Oregon’s wrong direction  

To beat the illicit cannabis market, you need some combination of law enforcement and low taxes. So it makes sense to set tax rates low, to start. Then, as the industry matures, and pre-tax prices come down, you can phase in higher tax rates.  You need a tax burden that leaves the after-tax price competitive with the black market price. Most folks will prefer the legal product just because it’s legal. Testing and packaging add value, too. So your aim for an after-tax legal price could be roughly at the black market price. As it changes from day to day.

But what rate do you start with? Maybe even zero, a tax holiday – as a transition measure.

So I’m questioning a proposal to beat the black market that has surfaced in Oregon: Switch from taxing by weight (which voters approved last November) to taxing by percentage. Here’s Jeff Mapes’ story: “[Senator] Prozanski said a [percentage-based] sales tax would better accommodate fluctuations in the price of marijuana. He said that marijuana flowers – the most potent part of the plant – have dropped in price recently and that a set-in-stone tax of $35 an ounce could make legal marijuana uncompetitive with the black market.”

Whoa. Sure, the black market price may be, as in Oregon, a moving target. I don’t doubt that the black market price has fallen. Why? One likely reason is that enforcement is not so fearsome. With legalization getting approval from Oregon’s voters, but no legal sales yet, maybe the oomph has gone out of the effort of busting sellers. Another way of saying that enforcement is weak is that the prohibition premium has gone down in this twilight time between voter approval and licensed sales. Other reasons for low black market prices that come to mind seem less plausible. One is willingness of sellers to take lower profits – all of a sudden. The other is lower costs that sellers suddenly incur. If economies of scale are kicking in for the black market as operations grow large, then that sounds like enforcement is weak.

There’s one more plausible reason for low black market prices: Black marketers are getting more efficient and cutting costs so they can lower prices. But the legal market should be able to match those efficiencies – and improve upon them. (The black market can’t match all the efficiencies of the legal market, just some of them. The black market still needs to hide.)

But even if the black market price is a moving target, a percentage of price tax base does not seem to way to hit it – or match it. That’s because the legal pre-tax price should be moving, too, independently of the black market price.  Whatever direction the black market price takes, the legal pre-tax price should move down over time as the prohibition premium disappears, as supply comes on line – and if legal businesses scale up, that, too, will help bring legal prices down.  The RAND Report for Vermont makes that case.  So taxes should (meaning normatively ought to, not in the sense of a prediction) eventually go up, not down, as pre-tax legal prices go down.

What baffles me about the Oregon proposal is this: “The sales-tax proposal didn’t include any specified percentage. Legislators said staffers are still trying to figure out how much to charge so it raises about as much as a harvest tax.” Double Whoa. If it raises the same amount, the tax burden is the same, and you haven’t advanced the goal of making the pre-tax price lower, so as to beat the black market. I don’t get it.

I won’t cast any aspersions on the Legislators in Oregon. I first thought about it their way, in an article last revised in 2012:

“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.”  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1741735, page 22.

Maybe I had it right then. But I don’t think so. I didn’t think then enough about how pre-tax legal prices will be going down.  You just need an ultra-low tax rate at first. And strong enforcement against the black market. When cannabis is legal for everyone, the violator of the new law is not a freedom-loving rebel, but just a tax cheater. Changing the tax base is irrelevant at best – and at worst counterproductive in the long run as pre-tax legal prices go down.

Legislators in Oregon have other reasons to prefer a percentage base to a weight base that I don’t buy, but that are defensible. For one thing, taxing by percentage at retail lets marijuana be classified as “medical” at the last possible moment – so it can be singled out there and then for a tax break. For another, taxing by percentage at retail satisfies growers who don’t want to be the taxpayers. (Taxing by weight, which seems to be succeeding in Colorado, needs to happen early in the supply chain, so that flour and sugar in cookies don’t get taxed.) Those reasons support defensible values, and can be weighed against other values: collecting tax early in the supply chain to prevent diversion; avoiding the slipperiness of manipulable price; and treating taxpayers equally whether sick, well, or faking sickness. But beating the black market as reason to shift the tax base does not stand up, so far as I can tell.

Here’s another way of looking at it: A “tax on weight becomes a bigger part of the cost to consumers if marijuana prices go down.” That’s right. But the tax can sort of equal the prohibition premium, now the tax evasion premium. That amount need not go down with price fluctuations.

The Oregonian editorializes: “By having a taxing mechanism that can better withstand price instability, Oregon will have a better shot at creating a stable industry.” I agree with that sentiment. But shifting to a percentage-of-price tax base seems to go in precisely the wrong direction. “Going forward,” the Oregonian continues, “it will be essential that lawmakers avoid setting a tax rate too low to ride out the unexpected and ensure success.” Amen to that.

Look, there’s a problem with a low tax burden at first: Senator Ginny “Burdick says she is willing to lower taxes even more at first to bring additional people into the legal market. But she concedes that she doesn’t know how that would fly with legislative budget leaders looking forward to gaining a new revenue stream for the state.” Right. You have to spend money to make money. No one said this would be easy.

 

 

 

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Author: patoglesby

From 1982 to 1990, I worked in tax policy for Committees of the United States Congress. In recent years, I was Adjunct Lecturer at UNC-Chapel Hill's Business School and then Adjunct Professor at its Law School.

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