The Effect of Cannabis Legalization on Substance Demand and Tax Revenues
National Tax Journal (2021), 74:1, 107-145
45 Pages Posted: 25 Mar 2018 Last revised: 19 Jan 2023
Date Written: August 1, 2020
Abstract
Cannabis advocates argue legalization will increase tax revenues. However, if legal substances are substitutes, cannabis revenues may cannibalize other taxes. We document substitution between legal cannabis products and alcohol and tobacco products using detailed administrative and scanner data from Washington state. We estimate a flexible demand system for legal substances and find legalizing cannabis leads to a 15% decrease in alcohol, mainly by liquor and wine, and 5% decrease in cigarettes demand. Approximately 40% of Washington’s 2015 cannabis revenue was cannibalized from pre-existing sources. We find that Washington’s current substance taxes, even after accounting for substitution, are on the upward-sloping side of the Laffer curve.
Keywords: Cannabis, Recreational Substances, Substitution, Taxation, Demand Estimation, Public Finance, Industrial Organization
JEL Classification: H20, H71, H77, L65, L66
Suggested Citation: Suggested Citation