A cannabis pricing mistake from California to Canada: government can’t tax cannabis optimally

ABSTRACT

We apply a simple three good general equilibrium model to examine the optimality of a Pigouvian tax on a legal cannabis market which faces competition from a well-established illicit market. Despite the widespread support for Pigouvian taxes on cannabis, the availability of untaxed illicit cannabis with comparable costs and higher externalities renders taxation of legal cannabis suboptimal. Our results, derived from a relatively simple model, show that the welfare improving properties of a Pigouvian tax can be undermined by illicit market competition. Based on this simple analysis, we conclude that it is impossible for the pricing policies implemented in multiple jurisdictions (including California and Canada) to achieve the optimal, welfare maximizing outcome.

KEYWORDS:

• Cannabis
• taxation
• negative externality
• Pigouvian tax

JEL CLASSIFICATION:

• H21
• I18

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Statistics Canada Table 36–10-0124-01, https://www150.statcan.gc.ca/n1/pub/13-610-x/cannabis-eng.htm

² Saskatchewan is the only Canadian jurisdiction that has private production, distribution and retail.

³ At the time of writing Quebec, New Brunswick, Nova Scotia, and Prince Edward Island all have entirely public systems. New Brunswick has since announced it intends to privatize.

⁴ The remaining 5 provinces employ a mixed system consisting primarily of private retail and publicly run distribution.

⁵ Cannabis Act, SC 2018, c16, Section 7 Purpose.

⁶ https://www.canada.ca/en/health-canada/services/drugs-medication/cannabis/research-data/market/dried.html#tbl-2 accessed 2020–03-20.

⁷ It is important to note that allowing profits or losses in the sale of the good has no impact on the results as profits earned are remitted to the representative agent which implies their budget constraint reduces to

$P_0{X}_0+P_1{X}_1+P_2{X}_2=W+\pi =W+\left(P_0-c_0\right)X_0+\left(P_1-c_1\right)X_1+\left(P_2-c_2\right)X_2+c_0{X}_0+c_1{X}_1+c_2{X}_2=W$

It is important to note that allowing profits or losses in the sale of the good has no impact on the results as profits earned are remitted to the representative agent which implies their budget constraint reduces to

$P_0{X}_0+P_1{X}_1+P_2{X}_2=W+\pi =W+\left(P_0-c_0\right)X_0+\left(P_1-c_1\right)X_1+\left(P_2-c_2\right)X_2+c_0{X}_0+c_1{X}_1+c_2{X}_2=W$

It is important to note that allowing profits or losses in the sale of the good has no impact on the results as profits earned are remitted to the representative agent which implies their budget constraint reduces to

$P_0{X}_0+P_1{X}_1+P_2{X}_2=W+\pi =W+\left(P_0-c_0\right)X_0+\left(P_1-c_1\right)X_1+\left(P_2-c_2\right)X_2+c_0{X}_0+c_1{X}_1+c_2{X}_2=W$

⁸ We have constructed a model in which only 3 goods exist, one of which is beyond the influence of government. It is this property that motivates us to use it as the numeraire.

⁹ However, it is concerning to note that both Amlung and MacKillop (2019) and Amlung et al. (2019) provide demand system estimates that suggest increased total demand after legalization at current prices or even higher legal prices.