How Should We Tax Legal Cannabis?

If we legalise weed, how should we tax it? A new working paper on the taxation of recreational marijuana in Washington State has a number of important insights. The study—released by researchers from the University of Oregon—focuses on the effects of Washington State’s unexpected 2015 switch from a 25% gross receipts tax (collected at every step in the supply chain) to a single 37% excise tax at retail. Three findings particularly stand out:

1) Gross receipts taxes on cannabis are inferior to excise taxes at retail.

The study finds that the tax change was roughly revenue-neutral, but the previous tax regime “discouraged otherwise efficient trades between cultivators and processors, thus creating deadweight loss.” The mechanism by which this occurred was the incentivization of inefficient vertically-integrated transactions: “an inventory lot of marijuana is considered ‘vertically integrated’ marijuana if it was cultivated and processed by the same firm.”

Put simply, if a transaction tax is levied at each stage of the cannabis production process, firms are encouraged to do everything in-house: even though this might not be the most efficient solution overall. This inefficiency is illustrated in the table below, which adjusts for the fact that “it takes roughly six weeks after processors purchase raw material from cultivators before the resulting products are sold to retailers” After the tax change, “the fraction of vertically integrated sales [fell] by 3.7 percent after the adjustment period (Column 1), which [was] driven by a 42 percent long run increase in non-vertically produced marijuana sold (Column 2)”:

Vertical integration can provide a number of useful advantages for cannabis firms, but there are also potential disadvantages. Although vertically integrated transactions continued to dominate the market after the tax change, the significant shift towards non-vertically integrated transactions provided efficiency gains. The study was careful to include new entrants to the market post-tax reform, since few incumbents would de-integrate: they would already have paid the fixed costs associated with vertical integration.

2) Mandatory vertical integration in the cannabis industry may reduce market inefficiency.

Since a move away from incentivizing vertical integration led to efficiency improvements, it follows that “requiring vertical integration, as Colorado does, will decrease market efficiency.” Those in favour of cannabis legalisation in the UK should make sure they does not repeat the mistakes of Colorado in this regard. Arguments in favour of mandating vertical integration center on the idea of easing the burden on regulators, who would only have to deal with one firm instead of several firms. But it seems implausible to suggest that the gains from making things easier for regulators would outweigh the efficiency losses from forced vertical integration.

3) Many U.S. states have set their cannabis taxation levels significantly below revenue-maximizing levels, although this is probably a good thing.

Another finding from the study was that Washington’s comparatively high levels of cannabis taxation were “close to the peak of the Laffer curve.” This is due to the fact that the authors’ estimates suggested the “medium-run response to a price increase [in cannabis] is elastic.”

In other words, there’s more state revenue on the table for places with lower levels of cannabis taxation. Does this mean that cannabis taxes should be set at Washington’s high levels? Not quite:

While our results suggest significant tax revenue may be left on the table in many jurisdictions, evaluating the impact of marijuana policy (and constructing optimal policy) in a broader social sense requires additional considerations. For one, the public health externalities of marijuana consumption are not well established. Nor is the relationship between legal marijuana consumption and the consumption of other ‘sin’ goods such as alcohol or tobacco. If it is indeed true, as many advocates claim, that marijuana consumption is ‘better’ in a public health sense than alcohol or tobacco consumption, the optimal regulation of marijuana should be designed to take into account responses in these other markets as well.

The authors of the study do not mention another problem with setting revenue-maximisation as the goal of cannabis taxation policy: potentially preserving the black market in cannabis. As the Adam Smith Institute and Volteface pointed out in our The Tide Effect report on cannabis legalisation last year:

Revenue from taxation of the legal market will benefit the Treasury, although this benefit must be secondary to ensuring the legal market is placed at a competitive advantage to the illicit alternative.

My colleague Sam Bowman has previously argued that “cannabis will be seen as the test case for further drug reform,” and a poorly designed taxation system will undermine the change in consumption patterns that provides the rationale for legalisation.

Finding the best cannabis taxation policy may not be the most exciting part of legalisation efforts, but getting it right is crucial if we are to ensure that the goals of harm-reduction and market efficiency are met.

Obviously we want unilateral free trade in agriculture but not just there, equally obviously

A good little report out from Policy Exchange making the same point that we've been making here. Unilateral free trade is a good thing, Brexit allows us to have it again, therefore we should have unilateral free trade post-Brexit. The only slight flaw with this report being that it concentrates upon agriculture rather than adamantly insisting, as we do, that the logic covers everything - not that that's a vice, we as usual are just doing a little more of that table thumping.

