Lost Taxes and Other Costs of Marijuana Laws
by Jon Gettman

6. Budgetary Impact Due to the Diversion of Funds to the Illicit Marijuana Market

Based on a retail price of $7.87 a gram, a pound of marijuana is worth $3,570 and the commodity is worth $7,871,480 per metric ton. At this price the annual supply of 14,349 mt of marijuana available in the United States is worth $112.9 billion. The diversion of money spent on marijuana has a considerable impact on the fiscal budgets of all levels of government in the United States, especially through the diversion of this amount of money from the licit and taxed sectors of our economy to the illicit, untaxed, and unregulated illegal economy that thrives on these considerable expenditures.

The economist Joseph Schumpeter described entrepreneurial activity as a force of creative destruction on the economy. Entrepreneurs introduced new combinations of goods and services, and these attracted capital, diverting it from old combinations of goods and services. In the process this reallocation or redirection of spending diminished the value of the economic activity that loses the revenue to the new innovations. The creation of new economic channels effectively destroys many old channels of economic activity, a process defining the concept of creative destruction.

The market in marijuana in the United States is illicit, illegal, and as such it diverts capital away from the channels of the licit or legal economy, especially the channels from which local, state, and the federal government collect tax revenue. In this respect the emergence and growth of the illegal marijuana market is an act of creative destruction on the ability of government to collect tax revenue. Certainly some of the capital diverted into the marijuana market seeps back into the licit economy, but this phenomenon is no different from legal spending being re-circulated. The difference is that the initial purchase of marijuana, and a large portion of the redistribution of the purchase price, travels through economic channels which essentially avoid contributions to funding government.

It is obvious to most Americans that marijuana is not taxed, and that therefore there would be additional revenue for government if it were legal and taxed like other commodities. What is less apparent to most Americans is that the large, illicit market in marijuana costs government considerable revenue through its diversion of capital from the legal economy into the illicit economy. The primary budgetary impact of illegal marijuana sales is not the loss of potential tax revenue on marijuana, but the loss of actual tax revenue from the diversion of capital to the untaxed illegal market.

The 14,349 metric tons of marijuana purchased in the United States annually is worth $112.9 billion. If those funds were spent on legal commodities rather than marijuana those economic transactions would produce billions in tax revenues for local, state, and the federal government.

For example, according to the 2002 Economic Census by the US Bureau of the Census, the average business in the United States devotes 17.5% of its revenue to payroll. The money spent on marijuana, consequently, removes $112.9 billion from the gross domestic product, and results in a loss of payroll expenditures by businesses of $19.7 billion. Allowing for 15% federal income tax, 15% social security tax (combining individual and employer shares), and estimating a state income tax rate of 4.7%, this results in a loss of $6.8 billion in taxes for state and the federal government. Assuming an estimated sales tax of 5.4%, the result is a loss of $6.1 billion in tax revenue for state governments. Assuming an effective corporate tax rate of 2.6% of gross revenue, the result is a loss of $2.9 billion in tax revenue. This minimal model produces a total loss of tax revenue of close to $15.9 billion.

A more accurate estimation of lost tax revenue can be acquired through examination of current levels of government revenue as a percentage of Gross Domestic Product (GDP). (See Table 15.) The diversion of funds into the illicit market in marijuana costs government $31.1 billion in tax revenue annually. Local, state, and the federal government receive 28.7% of the GDP in tax revenue. If the money spent on marijuana were instead spent on legal goods, it would add $112.9 billion to the GDP, producing $11.6 billion in revenue to state and local governments, $7.2 billion to the federal government in social security and other social insurance premiums, and $12.2 billion in other federal tax revenue. Marijuana Prohibition results in the creative destruction of $31.1 billion in tax revenue.

In 2004 total US expenses on the criminal justice system (police protection, the judiciary, and corrections) totaled $193.5 billion(57). The cost allocation employed by the ONDCP report on the costs of drug abuse is to calculate the cost of drug law enforcement by using the percentage of drug arrests. In 2004 marijuana arrests accounted for 5.5% of all arrests. Consequently marijuana arrests cost taxpayers $10.7 billion in 2004.

Taken together, the lost tax revenue from the diversion of funds to the marijuana market and the cost of marijuana arrests produce a budgetary cost to local, state and the federal government of $41.8 billion.

 
 
  
 
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