THE BUDGETARY IMPACT
OF ENDING DRUG PROHIBITION

JEFFREY A. MIRON AND KATHERINE WALDOCK

Copyright © 2010 by the Cato Institute.
All rights reserved.

Cover design by Jon Meyers.

Printed in the United States of America.

CATO INSTITUTE
1000 Massachusetts Ave., N.W.
Washington, D.C. 20001
www.cato.org

Contents

Executive Summary

Introduction

The Analytic Framework

State and Local Expenditure for Drug Prohibition Enforcement

Federal Expenditure for Drug Prohibition Enforcement

The Tax Revenue from Legalized Drugs

Conclusion

Appendixes

Notes

Executive Summary

State and federal governments in the United States face massive looming fiscal deficits. One policy change that can reduce deficits is ending the drug war. Legalization means reduced expenditure on enforcement and an increase in tax revenue from legalized sales.

This report estimates that legalizing drugs would save roughly $41.3 billion per year in government expenditure on enforcement of prohibition. Of these savings, $25.7 billion would accrue to state and local governments, while $15.6 billion would accrue to the federal government. Approximately $8.7 billion of the savings would result from legalization of marijuana and $32.6 billion from legalization of other drugs.

The report also estimates that drug legalization would yield tax revenue of $46.7 billion annually, assuming legal drugs were taxed at rates comparable to those on alcohol and tobacco. Approximately $8.7 billion of this revenue would result from legalization of marijuana and $38.0 billion from legalization of other drugs.

Jeffrey A. Miron is a senior lecturer in economics at Harvard University and a senior fellow at the Cato Institute. Professor Miron earned his Ph.D. from the Massachusetts Institute of Technology and chaired the economics department at Boston University prior to joining the Harvard faculty. Katherine Waldock is a doctoral candidate at the Stern School of Business at New York University.

Introduction

State and federal governments in the United States face a daunting fiscal outlook. The national debt currently stands at 60 percent of GDP, its highest level since World War II, and under current projections this ratio will rise to more than 75 percent of GDP by 2020 and continue increasing thereafter.[1] States are also facing severe budget shortfalls.[2]

Both politicians and the public express concern about the debt, but the standard proposals for expenditure cuts or tax increases garner little support. Understandably, therefore, some politicians, commentators, interest groups, and citizens have embraced unconventional approaches to closing fiscal gaps, such as legalizing drugs. Legalization would reduce state and federal deficits by eliminating expenditure on prohibition enforcement—arrests, prosecutions, and incarceration—and by allowing governments to collect tax revenue on legalized sales.

This potential fiscal windfall is of particular interest because California, which is facing a budget shortfall of $19.9 billion for fiscal year 2011, will vote in November 2010 on a ballot initiative that would legalize marijuana under California law.[3] Advocates of the measure have suggested the state could raise “billions” in annual tax revenue from legalized marijuana, in addition to saving criminal justice expenditure or re-allocating this expenditure to more important priorities.[4] And should the California measure pass and generate the forecasted budgetary savings, other states would likely follow suit.

The fact that legalization might generate a fiscal dividend does not, by itself, make it a better policy than prohibition. Legalization would have many effects, and opinions differ on whether these are desirable on net. Both sides in this debate, however, should want to know the order of magnitude of the fiscal benefit that might arise from legalization.

This report estimates and discusses the reductions in government expenditure and the increases in tax revenue that would result from legalizing drugs. The report concludes that drug legalization would reduce government expenditure by about $41.3 billion annually. Roughly $25.7 billion of this savings would accrue to state and local governments, and roughly $15.6 billion would accrue to the federal government. Approximately $8.7 billion of the savings would result from legalization of marijuana, $20.0 billion from legalization of cocaine and heroin, and $12.6 from legalization of all other drugs. Legalization would also generate tax revenue of roughly $46.7 billion annually if drugs were taxed at rates comparable to those on alcohol and tobacco. Approximately $8.7 billion of this revenue would result from legalization of marijuana, $32.6 billion from legalization of cocaine and heroin, and $5.5 billion from legalization of all other drugs.

This report will begin with an explanation of our estimation methodology. We will then set forth and explain our estimates of the expenditures that can be saved by ending drug prohibition, and then explain our estimate of the tax revenue that would accrue by ending drug prohibition. The report will conclude with a brief discussion of the implications of our research findings.

