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As More States Legalize Marijuana, Economics Comes into Play

KEY TAKEAWAYS

  • More states are legalizing marijuana for medical or recreational use, and this movement has created a patchwork of laws and policies on how the drug is treated.
  • Among the states that allow the medical use of marijuana, laws can vary greatly in terms of the medical conditions that can be treated by the drug.
  • Policymakers face complex decisions on how to regulate marijuana. For example, the goal of maximizing revenue may conflict with the goal of reducing recreational use.

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The topic of marijuana (cannabis) legalization moved into headlines following Colorado’s and Washington’s decisions to permit recreational use of the drug in 2012. Yet, these changes reflect nearly 50 years of evolution in drug policy. As of January 2020, eleven states and Washington, D.C., permit the sale of marijuana for adult recreational use. Marijuana sale and use remain illegal under federal law.

The relaxation of state laws on the possession and use of marijuana can be traced back to 1973, when Oregon became the first state to decriminalize the possession of modest quantities of marijuana, with a maximum penalty of a $100 fine. Then, in 1996, California approved marijuana usage for medical purposes. As of January 2020, about half of the states and numerous local jurisdictions have decriminalized possession to varying degrees, and 33 states currently have policies that allow patients to use marijuana if they qualify based on their medical diagnosis. See NORML webpage for a current list.

Data for recreational-use states do indicate growth in legal sales and use. For example, in Colorado, monthly recreational sales were between $10 million and $20 million in early 2012; these sales have stabilized to around $90 million per month in 2018, or around $1 billion per year (just under $200 per person per year). See Felix and Chapman for an analysis on Colorado. It is important to note that a portion of these sales could be to nonresidents. Reported marijuana usage by adults in Colorado rose from 10.4% in 2011-12 to 18.1% by 2017-18. This is defined as use over the past month. See National Survey on Drug Use and Health, State Estimates.

Notable increases in usage after legalization are also evident in Washington and Oregon; in fact, Oregon had the second highest usage rate in the country in 2017-18, with 20% of adults using marijuana at least one time in the past month. In contrast, national usage has been only slowly increasing, up from 7.1% in 2011-12 to 9.8% in 2017-18. Longer-term trends indicate that daily marijuana use by all adults has remained relatively stable and at low levels since 2000; some subgroupings put daily rates at below 3%.

A Closer Look at the Eighth District States

Marijuana is treated differently among the seven states that are part of the Eighth Federal Reserve District: Headquartered in St. Louis, the Eighth Federal Reserve District includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.

  • Three states (Illinois, Missouri and Mississippi) have decriminalized personal possession of marijuana to some degree.
  • Three states (Arkansas, Illinois and Missouri) currently have or will have medical marijuana programs in 2020.
  • Illinois has allowed sales of marijuana for recreational use.
  • Three states (Indiana, Kentucky and Tennessee) continue to criminalize all possession of marijuana.

Adult marijuana use across these seven states is near or below the national average, with 2016-17 estimates ranging from 7.9% in Kentucky to 9.6% in Indiana.

On Jan. 1, 2020, Illinois became the first state in the Eighth District to allow the sale of marijuana for recreational use. January sales reached just under $41 million. Assuming no growth in sales, annually this is $480 million, or about $12 per capita. The Colorado experience suggests sales are likely to exceed this amount, assuming adequate supply.

The year 2020 also marked the addition of Missouri as a state allowing sales of medical marijuana. The table below summarizes key statistics of the medical markets in the three District states that allow these sales; it provides a snapshot of the supply and demand in the market in each respective state. Assuming similar demographics and medical needs in these states, varying state policies explain the different outcomes.

State First Year of Medical Marijuana Initial Number of Patients Current Number of Patients Number of Licensed Dispensaries in Operation Average Number of Patients per Dispensary in Operation
Illinois 2015 2,663 76,939 55 1,399
Arkansas 2017 5,459 15,466 6 2,578
Missouri (estimate) 2020 21,000* [46,319; 128,070**] 192 [241; 667]
* Reported number of preregistered patients
** The lower-bound estimate is based on the average share of population registered as patients (0.8%) across all U.S. states where medical marijuana is legal, and the higher-bound estimate is based on the maximum share in any state, which is Colorado at 2.1%.
NOTES: Arkansas has 32 licensed dispensaries, but only six are operating. The Missouri figure for licensed dispensaries in operation assumes every approved license applicant will operate a dispensary.
SOURCES: Arkansas Department of Health, 2019; Illinois Department of Public Health, 2019; Haslag, Crader and Balossi; and author’s calculations.

Initial patient enrollment in Illinois (2,663) and Arkansas (5,459) has steadily increased over time and at similar growth rates. Although Arkansas’ population is only a quarter of the population of Illinois, initial enrollment was more than twice as high. In contrast, initial reports for Missouri (with a population around half of Illinois’) indicated that over 21,000 patient cards were issued in 2019, well before the program came into effect. See Edwards.