The Common Agricultural Policy has, at great expense, reduced agricultural productivity by lessening competition and supporting inefficient farmers, and increased costs for consumers. Outside the EU, the UK will be free to abolish tariffs on food products, which will unlock new trade deals, help developing countries and deliver cheaper food for consumers. We can also reform the agricultural subsidies regime so that we reward farmers who deliver public goods like biodiversity and flood prevention, rather than rewarding wealthy landowners.

Policy Exchange recommends that:

After leaving the EU Customs Union, the UK should unilaterally phase out tariffs that increase consumer food prices and complicate new trade deals.

Yes, quite so, why don't we all eat from that cornucopia of the world's food markets? 

We would, and we have here and elsewhere, go further and offer the design of the perfect trade deal:

1.There will be no tariff or non-tariff barriers on imports into the UK.

2.Imports will be regulated in exactly the same manner as domestic production.

3.You can do what you like.

4.Err, that’s it.

Now that we've solved the entirety of Britain's trade stance before breakfast we'll get on with the more difficult things later in the day.

Wal-Mart: A progressive success story...

I stumbled upon a fantastic paper the other day from Jason Furman, who served as Chair of the Council of Economic Advisers under Barack Obama (H/T Matt Ygleisas at Vox).

In 'Wal-Mart: A Progressive Success Story' Furman defended Wal-Mart against its left-wing critics arguing that supermarket chain didn't benefit from corporate welfare and raised real wages.

It's a fun paper and it's arguments stretch beyond Wal-Mart. They could easily apply to gig economy firms who have expanded low-paid work and lowered prices at the same time. As well as recent debates around whether tax credits are a form of corporate welfare (they're not).

Here are some of the best bits.

On prices:

"The most careful economic estimate of the benefits of lower prices and the increased variety of retail establishments is in a paper by MIT economist Jerry Hausman and Ephraim Leibtag (neither researcher received support from Wal-Mart). They estimated that the direct benefit of lower prices at superstores, mass merchandisers and club stores (including but not limited to Wal-Mart) made consumers better off by the equivalent of 20.2 percent of food spending. In addition, the indirect benefit of lower prices at competing supermarkets was worth another 4.8 percent of income. In total, the existence of big box stores makes consumers better off by the equivalent of 25 percent of annual food spending. That is the equivalent of an additional $782 per household in 2003.

"Because moderate-income families spend a higher percentage of their incomes on food than upper-income families, these benefits are distributed very progressively."

On wages:

"The one study that was published in a peer-reviewed economics journal found that “Wal-Mart entry [in a county] increases retail employment by 100 jobs in the year of entry. Half of this gain disappears over the next five years as other retail establishments exit and contract, leaving a long-run statistically significant net gain of 50 jobs.” The paper also found a small negative impact on jobs at wholesalers “due to Wal-Mart’s vertical integration” and no statistically significant effect on other industries.

...

"Neumark et al. and another paper by Dube, Barry Eidlin and Bill Lester also studied the impact of Wal-Mart entry on nominal wages. ... All these declines are less than 1 percentage point. The paper also finds that grocery workers’ wages go down in both urban and rural areas and other workers see no significant change in wages. In total, Dube et al. estimate a $4.7 billion annual reduction in retail earnings.

"Neither paper estimated the impact of Wal-Mart on real wages. Presumably the workers in the retail sector and more broadly also benefit from the lower prices that follow the entry of a Wal-Mart. The nominal wage effects in both papers have to be compared to the 7 to 13 percent retail price effect in the long run found by Basker or the reduction in the broader CPI found by Global Insight. Taken together, the evidence appears to suggest that, even for retail workers, the benefits of lower prices could outweigh any potential cost of lower wages –potentially leading to higher real wages even in the retail sector."

On Corporate Welfare:

"The total tax bill, however, is not the relevant question. Instead the question is whether Wal-Mart and its employees pay their “fair share” in a way that is consistent with businesses and workers in similar circumstances. Dube and Jacobs ask one version of this later question. They argue that Wal-Mart pays less than comparable employers (as discussed earlier, the evidence suggests this is not the case) and ask the question: how much do Wal-Mart’s low wages cost taxpayers? They estimate that Wal-Mart pays its full-time workers $8,620 less than comparable employers. They further estimate that Wal-Mart workers get $1,952 in public assistance annually (including Medicaid, EITC, food stamps, and other programs), or $551 more than comparable employers. They assert that this difference is a “hidden cost” of Wal-Mart.