The Analytic Framework

Analyzing the budgetary impact of legalization requires a number of assumptions about exactly what policy change is being examined. The implications of legalization by one state, with prohibition maintained in all other states and by the federal government, are likely to differ from legalization by a number of states because competition between states would undermine the tax revenue that might accrue to a single state if it were the only legal source of drugs. Legalization by the federal government is likely to have substantially different impacts than legalization by states with federal prohibition still in place, since federal prohibition might hamper state legalization in various ways.

This report therefore considers the following policy change: simultaneous legalization by all states and the federal government. This policy change is not currently on the table, nor is it likely to occur in the near future. But this hypothetical case is analytically tractable because it circumvents the need for assumptions about cross-border effects or about state versus federal impacts of legalization. More importantly, this hypothetical provides an upper bound on the expenditure savings and revenue increases that might occur from legalization.

The policy change considered here—legalization—is more substantial than decriminalization, which means repealing criminal penalties against simple possession but retaining them against drug smuggling and selling. The budgetary implications of legalization exceed those of decriminalization for three reasons.[5] First, legalization eliminates arrests for drug trafficking in addition to arrests for simple possession. Second, legalization saves prosecutorial, judicial, and incarceration expenses; these savings are minimal in the case of decriminalization. Third, legalization allows taxation of drug production and sale.

The estimates provided here should not be taken as precise estimates of the budgetary implications of a legalized regime for currently illegal drugs. The analysis employs numerous assumptions, some that plausibly bias the estimates downward and some that plausibly bias the estimate upward. Thus, the estimates reported here should be considered “ballpark figures” that indicate what order of magnitude of fiscal benefit policymakers should expect from legalization.

State and Local Expenditure for Drug Prohibition Enforcement

The savings in state and local government expenditure that would result from drug legalization consist of three main components: the reduction of expenditures of police resources from eliminating drug arrests; the reduction in prosecutorial and judicial resources from eliminating drug prosecutions; and the reduction in correctional resources from eliminating drug incarcerations.[6] Other savings in government expenditure might result from legalization, but these are minor or extremely difficult to estimate with existing data.[7]

To estimate the state and local savings in criminal justice resources, this report uses the following procedure. It estimates the percentage of state and local arrests for drug violations and multiplies this percentage by the state and local budget for police (subject to one adjustment discussed below). It estimates the percentage of state and local felony convictions for drug violations and multiplies this percentage by the state and local budget for prosecutors and judges (subject to one adjustment described below). It estimates the percentage of state and local incarcerations for drug violations and multiplies this percentage by the state and local budget for prisons. It then sums these components to estimate the overall reduction in state and local government expenditures. Under plausible assumptions, this procedure yields a reasonable estimate of the cost savings from drug legalization.

Portion of State and Local Police Budget Devoted to Drug Prohibition

The first cost of drug prohibition is the portion of state and local police budgets devoted to drug arrests. This report calculates that expenditure in two steps. It first calculates the percentage of drug arrests due to prohibition. It then multiplies this percentage by state and local expenditure on police, adjusted downward by approximately 9.6 percent to account for police activity unrelated to making arrests.[8]

Table 1 calculates the fraction of state and local arrests due to drug prohibition. Line 1 gives the total number of state and local arrests in 2007. Line 2 gives the number of such arrests for drug law violations. Line 3 gives the fraction of arrests due to drug law violations, defined as Line 2 divided by Line 1. Line 4 gives the percentage of drug arrests due to sale or manufacturing violations. Line 5 gives the percentage of overall arrests due to sale/manufacturing violations, defined as Line 3 times Line 4. Line 6 gives the percentage of drug law violations due to possession violations. Line 7 gives the percentage of overall arrests due to possession violations, defined as Line 6 times Line 3.