One reason for different enrollment rates is the differences in qualifying medical conditions among these states. For example, post-traumatic stress disorder (PTSD) was the top condition of qualifying patients for medical marijuana in Illinois at over 20% in 2019. In Arkansas, intractable pain, which is not included in the Illinois program, is the top qualifying condition at over 30%, whereas PTSD was reported by only 12% of qualifying patients. In Missouri, the list of qualifying conditions appears to be broader than for both Illinois and Arkansas by including:

  • “a chronic medical condition that is normally treated with prescription medication that could lead to physical or psychological dependence” and
  • “in the professional judgment of a physician, any other chronic, debilitating or other medical condition.” See Missouri’s “Frequently Asked Questions for Physicians.”

State governments are also responsible for determining the supply in the market and approving facilities to grow, produce and dispense marijuana to patients. Missouri has licensed many more dispensaries than both Illinois and Arkansas, meaning Missouri will maintain a system with the fewest patients per dispensary when they start operating this year. Fewer patients per dispensary could result in smaller establishments with lower revenue per store or, if fixed costs are high enough, some licensed dispensaries deciding not to operate. For example, in Arkansas, only six of the 32 licensed dispensaries are in operation because of a range of regulatory and market challenges.

Do Policies Align with Economic Theory?

While public discourse surrounding the legalization of marijuana often revolves around perceptions toward recreational drug use, an economic argument supporting (or opposing) legalization can be made regardless of one’s moral standing on use.

The medical use of marijuana raises the question of potential medical benefits and costs. One could view any drug from the same lens by asking, do the potential benefits from appropriate use of the drug outweigh the costs or risk of abuse? What makes the medical marijuana market unique to those of other drugs (e.g., prescription narcotics) is how it is treated by policymakers. For example, states typically do not subject prescription drugs to state sales taxes, while medical marijuana has been subjected to both state sales and excise taxes. Therefore, medical marijuana is taxed more like alcohol or tobacco than a medical drug.

The recreational use of any drug may create social costs, such as long-term health problems, injuries, accidents, unemployment, vagrancy and crime. See Becker, Murphy and Grossman. The model is designed to apply to any illegal drug, so this assumption means there is no socially beneficial (i.e., medical) case for use. Even with this assumption, the authors find taxation is the preferred policy of enforcement. As a result of these social costs, the free-market price is likely too low and therefore consumption is too high. Policymakers can attempt to solve this problem in two ways: first is criminal enforcement, which increases the cost of supplying drugs, reducing supply in the market and subsequently pushing up prices. Second is taxation on purchases, which reduces the quantity demanded in the market by increasing the price. In theory, both policies could achieve the same outcome of reducing drug use to a socially optimal level.

Policymakers face the difficult task of taking this theory to practice. Enforcement requires determining the most efficient techniques and the severity of penalization. Policymakers must also account for the adverse consequences of incarceration. On the other hand, taxation requires determining the optimal tax rate, which may vary for different types of consumers. Again, there may be a cost of enforcing this tax on those who seek to avoid payment. When determining which market outcome is the most efficient, an important consideration is the elasticity of supply and demand for drugs. If demand is inelastic (i.e., because the drug is highly addictive), enforcement may be optimal because consumers will still purchase close to the same amount even with higher taxes. See Becker, Murphy and Grossman for a complete discussion. For both policies, the main challenge is determining the social cost of drug use, which ultimately determines the degree of necessary enforcement or taxation.

Conclusions

Research is still needed to understand the economic impact of recent state policy changes, and differences across states provide researchers with many real-world “experiments” to study. However, with marijuana remaining illegal at the federal level, these firms face additional challenges in operating their businesses, such as lack of access to banking networks or developing interstate supply chains.

While legal marijuana has been touted as a means for improving the fiscal position of states through lowering enforcement expenditures and generating additional tax revenue, the reality is much more complex. First, taxation on medical marijuana use is inconsistent with tax policies on other drugs used in medical treatment. Over time one would expect these policies to converge if a consensus emerges on acceptable medical use. Second, increases in tax revenue from recreational sales likely overstate the fiscal impact or could be short-lived. Consumers are likely to spend a greater share of their income on marijuana and less on other taxable goods, such as alcohol. See Anderson. Furthermore, states may use the new tax revenue source as a replacement for existing revenue sources (or future revenue increases). See Dadayan for a historical perspective and review of tax policies. Third, as is the case with many types of “sin taxes”—taxes on products such as alcohol, tobacco and the lottery—individuals in lower income brackets are generally more likely to consume these products, thereby producing a regressive tax policy. Fourth, the reliance on sin taxes for revenue creates an incentive for policymakers to set a tax rate that maximizes revenue as opposed to a higher tax rate that would reduce consumption. For example, in the extreme case in which optimal consumption is zero, the optimal tax rate would be excessively high, and consumption (and tax revenue) would be near zero.

