Auctioning marijuana licenses — for a share of future revenue

Lotteries and “on the merits” selection of marijuana license holders are not working well. A 2015 RAND report, Considering Marijuana Legalization: Insights for Vermont and Other Jurisdictions, suggested auctions.  

But there’s a killer problem:  “Auctions ordinarily favor well-capitalized bidders (e.g., existing businesses), which can pay in all events, without depending on results. This favors favor bidders with wealth—with risk capital. So auctions are regressive in their allocation of a state-owned intangible asset.”

That problem could be addressed by having bidders bid not in dollar amounts, but in percentage of revenue they will pay as a license fee – an ad valorem tax by another name.  The fee would be paid after a year’s business is done, so undercapitalized and social equity licensees would not have to come up with money up front.

India is implementing this kind of “revenue share” auction for state-owned coal assets::

“Coal mines will be put for auction on the basis of revenue share instead of the regime of fixed rupee/tonne.

“The Cabinet Committee on Economic Affairs, chaired by Prime Minister Narendra Modi, has approved the methodology, the Coal Ministry said in a release.

“‘This methodology provides that bid parameter will be revenue share. The bidders would be required to bid for a percentage share of revenue payable to the Government. The floor price shall be 4 per cent of the revenue share.

“”Bids would be accepted in multiples of 0.5 per cent of the revenue share till the percentage of revenue share is up to 10 per cent and thereafter bids would be accepted in multiples of 0.25 per cent of the revenue share,’ the release said.”

For cannabis licenses, a lot of thinking would have to be done.  Maybe government would allocate licenses to the high bidders in percentage terms.  No one would be disqualified, but government could decide when to stop issuing licenses on the basis of predicting how much various bidders could in fact sell.

Here are excerpts from RAND-Vermont:

Bidding for permanent licenses is likely, from the state’s perspective, to leave money on the table. As the nascent marijuana industry struggles to outperform the black market, entrants are unlikely to amass and risk the capital necessary to pay for the present value of future rents from a permanent marijuana license. That is, given uncertainty, firms would deeply discount the prospective profits from the out-years. Taxation can make up for that shortcoming by taking up economic rents as they materialize. But proceeds of a one-time auction for permanent rights would bring in a disproportionate amount of revenue up front and could help pay for the cost of setting up legalization.

Instead of permanent licenses, annual licenses could be auctioned. (Auctions could sell off licenses for any number of years; we consider one year as an example.) A series of annual auctions might, like nimble taxes, yield increasing revenue over time. As the cost of producing marijuana drops, the privilege of selling it legally in a restricted market increases in value. With annual auctions, the state might take at least some of the increasing value of that privilege. If so, winners’ payments to the state would increase their costs of production, which might help prevent an unfortunate price collapse. 

The state could set a year’s quantity target for quotas based on prior volume (or, for the first year, on an estimate of likely first-year consumer demand). Several types of auctions are available (Klemperer, 1999). If the state seeks to avoid market concentration, it could limit producers to a certain percentage of the total quota. Related-party rules would be needed to enforce that kind of limitation. This gets back to the issues surrounding supply architectures in Chapter Four. 

The winner of an annual auction has no guarantee of renewal. That uncertainty might keep bids low and might keep potential entrants out of the market. Indoor marijuana production, in particular, would seem to be benefit from long-term investment. Typical investments in real property and in plant and equipment with a useful life beyond one year would be thrown into turmoil by the prospect of nonrenewal. Outdoor growers, whose operations are less capital-intensive, might be less daunted by the risk of nonrenewal. Annual licenses, perhaps more than any other allocation mechanism, could work against incumbent marijuana businesses. That would be a positive feature if government wants to disfavor entrenched incumbency in the marijuana industry. As Caulkins, Hawken, Kilmer, and Kleiman (2012) noted, “[O]nce business interests get entrenched in an industry, toughening the laws related to that industry becomes more difficult. . . . Private interests prioritize profit, not public health or public safety” (p. 245). 

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