Taxation and Market Power in the Legal Marijuana Industry

In 2012 the state of Washington created a legal framework for production and retail sales of marijuana. Nine other U.S. states and Canada have followed. These states hope to generate tax revenue for their state budgets while limiting harms associated with marijuana consumption. We use a unique administrative dataset containing all transactions in the history of the industry in Washington to evaluate the effectiveness of different tax and regulatory policies under consideration by policymakers and study the role of imperfect competition in determining these results. We examine 3 main research questions. First, how effective is Washington’s excise tax at raising revenue? With the nation’s highest tax rate on marijuana, is Washington maximizing revenue or potentially overtaxing, leading to reduced legal sales and lower tax revenue. Second, what is the incidence of taxes in this industry? Finally, most states have restricted entry, resulting in firms with substantial market power. What is the role of imperfect competition in studying these basic questions on tax policy? We combine structural methods and a reduced form sufficient statistic approach to show a number of results. First, Washington’s 37% excise tax is still on the upward sloping portion of the Laffer curve and state revenue could be substantially higher with a higher tax rate. The amount of revenue generated by a tax increase is significantly larger due to retailer market power than it would be under perfect competition. In addition, these taxes are primarily borne by consumers and not by firms, and there is a large social cost associated with each dollar raised.