Submitted by Darren Smith, Guest Blogger

With the coming legalization of marijuana consumption, growing and distribution in Colorado and Washington and other states that are likely to follow it seems many politicians in these states have converted from promoting themselves as generals in the War on Drugs to wanting significant tax revenue from the public who uses, is it possible this might lead to a failure on controlling organized crime and smuggling?

While many think of the bootlegging during the alcohol prohibition days as being smuggling of illegal alcohol being solely due just to the law at the time, there also were economic forces at hand which influenced this. It gave rise to persons importing the beverages in illegal international commerce and for those who desired to distill their own. The constriction of supply and lack of being readily available to those having a desire and many an addiction where demand was high led the prices rising drastically which provided an incentive for large sums of money that was not deterred by the existing laws.

Washington saw also significant bootlegging of alcohol after the state recently privatized its liquor monopoly. The new law placed a 10% fee payable to the Liquor Control Board on all wholesale sales of spirits and a 17% fee on top of that and markup for retail sales to consumers. A result of this was large amounts of thefts and fencing of stolen liquor for sales on the black market to consumers along with a flight of consumers near the borders of Oregon and Idaho in which both states saw immediate increases in sales of 25% to 30%, nearly all of which was along their borders with Washington. And from Native American Reservations which are not subject to the 17% retailer fee.

Currently Washington and Colorado are inline to put heavy taxation on recreational marijuana in these states where it has been legalized and regulated. Washington is the highest with excise taxes levied at 25% on the grower, 25% on the distributor and 25% on the retailer. This along with a large regulatory cost, see WA Initiative 502 for specifics, could at each level in the supply chain make legal recreational marijuana significantly higher than the illegal. As was discovered with alcohol prohibition if the cost or unavailability of is higher than what can be provided by the illegal marijuana market yet one could look to a legal item that fostered bootlegging of another kind, primarily due to economic factors.

Washington has one of the highest rates of cigarette taxation among the United States. Presently the taxation rate is $3.01 per pack. This pushes the price of a pack of premium brands to between $8.00 and $9.00 per pack. The intent of this taxation was to be earmarked for health, social services, and other benefits including smoking cessation programs. This high level of taxation has created first a situation where smokers have been avoiding most of the taxation by buying pipe tobacco, which is taxed significantly less, and rolling their own cigarettes. This cost of twenty home manufactured cigarettes is approximately $1.00. The second is the black market of cigarettes which has blossomed.

We can divide black market cigarettes into two areas: casual; and those derived from organized crime. Casual involves individual smokers bringing in cigarettes from out of state, often Oregon and Idaho where cigarette taxes are less and Native American Reservations that are scattered across the state and the sale to non tribal members is prohibited if they take them off reservation,. Some individuals will obtain these from associates in other states mailing it to them via Postal or other carriers. This is illegal under federal law and state law. But never the less it does happen.

The Organized Crime derived cigarettes often involve smuggling from international sources having the same brand of those obtained locally. The incentives for this are that cigarettes can be obtained from countries where the average smoker there cannot pay the same price as American sourced cigarettes due to income differences so the cost of the cigarettes to the illegal distributors is less along with the evasion of taxation to the consumer.

The cost to the consumer is attractive for them to pursue these sources despite the fact that possession of untaxed cigarettes or those bearing out of state ones is illegal if a tax stamp affixed by the wholesaler is not present. It is a misdemeanor under RCW 82.24.110(1)(n) for an individual to possess cigarettes without a Washington Tax Stamp affixed to the pack as a consumer due to rare enforcement and prosecution.

It is, the fact, that cigarette bootlegging is costing the state greatly. The Washington Department of Revenue estimates that thirty three percent of all cigarettes are illegally sold. This was a substantial increase over prior years before the cigarette tax was increased $1.00 per pack by the legislature in 2010. The department estimates there were 94,000,000 packs of contraband cigarettes were consumed in 2011. That is a loss of a staggering $284,000,000 in tax revenue.

Would this also be the case for marijuana in Washington? The question again is driven by economics and availability of means to avoid these taxes. Presently the consensus is that Reservations will not offer for sale marijuana legally due to federal jurisdiction. This might change if more states begin adopting legalization. If it does the same situation could happen with cigarettes. If Oregon or Idaho adopts legalized marijuana laws and there is a high enough price difference the same issue might happen as with both alcohol and cigarettes.

Other issues are regulatory costs. Washington law will mandate marijuana growers must comply with statutes so granular on the supply chain side that it nearly mandates accounting and record keeping to a per seed basis. One could imagine how devastating this could be to a wheat farmer if so required. Furthermore, the marijuana is required to be grown indoors with protracted monitoring and security. This might require a large capital expenditure to house the marijuana indoors where electrical lighting is required with infrastructure, property taxation, and plumbing is required. Regulations are so draconian that if the grower receives two citations for security being lax or other factors the Liquor Control Board can force the grower to destroy 25% of the crop or more. This could literally wipe out the profit for that crop. To mitigate the possible cost of this, the grower will have to pass this risk onto the distributor and ultimately the consumer.

Conversely the illegal grow market has very low cost. Marijuana grows very well and fast in portions of Eastern Washington where there are many days of sunshine and availability of streams and irrigation sources. The main capital costs of this are seeds, and PVC pipe and nothing more than hiding, transporting and farming labor. The comparison between illegal and legal creates lower cost and flexibility versus high cost and fixed, high overhead.

The law creates a provision where the Liquor Control Board may make recommendations to modify the taxation if the black market proves to be attractive to consumers. Additionally the possibility of the cost difference being so high that retailers could be forced out of business due to lack of demand, further aggravating the supply and flight to illegal sources. Moreover the illegal market is well established and offers it presently to the current users, most of which are accustomed to buying from illegal sellers, and who would comprise a large part of the future marijuana consumer.

To avoid this situation, recently Uruguay passed legislation on the distribution and sale price of marijuana with the goal being to meet or to be lower than the illegal market specifically to combat the incentive obtained though organized crime.

Will we continue to make mistakes again on the sale of substances in demand by consumers? Only time and economics will tell.

Sources:

King5 News
Chapter 69.50 Revised Code of Washington
Washington Liquor Control Board
Washington Department of Revenue