Percentage-based taxes for marijuana are too volatile.

Calculating marijuana taxes as a percentage of price creates the danger that taxes will be both too high and too low.

Taxes may be too high at first, as start-up expenses push costs up with resulting upward pressure on pre-tax prices.  Those high prices will be magnified by taxes that rise with the price level.  Taxes that are too high open the market to competition from bootleggers, with the pernicious results of (1) low actual collections and (2) continuing illegality.

Later, as economies of scale drive pre-tax prices down, taxes will shrink proportionately.  Low prices create another problem:  that legal prices will be so low that the Federal government (or some previously passive anti-marijuana interests) will rise up to shut down the program of legalization and bring back the hopeless war on drugs.

Weight- or potency-based taxes are more stable and less volatile.  Fifty states and hundreds of countries tax alcohol and tobacco on weight (volume) or potency – or don’t allow private sales at all.

We are in the primitive days of marijuana legalization.

I got this wrong — or only partly right — in my first article on this subject in early 2011, when I saw only the danger of losing a price war to bootleggers, and not the danger that taxed marijuana would be so cheap that it could cause the system to collapse.  I wrote:

“Basing a tax on sales price has one unique advantage.  This article dwells on the necessity of letting government authorities adjust the tax burden nimbly, so as to respond quickly to competition from bootleggers.  A price tax base provides some automatic response to bootleggers.  If bootleggers cut prices, prices should fall in the legal market to compete.  With a price base, a price cut by legitimate operators will result in a bigger immediate tax cut – which will put more pressure on bootleggers by putting less pressure on legitimate operators.

“For instance, if the pre-tax legal price is $200 per ounce, we could get a tax of $100 with either a 50 percent tax or a $100 per ounce tax – for an after tax price of $300.  If bootleggers offer a competitive price of $200 in a weight tax environment, legal operators would have to cut their price drastically, to $100 pre-tax ($200 after tax), to compete.  (This example ignores the inherently higher value of legal product.)  In a price tax environment, the competitive price would still be $200 after tax, made up of $133 pre-tax price and $67 tax.  That relative stability for legal producers is a good thing, because it allows for stable business planning – and higher prices in case of a price war.”

I was missing a big issue — prices that could be too low for the public or the Federal Government to tolerate.