Marijuana Tax: An Unintended Consequence of 280E – Fragmenting the Industry?

Premise:  A fragmented industry is harder to supervise and regulate.

Here’s what may be a counterproductive incentive of 280E.  Say Mom and Pop operate a marijuana business:

They find an opportunity to expand their business that costs 30 and yields net pre-tax income of 40 by doubling CGS to 120 and doubling gross receipts to 200.

After taxes, they are worse off.  So they won’t expand. [Is this a real case or just a theoretical sport case?  This example proves my point only if the second 40 of net pre-tax income costs more to earn than the first 40.]

The public policy problem is that section 280E tends to fragment the industry.  Instead of one supplier, 280E creates an incentive for there to be two suppliers – each more profitable after tax than one expanded supplier.

By contrast, this disincentive does not happen if Mom and Pop operate a legal business:

Let’s say they, too, find an opportunity to expand their business that costs 30 and yields net pre-tax income of 40 by doubling CGS to 120 and doubling gross receipts to 200.  Absent taxes, the marginal revenue exceeds the marginal cost, so they would do the deal.[1]  Taxes don’t change the result.

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