fraction of felony convictions in state courts for marijuana offenses. Data on this percentage are not available on a state-by-state basis, so this report uses the national percentage. Data on the percentage of possession convictions attributable to marijuana are also not available, so this report assumes it equals the percentage for trafficking convictions.

In 2000 the percent of felony convictions in state courts due to any type of trafficking violation was 22.0%.[9] Of this total, 2.7% was due to marijuana, 5.9% was due to other drugs, and 13.4% was unspecified. This report assumes that the fraction of marijuana convictions in the unspecified category equals the fraction for those in which a specific drug is given, or 31.4% [=2.7%/(2.7%+5.9%)]. The report also assumes that the percentage of possession convictions due to marijuana equals this same fraction. These assumptions jointly imply that the percentage of felony convictions due to marijuana equals the fraction of felony convictions due to any drug offense (34.6%) multiplied by the percentage of trafficking violations due to marijuana (31.4%). This yields 10.9% (=34.6%*31.4%).[10]

The second portion of Table 2 uses this information to calculate the judicial and legal budget due to marijuana prohibition. Column 3 gives the judicial and legal budget, by state. Column 4 gives the product of Column 3 and 10.9%, the percentage of felony convictions due to marijuana violations. This is the judicial and legal budget due to marijuana prosecutions. For 2000, the amount is $2.94 billion.
The Corrections Budget Due to Marijuana Prohibition

The third main cost of marijuana prohibition is the portion of the corrections budget devoted to incarcerating marijuana prisoners. A reasonable indicator of this portion is the fraction of prisoners incarcerated for marijuana offenses.

As with the percentage of prosecutions due to marijuana, state-by-state information on the percentage of prisoners incarcerated for marijuana offenses is not available. Appropriate data do exist for a few states, however, and this percentage is likely to be similar across states. This report therefore computes a population-weighted average based on the few states for which data exist; it then imposes this percentage on all states. This percentage is 1.0%, as documented in Appendix A.

The third portion of Table 2 calculates the corrections budget due to marijuana prohibition.[11] Column 5 gives the overall corrections budget, by state. Column 6 gives the product of Column 5 and 1.0%, the estimated fraction of prisoners incarcerated on marijuana charges. This is the corrections budget devoted to marijuana prisoners. For 2000, the amount is $484 million.
Overall State and Local Expenditure for Enforcement of Marijuana Prohibition

As shown at the bottom of Table 2, total state and local government expenditure for enforcement of marijuana prohibition was $5.1 billion for 2000. This is an overstatement of the savings in government expenditure that would result from legalization, however, for two reasons. First, under prohibition the police sometimes seize assets from those arrested for marijuana violations (financial accounts, cars, boats, land, houses, and the like), with the proceeds used to fund police and prosecutors.[12] Second, under prohibition some marijuana offenders pay fines, which partially offsets the expenditure required to arrest, convict and incarcerate these offenders. The calculations in Appendix B, however, show that this offsetting revenue has been at most $100 million per year in recent years at the state and local level. This implies a net savings of criminal justice resources from marijuana legalization of $5.0 billion in 2000. Adjusting for inflation implies savings of $5.3 billion in 2003.[13] [14] [15]
III. Federal Expenditure for Marijuana Prohibition Enforcement

This section estimates federal expenditure on marijuana prohibition enforcement. There are no data available on expenditure for marijuana interdiction per se; existing data report expenditure on interdiction of all drugs, without separately identifying expenditure aimed at marijuana versus other drugs. It is nevertheless possible to estimate the portion due to marijuana prohibition using the following procedure:

1. Estimate federal expenditure for all drug interdiction;
2. Estimate the fraction of this expenditure due to marijuana interdiction based on the fraction of federal prosecutions for marijuana;
3. Multiply the first estimate by the second estimate.

This provides a reasonable estimate of federal expenditure for marijuana interdiction so long as this expenditure is roughly proportional to the variable being used to determine the fraction of total interdiction devoted to marijuana.[16]

Table 3 displays federal expenditure for drug interdiction. This was $13.6 billion in 2002 (Miron 2003b), and it is the figure that applies for all drugs.[17] [18] [19] To determine expenditure for marijuana interdiction, it is necessary to adjust for the fraction of federal expenditure devoted to marijuana as opposed to other drugs.

