Our research identifies the main federal budgetary impacts of federal legalization of cannabis and estimates their magnitude when possible. This exercise assumes that cannabis is regulated and that both medical and recreational cannabis will be taxed, with states and localities following suit. It improves upon the limited prior research in this area by analyzing a much wider set of sources of federal revenue and spending.
Our key findings on the revenue side are that the largest potential effect arises from an increase in labor force participation, which prior research suggests may result from workers using cannabis as a form of pain management therapy. Increases in government revenue from an excise tax on cannabis could also be significant even after accounting for expected offsetting factors. Existing evidence suggests that legalizing cannabis could reduce alcohol consumption and thus decrease alcohol tax revenues. Other changes to revenue—including revenue from the corporate income tax on cannabis producers or Food and Drug Administration fees—are likely to be less significant.
On the spending side, whether cannabis products will be treated as prescription drugs is crucial to the budgetary effects of legalization. If they are, this will trigger significant federal spending on cannabis through Medicare, Medicaid, and the veterans’ health insurance programs, though these costs may be offset by reduced spending on other forms of health care. Research suggests that legalizing cannabis reduces prescription opioid use, opioid-related emergency room visits, and admissions to substance abuse treatment centers for heroin‐related treatment. However, these benefits may be offset by expenses related to cannabis use disorder, including increased emergency room use. Additionally, if cannabis legalization increases aggregate spending on private health insurance, the forgone revenue attributable to the tax exclusion for employer-sponsored health insurance would increase.
A variety of factors limit the probable effect on outlays. Most cannabis companies are likely to seek marketing authorization from the Food and Drug Administration under a harm‐reduction or supplement‐like regulatory standard, as opposed to the more stringent safe-and-effective standard used for prescription drugs, thus excluding them from mandatory coverage by federal health insurance programs. The few cannabis products that earn marketing approval as a prescription drug will likely have higher copayment and coinsurance rates, and health insurance programs will likely require patients to seek prior authorization before covering these drugs. Thus, most cannabis and cannabis‐derived products are likely to be distributed through retail sales channels subject to significant restrictions, such as cannabis‐only sales venues with controlled access, stores with age restrictions, or designation as behind‐the‐counter products. Many plans will choose not to cover nonprescription cannabis products given the political nature and scrutiny of these markets and the emerging but still weak clinical evidence.
Cannabis legalization may also indirectly affect federal outlays. For example, suppose the legalization of cannabis leads to a decrease in opioid use and a subsequent reduction in mortality from opioid abuse. In that case, there will be increased outlays in Medicare and Social Security due to increased longevity.
Many of these budgetary implications are highly contingent on detailed future policy choices. For example, determining the economically optimal excise tax requires quantifying the social harms of cannabis consumption. Moreover, in a highly regulated market, non-tax measures—such as detailed product regulation and licensing restrictions that limit the number of sellers—curb competition, thus raising prices and creating an implicit tax. Therefore, determining the optimal excise tax also requires a precise estimate of this preexisting implicit tax. Research on Washington State, for example, found that though the state’s explicit cannabis tax is 37 percent, the combination of regulatory and tax policies creates an implicit 63 percent tax.
This dynamic has potentially important implications for federal cannabis policy. The appropriate federal excise tax should be considered in conjunction with an estimate of the impact of regulatory restrictions on competition and prices in the cannabis market.
Finally, while the budgetary impact of federal legalization of cannabis reflects the effect on both revenues and outlays, it is not necessarily optimal to set the excise tax regime such that revenues equal outlays. There is no reason such an arrangement—where taxes on privately financed consumption fund publicly financed consumption—is necessarily optimal, just as it is likely not optimal to fund public schools entirely with a tax on private schools. Nevertheless, the net budgetary impact of federal legalization is important for political reasons and congressional procedure alike.
Note
This research brief is based on Alex Brill, Brian J. Miller, and Stan Veuger, “Implications of Cannabis Legalization for the US Federal Budget,” Public Budgeting & Finance (forthcoming).