Olivia Wilkinson, a research associate at the Federal Reserve Bank of St. Louis, provided research assistance.

Endnotes
  1. As of January 2020, eleven states and Washington, D.C., permit the sale of marijuana for adult recreational use. Marijuana sale and use remain illegal under federal law.
  2. See NORML webpage for a current list.
  3. See Felix and Chapman for an analysis on Colorado. It is important to note that a portion of these sales could be to nonresidents.
  4. This is defined as use over the past month. See National Survey on Drug Use and Health, State Estimates.
  5. Headquartered in St. Louis, the Eighth Federal Reserve District includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.
  6. See Edwards.
  7. See Missouri’s “Frequently Asked Questions for Physicians.”
  8. See Becker, Murphy and Grossman. The model is designed to apply to any illegal drug, so this assumption means there is no socially beneficial (i.e., medical) case for use. Even with this assumption, the authors find taxation is the preferred policy of enforcement.
  9. When determining which market outcome is the most efficient, an important consideration is the elasticity of supply and demand for drugs. If demand is inelastic (i.e., because the drug is highly addictive), enforcement may be optimal because consumers will still purchase close to the same amount even with higher taxes. See Becker, Murphy and Grossman for a complete discussion.
  10. See Anderson.
  11. See Dadayan for a historical perspective and review of tax policies.
  12. For example, in the extreme case in which optimal consumption is zero, the optimal tax rate would be excessively high, and consumption (and tax revenue) would be near zero.
References

Anderson, Patrick. “Blue Smoke and Seers: Measuring Latent Demand for Cannabis Products in a Partially Criminalized Market.” Business Economics, January 2020, Vol. 55, No. 1.

Arkansas Department of Health and the Arkansas Department of Finance and Administration. “Medical Marijuana: 2019 Fiscal Year Report.” 2019.

Becker, Gary; Murphy, Kevin; and Grossman, Michael. “The Market for Illegal Goods: The Case of Drugs.” Journal of Political Economy, February 2006, Vol. 114, No. 1.

Dadayan, Lucy. “States’ Addiction to Sins: Sin Tax Fallacy.” National Tax Journal, December 2019, Vol. 72, No. 4.

Edwards, Greg. “Missouri Medical Marijuana Patients Far Exceed Projections.” St. Louis Business Journal, Dec. 3, 2019.

Felix, Alison; and Chapman, Sam. “The Economic Effects of the Marijuana Industry in Colorado.” Federal Reserve Bank of Kansas City Rocky Mountain Economist, April 2018.

Haslag, Joseph; Crader, G. Dean; and Balossi, William. “Missouri’s Medical Marijuana Market: An Economic Analysis of Consumers, Producers, and Sellers.” Report for Missouri Department of Health and Senior Services, 2019.

Illinois Department of Public Health. “Annual Progress Report: Compassionate Use of Medical Cannabis Patient Program Act.” 2019.

Charles Gascon is a regional economist and a senior coordinator in the Research Division at the Federal Reserve Bank of St. Louis. His focus is studying economic conditions in the Eighth District. He joined the St. Louis Fed in 2006. Read more about the author and his research.

States are facing complex decisions on how to regulate marijuana. As more of them decide to legalize cannabis, economics comes into play.

The Economic Benefits of Legalizing Weed

Although the Presidential election drew most of the attention in November of 2020, there were several other important decisions made at the polls as well: notably, several states held votes to determine the future of the legal cannabis industry in one form or another. Taking a leaf out of Colorado or Washington’s book, four states—New Jersey, South Dakota, Montana, and Arizona—decided to make marijuana consumption for recreational purposes legal. Mississippi also voted to allow medical marijuana.

All told, more and more states are moving to legalize marijuana (whether for medicinal or recreational use, or both), and the impact has already been tremendous. The legal changes have spawned a burgeoning industry of legal cannabis companies, including those which aim to research and develop cannabis-based medical products, those which are working to distribute and grow marijuana, and many others. All told, more than half of U.S. states have medical marijuana laws on the books, and fifteen states have legalized certain quantities of marijuana for recreational use as well.    

The economic benefits of legalizing weed have already been apparent as the first states have moved to change their legal positions. Overall, legal marijuana could mean a big push for state economies and big bucks for both the state and the federal governments.   Below, we’ll explore some of the key economic benefits of legal marijuana.

Key Takeaways

  • There has been a growing popular movement in the United States to legalize marijuana for medicinal and recreational uses, with several states adopting such measures already.
  • One motivation for legalization is the economic benefits that can come from the regulated commercial availability of marijuana.
  • Increased tax revenues, job growth, and investment opportunities all are powerful incentives to push for legalization.

