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How to Lure Consumers Away from the Marijuana Black Market

Posted by on Friday, October 5, 2018 in News, Updates.

[Updated 10/8 8:44 am to add more information.]

Even in states that have legalized the commercial supply of marijuana, some lawful consumers continue to purchase marijuana from the black market. Those black market sales pose several problems for state regulators; among other things, for example, they (likely) don’t generate any marijuana tax revenues for the state.

A new report from Eaze Solutions, a marijuana delivery service, provides some data on the size of the black market and identifies steps regulators could take to lure customers away from it. The Eaze report draws upon a July 2018 survey the company conducted of its own customers and other marijuana users in California and Colorado. The full report (The High Cost of Illegal Cannabis) can be found here.

In this post, I’ll discuss two interesting findings from the report. At the end of the post, I’ll also offer some brief thoughts on how companies like Eaze can use their data to help address marijuana policy questions. At the outset, however, let me note that I have some misgivings about the external validity of the survey results used by Eaze. Most importantly, we don’t know whether the respondents Eaze surveyed are representative of all marijuana consumers, and thus, whether their responses accurately reflect the views of all marijuana consumers. Consider just one potential problem: if the people who buy marijuana from a delivery service like Eaze have more money than marijuana users generally, they might be less sensitive to price than would be the average marijuana consumer. So their answers to Eaze’s questions about how tax rates affect their likelihood of buying from the black market (see below) might not be generalizable. For reasons like this one, I think we should take the survey results with a grain of salt—even though they are interesting and worthy of further investigation.

So with that caveat in mind, let me highlight the two most notable findings from the report:

  • The vast majority of consumers appear to prefer the licensed marijuana market.

Eaze reports that only 18% of the California consumers it surveyed bought marijuana from the illicit market in the prior three months. It also reports that only 10% of California respondents purchased most often from an illicit source; this figure was even lower for Colorado respondents (5%).

While Eaze suggests these numbers are cause for some alarm, frankly, I’m surprised (and reassured) they’re so low. Indeed, they appear similar to the numbers for other legal, regulated industries. Consider tobacco cigarettes. As I discuss in State Taxation of Marijuana Distribution (and Other Federal Crimes), pages 240-243, a similar percentage of tobacco cigarette sales (about 7-13% on average) go untaxed. Granted, not all cigarette tax evasion stems from sales by black market vendors; part of it, for example, might stem from unreported sales by licensed cigarette vendors. But the figures for cigarette tax evasion suggest that licensed marijuana vendors have already captured a share of the marijuana market similar to that of their licensed counterparts in older, more established markets.

So if Eaze’s numbers are to be believed, they are somewhat reassuring. They suggest that existing marijuana regulations haven’t put the legal marijuana market at a huge competitive disadvantage vis-à-vis the black market.

Of course, related to the caveat I noted above, there might be some problems with Eaze’s data. The survey sampled from Eaze’s own customers and other marijuana consumers using online path-to-purchase research. This methodology may fail to reach many consumers who never buy from the legal marketplace (e.g., they would not be among Eaze’s customers, presumably). If so, Eaze’s survey results would underestimate the rate of participation in the black market—by how much would depend on the size of that underrepresented population.

It would have also been useful to know what surveyed consumers considered to be an ‘illicit supplier’: e.g., did they think of the dealer in the parking lot (the black market), or did they also include the retail storefront that might be operating with some but not all of the required permits (call this a gray market)? Eaze may not have asked this question of consumers, and frankly, consumers may not be able to tell whether a vendor is fully licit or not–that’s a particular problem in California, where the legal status of many vendors may not yet be clear, as I discuss here.

  • Reducing taxes by 5% points might lure 23% of black market consumers to go legal . . . but such a cut might cost more than it’s worth.

Of course, even if the black market numbers are “low”, it might be possible to reduce them further. Indeed, Eaze’s survey suggests a way to do that, i.e., to lure (even) more consumers away from the black market: lower marijuana taxes.

To reach that conclusion, Eaze asked its survey respondents their impressions of licit and illicit marijuana suppliers. Not surprisingly, those respondents tended to be more satisfied with the labeling and testing of products sold by licensed vendors, but more satisfied with the prices (and lack of taxation) of products sold by black market vendors. Even more helpfully, Eaze also asked respondents how hypothetical changes in marijuana tax rates would affect their likelihood of buying from the black market. For example, Eaze reports that lowering marijuana taxes by 5% (from 34% to 29% in California) would convince 23% of current black market consumers to abandon the black market altogether.