"Their analysis, however, is incomplete and as a result features the wrong answer. Assume that the Dube and Jacobs’ numbers are accurate. If Wal-Mart pays the employee $8,620 less, that money has to go somewhere. If this money goes into corporate profits or executive compensation, it will result in an additional $3,017 in taxes at the 35 percent marginal rate. If even one-fifth of Wal-Mart’s lower wages went to corporate profits or top executives, that would be enough to make its low wages – by the Dube-Jacobs estimate – a net revenue increaser for the federal government. Based on the Dube-Jacobs results, it is overwhelmingly likely that if Wal-Mart pays lower wages, then this would improve the government’s fiscal situation.

"But encouraging private-sector companies to distribute their compensation to maximize net government revenues is peculiar and backwards. Who would recommend, for instance, that a corporation cut pay for its middle-income workers in order to raise executive compensation on the theory that this will raise total tax collections because executives are in a higher tax bracket?"

Read the full paper.

To think that people are complaining about this

It's true that America's Cheesecake Factory is not the sort of gourmet food consumed by refined aesthetes like you and we. But it's perfectly acceptable food for all that, rather better than average in fact. You also get a hefty portion for not all that much money. The puzzle though is that people complain about this:

Watch out, diners: There are serious calories in some restaurant meals.

That was the message of the Center for Science in the Public Interest, a nutrition advocacy group, as it released its annual "Xtreme Eating Award" winners — the most calorie-stuffed dishes and drinks from the country's chain restaurants.

Topping the list were entrees like The Cheesecake Factory's Pasta Napoletana, which the chain describes as a meat lover's pizza in pasta form. The pasta, dressed in a Parmesan cream sauce, is topped with Italian sausage, pepperoni, meatballs, and bacon and clocks in at 2,310 calories, 79 grams of saturated fat, and 4,370 mg of sodium.

We checked the price of this and in the LA area it seems to come in at $14. At which point we really do start to wonder why people are complaining.

Our point being that there has never in human history been a time when the average working guy or gal could go and have a full day's worth of calories of meaty goodness - OK, we know that meatballs and sausage are made of the scrag ends but still - for two hours of minimum wage labour, or more pertinently around 30 minutes work at the US median hourly wage of $25. Not cooked in a restaurant there hasn't been a time before now when this was true.

Far from us complaining about this we'll just add it to our list of proofs that the Good Old Days are right now.

RPI is silly, but not completely crazy

Chris Giles, the FT's economics editor, has recently been waging a war on the retail prices index (RPI)—Britain's venerable price statistic used to set rail prices, student loans interest, and repayment of some gilts. I'm a fan of Chris, but I think he's gone a bit far: yes, RPI is a bad index, but no, it's not necessarily unfair and wrongheaded in the way he describes.

Nowadays, the official measure of inflation is the consumer prices index (CPI), which, unlike RPI, is designated a national statistic. It's what the Bank of England uses for the flexible inflation target its monetary policy is based around and it differs from RPI by using a much better aggregation method, a bigger and more broad-based sample, and excluding housing.

It's not a judgement call: it's just a better index, which is why more or less everything has switched over. But some things aren't. For some of them it's because they date backwards. For example, the government has long sold RPI-linked gilts—there are £407bn outstanding according to Giles—from which we impute the TIPS market forecast of inflation. For others, it's less obvious why they do.

Now Giles has one very good point. In 2010 the RPI formula was changed to measure certain goods (especially clothes) more wrongly. This inflates the index. This means that repayments to pre-2010 RPI-linked-gilt-holders are higher than they would otherwise have been. Whenever this move was expected—or if unexpected, announced—this was a handout to pre-2010 holders. But after that point, it's all priced in. Everyone knows the index will overestimate inflation, and everyone knows by about how much (any error benefits the govt as much as the investors). Yes, we shouldn't have done it, and maybe we should even claw this money back—but it was a once-off error. Market pricing means it doesn't compound.

But I don't follow his other points at all. Yes, RPI adds some arbitrary amount onto "true" inflation, so post-2012 RPI-linked student loan interest rates are higher than they would be with CPI. But the interest rate on these student loans is entirely arbitrary anyway. Given their repayment rates (around 55%) and repayment schedules, the government is clearly subsidising their true cost to an astonishing degree. The RPI link is a semi subtle way of getting a small portion of that back. Like how "money illusion" means unexpected inflation is good during slumps.

The same is true of rail fares. It's good that RPI hides a little bit of extra increase in real fares. Economising on scarce resources through prices is a good thing, and we currently subsidise rail somewhat too much. If we do it through explicit price increases, people might bear a larger psychological burden when we (slightly) reduce how much the government pays for people's rail travel.

