Does sin tax on the legal market facilitate the illicit market? An ex-ante assessment on the US cannabis market

Abstract

Sin tax is essential to reduce the harm caused by products like cannabis. However, excessive taxation may facilitate illicit markets. We examine sin tax policies' impact on legal and illicit cannabis markets in the selected US states. Using a Constant Elasticity of Substitution utility framework, we assess scenarios like sin tax increase and anti-illicit cannabis policies. Our findings indicate high sin taxes may drive consumers to illicit markets, but anti-illicit market policies could control its extent. However, there is a trade-off between market size, tax revenue, consumers' utility, and illicit market control. Thus, optimizing sin tax policies is challenging, necessitating a second-best approach.