I find this number plausible. For one thing, it is (roughly) consistent with research on the price elasticity of demand for marijuana (discussed in the book on pages 230-231). That research generally shows a 3-5% drop in overall demand for marijuana following a 10% price increase. Eaze, of course, is examining demand for marijuana from particular vendors (black market vendors versus licensed vendors), rather than overall demand for marijuana. In other words, the statistics I just cited are not directly comparable. Still, suggesting, as Eaze does, that about 4% of consumers (23% times 18%) would switch from the black market to the licensed market in response to a 5% price cut in the price charged by the latter seems in line with the research on the price elasticity of demand for marijuana. In addition, the Eaze findings are also (again roughly) consistent with research on closing cigarette tax gaps (discussed in the article linked above); that research shows (not surprisingly) that higher cigarette taxes are correlated with higher rates of cigarette tax evasion.

To be sure, I would have liked to see more detail from the Eaze report. For example, it would have been useful to get a separate breakdown of the responses to this tax question by medical marijuana vs. recreational (adult use) users. As I discuss in the book, the former (medical marijuana patients) generally pay much, much lower taxes on marijuana (see pages 489-498). And Eaze reports that a very large percentage of its respondents (90%!) reported some medical use for marijuana (though that doesn’t necessarily make them all qualified patients eligible for relief from marijuana taxes). I expect medical marijuana patients would be relatively unconcerned about marijuana taxes. Hence, if those users comprise a large portion of Eaze’s survey respondents (as they seem to), Eaze’s figures may understate the effect of a tax cut on recreational users. In other words, recreational users might be much more likely to buy from the legal market if taxes were cut.

Assuming, however, that Eaze’s survey numbers are accurate, they suggest that cutting taxes would be a very expensive way to cut participation in the black market. To see why, consider this simple illustration. Suppose we have 100 total marijuana consumers in a state, each of whom buys $100 in marijuana per year (pre-tax). Let’s assume the state (like California) currently charges a 34% tax on all marijuana sales. Per Eaze’s data, let’s assume as well that 18 of those 100 consumers currently buy (untaxed) marijuana on the black market–and that 23% of those (roughly 4 consumers) would instead buy from licensed vendors if the state cut its tax rate to 29%. The behavior of all of the other consumers would be unchanged following any tax cut.

Here’s a table showing the total tax collections before the tax cut . . .

Tax 34%               Customers    Sales before taxes    Taxes collected
Licensed market         82                  $8,200                    $2,788
Black market              18                   $1,800                        —

. . . and after

Tax 29%              Customers     Sales before taxes    Taxes collected
Licensed market        86                  $8,600                    $2,494
Black market             14                   $1,400                         —

Comparing the “Taxes collected” figures from both tables, we can see that tax revenues fall by about $300 (or more than 10%) following the tax cut, even though more people are now participating in the legal market. The problem with the tax cut strategy is that the state has to cut taxes for a lot of people, just to get few more (23% of 18%) to participate in the legal market. To be sure, the reduction in taxes might cause many people to buy more marijuana from legal shops. But it would take a fairly sizable increase in consumption to offset the foregone tax revenues – and the state might not consider the increase in consumption to be a good outcome in the first instance.

Bottom line, if Eaze’s figures are correct, I don’t think they necessarily support calls for a reduction in marijuana taxes. (The book discusses the black market problem and the effect of state regulations on it in Chapter 9.)

  • Marijuana companies can use their data to help address policy questions.

Notwithstanding my concerns over the external validity of the data Eaze collected, I applaud the company’s effort. Companies like Eaze may be in a unique position to gather the information we need to answer key policy questions. For example, Eaze could use its unique data on marijuana deliveries to help policymakers figure out the extent to which delivery services might substitute for retail storefronts. Many localities have sought to ban retail marijuana stores (see my article on Marijuana Localism  and the book pages 550-560), over the objections of marijuana users. But if delivery is a satisfactory substitute for retail stores for most consumers, enabling that option might be a good compromise, i.e., a good way to balance the concerns of store opponents with the concerns of marijuana users.

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  • Patrick Oglesby

    October 8th, 2018

    A tax cut designed to solve a non-problem in the opening months of the cannabis market will backfire in the longer term. Pre-tax prices fall as markets mature, and taxes are much easier to sustain then, especially if law enforcement takes on the illegal market.