Taxation and Market Power in the Legal Marijuana Industry

Hollenbeck, Brett and Uetake, Kosuke (2018): Taxation and Market Power in the Legal Marijuana Industry.

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: tax incidence, marijuana, pass-through, imperfect competition, regulation
• Subjects: D - Microeconomics > D2 - Production and Organizations > D22 - Firm Behavior: Empirical Analysis; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency ; Optimal Taxation; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H22 - Incidence; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L13 - Oligopoly and Other Imperfect Markets; L - Industrial Organization > L5 - Regulation and Industrial Policy > L51 - Economics of Regulation; L - Industrial Organization > L8 - Industry Studies: Services > L81 - Retail and Wholesale Trade ; e-Commerce

References

ADDA, J., B. MCCONNELL, AND I. RASUL (2014): “Crime and the Depenalization of Cannabis Possession: Evidence from a Policing Experiment,” Journal of Political Economy, 122(5), 1130–1202.

AGARWAL, S., S. CHOMSISENGPHET, N. MAHONEY, AND J. STROEBEL (2014): “A Simple Framework for Estimating Consumer Benefits from Regulating Hidden Fees,” The Journal of Legal Studies, 43(S2), S239–S252.

AGUIRREGABIRIA, V., D. ERSHOV, AND J. SUZUKI (2015): “Estimating the Effects of Deregulation in the Ontario Alcohol Retail Market,” Working Paper.

ANDERSON, S., A. DE PALMA, AND B. KREIDER (2001): “Tax Incidence in Differentiated Product Oligopoly,” Journal of Public Economics.

ATKIN, D., AND D. DONALDSON (2015): “Who’s Getting Globalized’ The Size and Implications of Intra-national Trade Costs,” Working Paper.

ATKINSON, A., AND J. STIGLITZ (2015): Lectures on Public Economics. Princeton University Press.

AUERBACH, A. (1985): “The Theory of Excess Burden and Optimal Taxation,” Handbook of Public Economics, 1.

BECKER, G., M. GROSSMAN, AND K. MURPHY (1991): “Rational Addiction and the Effect of Price on Consumption,” American Economic Review: Papers and Proceedings, 81(2), 237–241.

BERRY, S. (1994): “Estimating Discrete Choice Models of Product Differentiation,” RAND Journal of Economics, 25, 242–262.

BERRY, S., AND P. HAILE (2014): “Identification in Differentiated Products Markets Using Market Level Data,” Econometrica, 82, 1749–1797.

BERRY, S., J. LEVINSOHN, AND A. PAKES (1995): “Automobile Prices in Market Equilibrium,” Econometrica, 63, 841–890.

BOLLINGER, B., AND S. SEXTON (2018): “Local Excise Taxes, Sticky Prices, and Spillovers: Evidence from Berkeley's Soda Tax,” ´ mimeo.

CAWLEY, J., AND D. FRISVOLD (2017): “The Incidence of Taxes on Sugar-Sweetened Beverages: The Case of Berkeley, California,” Journal of Policy Analysis and Management, 36(2).

CONLON, C., AND N. RAO (2016): “Discrete Prices and the Incidence and Efficiency of Excise Taxes,” Working Paper.

DRAGONE, D., G. PRAROLO, P. VANIN, AND G. ZANELLA (2017): “Crime and the Legalization of Recreational Marijuana,” mimeo.

DUBE, J.-P. (2004): “Multiple Discreteness and Product Differentiation: Demand for Carbonated Soft Drinks,” Marketing Science, 23(1), 66–81.

DUBE, J. P., AND S. GUPTA (2008): “Cross-Brand Pass-Through in Supermarket Pricing,” Marketing Science, 27(3), 324–333.

FABINGER, M., AND G. WEYL (2013): “Pass-Through as an Economic Tool: Principles of Incidence under Imperfect Competition,” Journal of Political Economy, 121.