Table 3 next shows possible indicators of the relative magnitude of marijuana interdiction as compared to other-drug interdiction. These indicators include use rates, arrest rates, and felony convictions for marijuana versus other drugs. For the purposes here, the most appropriate indicator is the percentage of DEA arrests or convictions for marijuana as opposed to other drugs.[20]

The data therefore indicate that $2.6 billion is a reasonable estimate of the federal government expenditure to enforce marijuana prohibition in 2002.

As with state and local revenue, this figure must be adjusted downward by the revenue from seizures and fines. Appendix B indicates that this amount has been at most $214.2 million in recent years, implying a net savings of about $2.39 million. Adjusting for inflation implies federal expenditure for enforcement of marijuana prohibition of $2.4 billion in 2003.[21]
IV. The Tax Revenue from Legalized Marijuana

In addition to reducing government expenditure, marijuana legalization would produce tax revenue from the legal production and sale of marijuana. To estimate this revenue, this report employs the following procedure. First, it estimates current expenditure on marijuana at the national level. Second, it estimates the expenditure likely to occur under legalization. Third, it estimates the tax revenue that would result from this expenditure based on assumptions about the kinds of taxes that would apply to legalized marijuana. Fourth, it provides illustrative calculations of the portion of the revenue that would accrue to each state.
Expenditure on Marijuana under Current Prohibition

The first step in determining the tax revenue under legalization is to estimate current expenditure on marijuana. ONDCP (2001a, Table 1, p.3) estimates that in 2000 U.S. residents spent $10.5 billion on marijuana. This estimate relies on a range of assumptions about the marijuana market, and modification of these assumptions might produce a higher or lower estimate. There is no obvious reason, however, why alternative assumptions would imply a dramatically different estimate of current expenditure on marijuana. This report therefore uses the $10.5 billion figure as the starting point for the revenue estimates presented below.

Expenditure on Marijuana under Legalization

The second step in estimating the tax revenue that would occur under legalization is to determine how expenditure on marijuana would change as the result of legalization. A simple framework in which to consider various assumptions is the standard supply and demand model. To use this model to assess legalization's impact on marijuana expenditure, it is necessary to state what effect legalization would have on the demand and supply curves for marijuana.

This report assumes there would be no change in the demand for marijuana.[22] This assumption likely errs in the direction of understating the tax revenue from legalized marijuana, since the penalties for possession potentially deter some persons from consuming. But any increase in demand from legalization would plausibly come from casual users, whose marijuana use would likely be modest. Any increase in use might also come from decreased consumption of alcohol, tobacco or other goods, so increased tax revenue from legal marijuana would be partially offset by decreased tax revenue from other goods. And there might be a forbidden fruit effect from prohibition that tends to offset the demand decreasing effects of penalties for possession. Thus, the assumption of no change in demand is plausible, and it likely biases the estimated tax revenue downward.

Under the assumption that demand does not shift due to legalization, any change in the quantity and price would result from changes in supply conditions. There are two main effects that would operate (Miron 2003a). On the one hand, marijuana suppliers in a legal market would not incur the costs imposed by prohibition, such as the threat of arrest, incarceration, fines, asset seizure, and the like. This means, other things equal, that costs and therefore prices would be lower under legalization. On the other hand, marijuana suppliers in a legal market would bear the costs of tax and regulatory policies that apply to legal goods but that black market suppliers normally avoid.[23] This implies an offset to the cost reductions resulting from legalization. Further, changes in competition and advertising under legalization can potentially yield higher prices than under prohibition.

It is thus an empirical question as to how prices under legalization would compare to prices under current prohibition. The best evidence available on this question comes from comparisons of marijuana prices between the U.S. and the Netherlands. Although marijuana is still technically illegal in the Netherlands, the degree of enforcement is substantially below that in the U.S., and the sale of marijuana in coffee shops is officially tolerated. The regime thus approximates de facto legalization. Existing data suggest that retail prices in the Netherlands are roughly 50-100 percent of U.S. prices.[24] [25]

The effect of any price decline that occurs due to legalization depends on the elasticity of demand for marijuana. Evidence on this elasticity is limited because appropriate data on marijuana price and consumption are not readily available. Existing estimates, however, suggest an elasticity of at least -0.5 and plausibly more than -1.0 (Nisbet and Vakil 1972).[26] [27]

If the price decline under legalization is minimal, then expenditure will not change regardless of the demand elasticity. If the price decline is noticeable but the demand elasticity is greater than or equal to 1.0 in absolute value, then expenditure will remain constant or increase. If the price decline is noticeable and the demand elasticity is less than one, then expenditure will decline. Since the decline in price is unlikely to exceed 50% and the demand elasticity is likely at least -0.5, the plausible decline in expenditure is approximately 25%. Given the estimate of $10.5 billion in expenditure on marijuana under current prohibition, this implies expenditure under legalization of about $7.9 billion.[28]

Tax Revenue from Legalized Marijuana

To estimate the tax revenue that would result from marijuana legalization, it is necessary to assume a particular tax rate. This report considers two assumptions that plausibly bracket the range of reasonable possibilities.