Switching to the CPI doesn't magic up money. In both cases it just makes the government pay more, and the users of the service less. Does Giles really think that the baseline is inflation plus the arbitrary number they've currently set by fiat, rather than inflation plus that arbitrary number, plus the arbitrary chunk of measurement error? It's hard to see why.

This isn't to say that we shouldn't switch away from RPI. It's a bad stat, and if Chris is right about the legality of doing so, then it sounds like we could quite easily switch, eventually, without the large reputation costs that go with seeming like we're reneging on obligations. But let's not use motivated reasoning to get there. And is it really necessary to use language like "fleecing", or blame the ONS, who almost certainly are not the ones making the final judgement call?

Our self-driving future is here... almost

In the past the idea of a driverless car would have featured in a science fiction movie rather than in companies’ plans for anything between the next six months to ten years. But automated vehicles are increasingly becoming less of a product of the imagination and more of a reality. By 2020, roads may look completely different.

In a sense, driverless cars are already here. In the summer of 2016, Uber began trialling them in Pittsburgh—although there were still two members of staff in the vehicles to make notes and step in if anything went wrong. Not that they needed to: the cars were mostly capable of navigating the city without human intervention.

We are very much still in trial stages, but some vehicle companies and their founders are confident of making great strides in the immediate future. Elon Musk, the creator of Tesla, said in April 2017 that by the “November or December of this year, we should be able to go from a parking lot in California to a parking lot in New York, no controls touched at any point during the entire journey”. Although he did clarify that the passenger would need to be able to intervene (so wouldn’t be able to fall asleep, for example), he predicted that Level 4 automated Tesla vehicles—where a car is driverless in almost all situations—would be available from 2019.

Google too have been involved in testing automated vehicles, with perhaps even more optimistic starting estimates than Tesla’s Elon Musk. In 2012, at which point Google’s driverless vehicles had already test-driven 300,000 miles, Sergey Brin said that “you can count on one hand the number of years it will take” for Google to have produced automated vehicles for the public. Although the technology behind the vehicles has not been finalised yet they have developed their automated vehicle project into an official company called Waymo as of December 2016. Chris Urmson, head of the project, has said that they are aiming to release the product by 2020.

Other car manufacturers are not so ambitious but are still making predictions that would see the introduction of entirely automated vehicles within the next five years. Nissan-Renault are looking to slowly increase the capacity of their cars to drive independently. Their aim for the ability to navigate a multi-lane highway by 2018, and complete automated ability in more complex driving situations such as urban environments, by 2020. BMW is working with Intel and Mobileye to create fully automated vehicles by 2021.

Even those that are cautious about the technology are working on ambitious timescales. The president of the Insurance Institute for Highway Safety and the Highway Loss Data Institute, Adrian Lund, said in 2016 that he thought a Level 5 automated vehicles—the top level of automation, which would not require a driver under any circumstances—would be a minimum of 10 years away. A Level 4 vehicle could be managed within five, he thought.

Hyundai has also taken a slower approach: they are “targeting for the highway in 2020 and urban driving in 2030.” It is worth bearing in mind, however, that many later estimates make reference to Level 5 vehicles, while frequently earlier ones are for vehicles that have reached Level 4 of automation. Naturally timeframes are going to be longer if they are aiming for a higher level of technological advancement.

As things stand, the technology is still very much a work in progress, and accidents can and do happen. In May 2016, a trial drive of a Tesla ended in a fatality when “neither Autopilot nor the driver noticed the white side of the tractor trailer against a brightly lit sky, so the brake was not applied”. However, they did note that this was the first fatality of over 130 million miles of autopilot driving, whereas the world average is a fatality every 60 million miles.

Predicting the future is difficult. We cannot be sure exactly when autonomous vehicles will finally be here. But the best guess is we'll start seeing something serious in the next decade. Seeing as it typically takes fifteen years for the great majority of car owners to update their models, if manufacturers switch to only automated vehicles by 2030, it will still be at least 2045 by the time driverless cars completely dominate the road. While this may seem a while away, it seems as if ultimately, within many of our lifetimes, driverless cars will have a monopoly on roads across the globe.

Only one of these ideas on security of supply is correct

Jay Rayner tells us in The Observer that:

There is an imperative for Britain to become more self-sufficient, not for reasons of petty nationalism or to fulfil some agrarian fantasy of localism but because, without it, in the current political climate, we risk not being able to keep ourselves fed. There are a number of levers that can be pulled.

So therefore we must all pay more for Good British Food so that Good British Farmers can supply us in our greater self-sufficiency.