FABRA, N., AND M. REGUANT (2014): “Pass-Through of Emissions Costs in Electricity Markets,” American Economic Review, 104(9), 2872–99.

GAVRILOVA, E., T. KAMADA, AND F. ZOUTMAN (forthcoming): “Is Legal Pot Crippling Mexican Drug Trafficking Organisations? The Effect of Medical Marijuana Laws on US Crime,” The Economic Journal.

GORDON, B., AND B. SUN (2015): “A Dynamic Model of Rational Addition: Evaluating Cigarette Taxes,” Marketing Science, 34(3), 309–472.

GRIGOLON, L., AND F. VERBOVEN (2014): “Nested Logit or Random Coefficients Logit? A Comparison of Alternative Discrete Choice Models of Product Differentiation,” Review of Economics and Statistics, 66, 916–935.

HANSEN, B., K. MILLER, AND C. WEBER (2018): “The Taxation of Recreational Marijuana: Evidence from Washington State,” Working Paper.

HANSSENS, D. (2015): Empirical Generalizations About Marketing Impact. Marketing Science Institute.

HAO, Z., AND B. COWAN (2017): “The Cross-border Spillover Effects of recreational marijuana legalization,” mimeo.

HONG, G. H., AND N. LI (2017): “Market Structure and Cost Pass-Through in Retail,” The Review of Economics and Statistics, 99(1), 151–166.

HOTTMAN, C. (2018): “Retail Markups, Misallocation, and Store Variety across U.S. Cities,” Working Paper.

JACOBI, L., AND M. SOVINSKY (2016): “Marijuana on Main Street? Estimating Demand in Markets with Limited Access,” American Economic Review, 106.

KHAN, R., K. MISRA, AND V. SINGH (2016): “Will a Fat Tax Work?,” Marketing Science, 35(1), 10–26.

MCSHANE, B. B., C. CHEN, E. T. ANDERSON, AND D. I. SIMESTER (2016): “Decision Stages and Asymmetries in Regular Retail Price Pass-Through,” Marketing Science, 35(4), 619–639.

MILLER, N., M. OSBORNE, AND G. SHEU (2016): “Pass-Through in a Concentrated Industry: Empirical Evidence and Regulatory Implications,” RAND Journal of Economics.

MILLER, N., M. OSBORNE, AND G. SHEU (2017): “Pass-through in a concentrated industry: empirical evidence and regulatory implications,” The RAND Journal of Economics, 48(1), 69–93.

MILLER, N., AND M.WEINBERG (2017): “Understanding the Price Effects of theMillerCoors Joint Venture,” Econometrica.

MIRAVETE, E., J. THURK, AND K. SEIM (2018a): “Market Power and the Laffer Curve,” Econometrica,86(5), 1651–1687. (2018b): “One Markup to Rule them All: Taxation by Liquor Pricing Regulation,” Working Paper.

NAKAMURA, E., AND D. ZEROM (2010): “Accounting for Incomplete Pass-Through,” The Review of Economic Studies, 77(3), 1192–1230.

NEVO, A. (2001): “Measuring Market Power in the Ready-to-Eat Cereal Industry,” Econometrica, 69, 307–342.

SEILER, S., A. TUCHMAN, AND S. YAO (2018): “The Impact of Soda Taxation,” mimeo.

THOMAS, D. (2018): “License Quotas and the Inefficient Regulation of Sin Goods: Evidence from the Washington Recreational Marijuana Market,” mimeo.

THOMASSEN, O., H. SMITH, S. SEILER, AND P. SCHIRALDI (2017): “Multi-Category Competition and Market Power: A Model of Supermarket Pricing,” American Economic Review, 107(8), 2308–2351.

WALDFOGEL, J., AND K. SEIM (2013): “Public Monopoly and Economic Efficiency: Evidence from the Pennsylvania Liquor Control Boards Entry Decisions,” American Economic Review, 103.