The first assumption is that tax policy treats legalized marijuana identically to other goods. In that case tax revenue as a fraction of expenditure would be approximately 30%, implying tax revenue from legalized marijuana of $2.4 billion.[29] The amount of revenue would be lower if substantial home production occurred under legalization.[30] The evidence suggests, however, that the magnitude of such production would be minimal. In particular, alcohol production switched mostly from the black market to the licit market after repeal of Alcohol Prohibition in 1933.

The second assumption is that tax policy treats legalized marijuana similarly to alcohol or tobacco, imposing a "sin tax" in excess of any tax applicable to other goods.[31] Imposing a high sin tax can force a market underground, thereby reducing rather than increasing tax revenue. Existing evidence, however, suggests that relatively high rates of sin taxation are possible without generating a black market. For example, cigarette taxes in many European countries account for 75—85 percent of the price (US Department of Health and Human Services 2000).

One benchmark, therefore, is to assume that an excise tax on legalized marijuana doubles the price. If general taxation accounts for 30% of the price, this additional tax would then make tax revenue account for 80% of the price. This doubling of the price, given an elasticity of -0.5, would cause roughly a 50% increase in expenditure, implying total expenditure on marijuana would be $11.85 billion (=$7.9 x 1.5). Tax revenue would equal 80% of this total, or $9.5 billion. This includes any standard taxation applied to marijuana income as well as the sin tax on marijuana sales.

The $9.5 billion figure is not necessarily attainable given the characteristics of marijuana production, however. Small scale, efficient production is possible and occurs widely now, so the imposition of a substantial tax wedge might encourage a substantial fraction of the market to remain underground. The assumption of a constant demand elasticity in response to a price change of this magnitude is also debatable; more plausibly, the elasticity would increase as the price rose, implying a larger decline in consumption and thus less revenue from excise taxation. The $9.5 figure should therefore be considered an upper bound.

These calculations nevertheless indicate the potential for substantial revenue from marijuana taxation. A more modest excise tax, such as one that raises the price 50%, would produce revenue on legalized marijuana of $6.2 billion per year.
Distribution of the Marijuana Tax Revenue

The estimates of tax revenue discussed so far indicate the total amount that could be collected summing over all levels of government. In practice this total would be divided between state and federal governments. It is therefore useful to estimate how much revenue would accrue to each state, and to state governments versus the federal government, under plausible assumptions.

Table 4a indicates the tax revenue that would accrue to each state and to the federal government under the assumption that each state collected revenue equal to 10% of the income generated by legalized marijuana and the federal government collected income equal to 20%. This is approximately what occurs now for the economy overall, except that the ratio of tax revenues to income varies across states from the 10% figure assumed here. The table indicates that under these assumptions, the federal government would collect $1.6 billion in additional revenue while on average each state would collect $16 million in additional tax revenue.

These calculations ignore the fact that marijuana use rates differ across states, so application of identical policies would yield different amounts of revenue per capita. Wright (2002, Table A.4, p.82), for example, indicates that the percent of those 12 and over reporting marijuana use in the past month ranged in 1999-2000 from a low of 2.79% in Iowa to a high of 9.03% in Massachusetts. Table 4b therefore shows the breakdown of revenue by state under the assumption that tax revenue is proportional to state marijuana use rates. A third possibility, which cannot easily be examined with existing data, is that revenue by state differs depending on the distribution of marijuana production.
V. Summary

This report has estimated the budgetary implications of legalizing marijuana and taxing and regulating it like other goods. According to the calculations here, legalization would reduce government expenditure by $5.3 billion at the state and local level and by $2.4 billion at the federal level. In addition, marijuana legalization would generate tax revenue of $2.4 billion annually if marijuana were taxed like all other goods and $6.2 billion annually if marijuana were taxed at rates comparable to those on alcohol and tobacco.
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*tables not included*

Jeffrey A. Miron
Visiting Professor of Economics
Harvard University
Cambridge, MA 02138
781-856-0086
miron@fas.harvard.edu
 
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