Also in The Observer, on the same day, a story about that other current green obsession, electric cars and the minerals with which to make their batteries:

Macquarie Research predicts that trouble in the DRC and rising demand for electric vehicles will lead to a four-year-long cobalt shortage. Writing in academic journal The Conversation, Ben McLellan, senior research fellow at Kyoto University, warned further: “Manufacturers such as electric vehicle makers should be concerned that the supply of one of the key mineral components, or the processing and refining infrastructure, could become too centralised in a single country. Without diverse source options, the possibility of supply restriction becomes more likely.”

It is of course the second of these ideas which is correct. Security of supply comes from having many sources of supply each enjoying, or suffering from, different sets of conditions. With minerals the thing to worry about is some feckless incompetent gaining political power and thus disrupting supply. With agricultural production that too matters - Zimbabwe is no longer the major maize exporter it once was - but we also have natural variability of weather. We want to be sourcing our food from as many different "weather areas" as we can.

Earlier in the year there was a lettuce shortage in the UK as Spanish weather disrupted the crop. Not a huge problem as other more expensive sativa could be supplied from elsewhere. But imagine the problems Spain would have had if they were attempting to produce all the food consumed there purely there? 

This is not idle speculation either. The last incidences of true swollen belly children falling down dead famine in England were in Nothumberland and Cumbria just before the railway networks reached there. The reliance upon local food when the crop failed kills in the absence of the ability to acquire food elsewhere.

We agree entirely that security of supply of food is an excellent idea, as it is with minerals. But the solution with food is also as it is with minerals - many widely dispersed, subject to different conditions sources of supply. Self-sufficiency is the direct opposite of secure.

This is the way to protect the environment, buy it

Orri Vigfusson has a legitimate claim to being the saviour of the Atlantic salmon population. As his obituary points out:

The problem had begun, he said, in the 1950s, when the fishing industry discovered that salmon from rivers in North America and Europe gathered in the sea around Greenland and the Faroe Isles. A massive fishing operation was established, with thousands of miles of driftnets placed across the routes taken by the fish and the near destruction of the species.

Vigfússon realised that in the long run this was not sustainable and in 1989 set up the North Atlantic Salmon Fund with the aim of preserving and restoring those stocks. Using the wealth he had acquired from various business interests — including selling Icelandic vodka to the Russians — he bought up the fishing rights from trawler owners and others whose livelihoods had led to the depletion of the fish. The fund raised additional cash to support his work and over nearly three decades it has been able to buy and retire an estimated 85 per cent of commercial salmon quotas in the North Atlantic basin.

We have long insisted that fishing quotas should be exactly such transferable, monetisable, assets. Not despite these efforts rather because of them. No one needed to be dispossessed of their property of livelihood by law, we could and did leave it to the normal workings of the market. One of the driving economic forces here being the realisation that salmon fly fishing rights along rivers were worth more than the rights out to sea to those same salmon. Buying uot the one to protect the other thus made perfect economic sense.

 He believed that commercial conservation agreements were better than intergovernmental treaties. “Why? Because if you don’t [follow the agreement], you don’t get paid,” he said. “Money talks.”

Quite so. There are many who hanker for a world in which this isn't true but we really do think it best to deal with humans as they are, not as we might wish them to be. Therefore, if you want to preserve the environment why not buy a bit of it then preserve  it? 

We really don't know very much, certainly not enough to plan

This point has of course been made before, even by the occasional person even more illustrious than we are. However, it does bear repeating, we just don't know very much about our world:

The Current Population Survey Annual Social and Economic Supplement (CPS ASEC) is the source of the nation’s official household income and poverty statistics. In 2012, the CPS ASEC showed that median household income was $33,800 for householders aged 65 and over and the poverty rate was 9.1 percent for persons aged 65 and over. When we instead use an extensive array of administrative income records linked to the same CPS ASEC sample, we find that median household income was $44,400 (30 percent higher) and the poverty rate was just 6.9 percent. We demonstrate that large differences between survey and administrative record estimates are present within most demographic subgroups and are not easily explained by survey design features or processes such as imputation. Further, we show that the discrepancy is mainly attributable to underreporting of retirement income from defined benefit pensions and retirement account withdrawals.

Note that this is the US Census analysing their own numbers. And note how far out they are, an entire 30% of median income. On the basis that, you know, people lie about their income.

All of which is an excellent example of what Hayek was pointing out, we don't in fact have the information to be ab le to plan the economy in any meaningful manner. Here, what value all those plans to reduce elderly poverty when we're 30% out in our estimation of how much elderly poverty there actually is? And that's from the best figures available to government.

Our ability to change things is severely limited by our inability to know how things actually are.