Pot revenue hinges on black market

Staff writerJuly 30, 2013 

Once legal pot sales start in Washington, heavily taxed and regulated new businesses will try to muscle into a market cornered by illegal drug dealers and semi-legal shops dispensing marijuana as a medicine.

Consultants advising state regulators said it’s highly uncertain how much of the market will gravitate to the state’s new recreational pot system under Initiative 502.

“I-502 stores may not compete well on price with medical access points if they have similar production processes but face higher taxes,” consultants with BOTEC Analysis Corp. wrote. “The medical market could be hobbled by legislative intervention, but another and perhaps even greater concern is competition from the black market.”

Customers outside Washington’s borders could help keep the black market afloat here by continuing the demand for shipments of illegal pot to their states. “So one might expect purely illegal marijuana to remain available in Washington,” wrote the consultants, researchers at Carnegie Mellon University.

They examined the question of market share for its effect on state revenue.

Consultants’ conclusions about the state’s potential take are not all that different from those offered by the state Office of Financial Management during the campaign to pass I-502. But they arrive at the conclusions in different ways.

OFM assumed Washington’s demand for marijuana is about 85 million grams a year, and assumed the new legal stores would take over all of that market.

Washingtonians actually consume nearly twice that amount, 165 million grams a year, consultants said, using preliminary estimates that could change in a new report due out this week. But they said it “seems unrealistic that the I-502 market will be able to replace the illegal market any time soon.”

Consultants said I-502 stores might start out with only about 13 percent of the total market and then grow larger over time.

Still, the researchers said it is possible that revenue will reach the $2 billion over five years cited by OFM as the maximum amount of state revenue, although they cautioned it would require five full years of implementation, starting when the licensed stores open next year.


Even existing medical marijuana shops, consultants said, may hold a surprisingly small share of the market — less than one-fifth, they estimate. Their calculations “suggest that medical access points may themselves not now be competing well with the purely illegal markets despite not being burdened with excise taxes,” they wrote.

Jonathan Caulkins, Susan Andrzejewski and Linden Dahlkemper wrote the paper. They caution that their assumptions about market share are “highly uncertain.”

Lead BOTEC consultant Mark Kleiman, in fact, acknowledged some doubt about the estimate of medical market share, saying it came from federal law enforcement and that he’s skeptical that so many people are continuing to buy illegally when they could go to one of hundreds of medical storefronts.

But liquor board member Chris Marr said the smaller share of the market ascribed to medical marijuana shows that an ongoing debate over whether to regulate and tax medical shops misses the point that the black market is larger and here to stay.

Black-market buyers are the heaviest users and won’t switch to legal pot unless the price is right, Marr said.

“I’m more inclined to believe that it’s going to be a challenge getting past, say, 25 percent of the market initially,” Marr said.

The consultants’ analysis considers several scenarios for how the market could change over time. One possibility, they said, is that the new stores will eliminate the medical market and start eroding the black market.

At first, prices will be higher in I-502 stores than at medical storefronts, they wrote. While competition and innovation of legalization might drive prices down, they wrote, “the majority of experts” say high prices will continue — unless government intervenes by either lowering the businesses’ taxes or arresting their black-market competitors.


Kleiman, a UCLA professor, said the state will have to spend money — on enforcement — to make money.

“The strictly illicit business and the medical business are a paper tiger,” Kleiman said, “but a paper tiger doesn’t fall over until you push it, and at the moment I don’t see the impetus to push.”

With pot legal, it’s hard to make a case on public safety grounds for cracking down on illegal sellers, Marr noted. He said the solution is probably for lawmakers to tie enforcement to revenue by diverting some marijuana tax proceeds to police.

The initiative did not earmark money to local law enforcement.

“If you’re only capturing 13 to 25 percent of the market, anything you provide to local government to keep the illicit marketplace in check provides you with significant revenue,” Marr said.

For now, the consultants envision tax revenue as high as $3.2 billion or more over 10 years, and as low as $1.4 billion.

It could drop further, to as low as $650 million, if lawmakers choose to reduce marijuana taxes. The initiative set taxes at 25 percent at each of three levels of sales.

But consultants stressed uncertainty about how the stores would compete. “The biggest threat to potential tax revenues is that I-502 stores may not achieve a large market share,” they wrote.

There are other potential sources of competition besides the medical and black markets, Kleiman said. One is the possibility of nearby states such as Oregon legalizing marijuana.

With public opinion becoming more and more favorable to legalization, Kleiman said, the federal government may not be far behind.

“I’ve been telling people — Hillary’s second term,” he said.

Jordan Schrader: 360-786-1826 jordan.schrader@ thenewstribune.com blog.thenewstribune.com/politics @Jordan_Schrader

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