[THE VIEW]The Dilemma of Cannabis Legalization and Market Regulation in the US

Faced with the Dilemma of Tax Revenue and Misuse
Different Approaches to Business Limits by State

In a previous column, the author discussed how the United States has collected taxes through the legalization of cannabis. This time, the focus is on how the U.S. regulates markets for goods with externalities, using cannabis legalization as a case study.

The states in the U.S. that have legalized cannabis face two dilemmas. To generate significant tax revenue through legalization, taxes must be kept low to encourage consumption. However, products like cannabis, alcohol, and tobacco typically cause negative externalities in society, such as health problems from misuse, addiction, various accidents, and reduced productivity. Therefore, the government must also curb excessive consumption of these goods. Paradoxically, the most common method to suppress consumption is through high taxes. Generally, special taxes raise consumer prices, which helps reduce consumption.

Besides taxes, there are more direct ways to regulate the market. Washington and Colorado, the first states to legalize cannabis in the U.S., adopted completely opposite regulatory approaches. Washington limited the number of businesses allowed to sell cannabis. In contrast, Colorado placed no restrictions on the number of businesses, resulting in many more cannabis stores. More stores lead to fiercer competition, which typically lowers market prices. Therefore, one might expect per capita cannabis consumption to be higher in Colorado than in Washington, but due to other regulations, this is not necessarily the case. Washington also limits the number of stores a single business can operate, whereas Colorado does not.

Along with the number of businesses, regulations on the scope of business activities also affect market competition. Washington prohibits cannabis producers or distributors from engaging in retail sales. However, until recently, Colorado allowed cannabis businesses to handle production, distribution, and retail all together. As a result, Washington has competition among small retailers, while Colorado has large companies with monopolistic or oligopolistic market structures, leading to higher market concentration. Consequently, cannabis prices in Colorado may be higher than in Washington.

The contrasting regulations seem to reflect the different priorities of each state. Washington applied the regulatory methods used for alcohol over the past 80 years?though currently less utilized?to cannabis. Rather than promoting free market competition, Washington aimed to reduce accessibility and suppress consumption by limiting the number of cannabis stores and raising prices. Similarly, Washington’s cannabis tax rates are significantly higher than average. There was also an intent to prevent indiscriminate cannabis businesses to avoid the activation of black markets.

Colorado, on the other hand, appears to prioritize free competition and corporate efficiency over consumption suppression to reduce externalities. However, both states share the common goal of controlling black markets. By regulating cannabis retailers to sell only legally produced products, they aimed to prevent the purchase and sale of goods in the black market.

Did these differing regulatory approaches result in different market prices? Ultimately, cannabis prices in the two states are similar. Some studies estimate that cannabis consumption is higher in Colorado than in Washington, which may be due to tourism.

Seo Boyoung, Professor at Indiana State University, USA