Impact on Tax Revenue

Better than expected sales of marijuana in Colorado and Washington over the past several years have resulted in buoyant tax revenues. In 2019, Colorado collected more than $302 million in taxes and fees on medical and recreational marijuana. Sales in the state totaled over $1.7 billion.     Sales in the U.S were $12.2 billion, in 2019, and is projected to increase to $31.1 billion by 2024, according to a report from Arcview Market Research and BDS Analytics.   Local research supports this view as well; a report from the Colorado State University-Pueblo’s Institute of Cannabis Research recently found that the legal cannabis industry has contributed more than $80.8 million to the local economy in 2017, primarily through taxes and other fees.   Should marijuana become legal on a federal level, the benefits to the economy could be exceptional: a report from cannabis analytics company New Frontier suggests that federally legal pot could generate an additional $105.6 billion in aggregate federal tax revenue by 2025.  

That is the carrot that dangled before many states. In December 2019, it was reported that since January 2018, California’s cannabis sales had generated 411.3 million in excise tax, $98.9 million in cultivation tax, and $335.1 million in sales tax.   The Massachusetts Cannabis Control Commission reported in November 2019 that in the first year of opening marijuana retailers, $393.7 million was generated in gross sales.   (See also: What Will Jeff Sessions Mean for the Marijuana Industry?)

Income and Jobs

Setting up marijuana nurseries and dispensaries would be the first step for the states that voted in favor of medical marijuana. These would not only create jobs but also set the ball rolling for economic activity in the pot industry in these areas. In the case of states like California and Nevada where such infrastructure already exists, the economic impact has become more quantifiable as the sector has matured.

A RCG Economics and Marijuana Policy Group study on Nevada says that legalizing recreational marijuana in the state could support over 41,000 jobs till 2024 and generate over $1.7 billion in labor income.   The ICF study estimates at least 81,000 additional direct, indirect and induced jobs in California as a result of legalized marijuana sales. It also projects an increase in total labor income by at least $3.5 billion.  

New Frontier’s report predicting the impact of federally legal marijuana suggests that nationwide legalization could generate 1 million jobs by 2025.   These jobs would likely come from the quickly growing industry which would spring up across the nation. Workers would be needed to farm, process, distribute, and sell marijuana-based products. Further, there would be ample opportunities for secondary industries which were related to legal cannabis although not directly involved in its production and distribution. These might include software developers, financing services, construction companies, and many others.

Investment Opportunities

Legal marijuana presents the possibility of tremendous benefits to economies on a local and a national scale. It also could help to secure the investment portfolios of investors across the country and further afield as well. While marijuana remains illegal on the federal level, it is difficult for investors to capitalize on the growth of the industry. The number of marijuana-related companies trading on public stock exchanges is miniscule, and while investors do have the option of working with over-the-counter exchanges, many of the most successful businesses in the early legal cannabis space have been based in Canada or other countries.

Should marijuana become legal on the national level, marijuana companies would be free to list their stocks on all U.S. exchanges, thereby enhancing liquidity and opening up access to many more investors. Should the growth rates for the cannabis space continue as they have in recent years, it’s likely that investors would express a keen interest in the industry.

Saved Money

When considering the economic benefits of legal marijuana, it’s important to think of the money that might be saved as well as revenue that could be generated through such a process. Currently, federal marijuana enforcement costs several billion dollars per year. A 2013 report by the American Civil Liberties Union found that the costs at that time were approximately $3.6 billion per year.   The more states that legalize cannabis, the lower the cost of enforcement would likely be; if marijuana were to be legalized on a national level, these costs would likely drop considerably. If marijuana were removed from the list of controlled substances, far fewer court cases involving the substance would go to trial, resulting in fewer incarcerations, and, in turn, more money saved.

Legalized marijuana also stands to benefit medical consumers of cannabis-based products. As marijuana becomes legal in more and more parts of the country, it’s likely that the price will drop overall as a result of commoditization. This may not immediately seem like good news for overall tax revenue or for marijuana companies looking to maximize profits. However, individuals utilizing marijuana-based products for medical treatment would stand to benefit considerably from lower prices for these items.

Bottom Line

There is ample pushback against the idea of legalizing marijuana across the country. Critics cite the potential for confusion among law enforcement officers aiming to keep up with shifting regulations, a concern about increased homelessness or youth use of the drug, the potential for decreased property values, and much more. Some are opposed to changing the regulatory status of marijuana simply because it means a change to the status quo. All of these reasons combine to decrease the likelihood that marijuana will become legal at a national level any time soon. However, as more and more states move to individually decriminalize pot use in various ways, and as the economic benefits of a legal marijuana industry take effect, there are also many compelling reasons to consider nationwide legalization.

As more states vote in favor of legalizing weed, here's a look at the economic benefits to state economies.