Table 1
Percentage of Arrests Due to Drug Prohibition, 2007

All Drugs

Heroin/
Cocaine

Marijuana

Synthetic

Other

1. Total Arrests

14,209,365

2. Arrests for Drug Violations

1,841,182

3. % of Arrests, Drug Violations

12.96

4. % of Drug Arrests, Sale/Man

17.50

7.90

5.30

1.50

2.80

5. % of Total Arrests, Sale/Man

2.27

1.02

0.69

0.19

0.36

6. % of Drug Arrests , Possession

82.50

21.50

42.10

3.30

15.60

7. % of Total Arrests, Possession

10.69

2.79

5.46

0.43

2.02

8. 0.5 * % of Arrests, Possession

5.34

1.39

2.73

0.21

1.01

Sources: Total arrests and arrests for drug violations: U.S. Department of Justice, Crime in the United States: Estimated Number of Arrests (Washington: Federal Bureau of Investigation, Uniform Crime Reporting Program, 2007), http://www.fbi.gov/ucr/cius2007/data/table_29.html. Drug violation and sale/ manufacturing percentages: U.S. Department of Justice, Crime in the United States: Persons Arrested (Washington: Federal Bureau of Investigation, Uniform Crime Reporting Program, 2007), http://www.fbi.gov/ucr/cius2007/arrests/index.html.

The information in Lines 5 and 7 is what is required in subsequent calculations, subject to one modification. Some arrests for drug violations, especially those for possession, occur because the arrestee is under suspicion for a non-drug crime but possesses drugs that are discovered by police during a routine search. This means an arrest for drug possession is recorded, along with, or instead of, an arrest on the other charge. If drug possession were not a criminal offense, the suspects in such cases would still be arrested on the charge that led to the search, and police resources would be used to approximately the same extent as when drug possession is a criminal violation.[9]

In determining which arrests represent a cost of drug prohibition, therefore, it is appropriate to count only those that are “standalone,” meaning those in which a drug violation rather than some other charge is the reason for the arrest. This issue arises mainly for possession rather than trafficking. Few hard data exist on the fraction of “stand-alone” possession arrests, but previous research studies suggest it is between 33 percent and 85 percent.[10] To err on the conservative side, this report assumes that 50 percent of possession arrests are due solely to drug possession rather than being incidental to some other crime. Thus the resources utilized in making these arrests would be available for other purposes if drug possession were legal. Line 8 of Table 1 therefore shows Line 7 divided by 2; this is the fraction of possession arrests attributable to drug prohibition.

Whereas Table 1 presents an overview of the percentages of drug arrests in the United States based on type of violation, Appendix A presents the same data broken down by individual state. Appendices C-G then use these fractions to calculate expenditures attributable to drug prohibition at the state level. Total police expenditure for the U.S. is indicated in the first part of Table 2. Line 1 gives total state and local expenditure on police in FY 2008, adjusted for non-arrest activities. Line 2 gives police expenditure due to arrests for sales/manufacturing. Line 3 gives police expenditures due to possession. Line 4 gives total police expenditure due to drug violations, defined as Line 2 plus Line 3.

Table 2
State and Local Expenditures Attributable to Drug Prohibition, Billions of 2008 dollars

All Drugs

Heroin/
Cocaine

Marijuana

Synthetic

Other

1. Police Budget

81.03

2. Police Budget, S/M violations

1.74

0.80

0.52

0.24

0.31

3. Police Budget, Possession violations

4.28

1.13

2.15

0.14

0.86

4. Police Budget, Drug Violations

6.02

1.93

2.67

0.38

1.17

5. Judicial Budget

17.27

6. % Felony Convictions, Drug Violations

34.00

15.15

9.64

2.85

6.34

7. Judicial Budget, Drug Violations

5.87

2.62

1.66

0.49

1.10

8. Corrections Operating Budget

72.90

9. % of Prisoners, Drug Charges

19.50

10.05

1.57

5.02

2.86

10. Correct. Budget, Drug Violations

14.22

7.33

1.14

3.66

2.09

11. Gross S/L Expend, Drug Prohibition

26.11

11.88

5.48

4.53

4.35

12. Net S/L Expend, Drug Prohibition*

25.68

11.68

5.39

4.45

4.28

Sources: The data on felony convictions are from Matthew Durose and Patrick A. Langan, Felony Sentences in State Courts, 2000, Bureau of Justice Statistics, Office of Justices Programs, U.S. Department of Justice, NCJ 198821 (2003), p. 2. The data on prisoners are from U.S. Department of Justice, Prisoners in 2007: Estimated Number and Percent Distribution of Prisoners under Jurisdiction of State Correctional Authorities (Bulletin NCJ 219416) (Washington: Federal Bureau of Investigation, 2008), http://www.albany.edu/sourcebook/pdf/t600012005.pdf. The data on budgets are from U.S. Census Bureau, State and Local Government Finances by Level of Government and by State (2008), http://www.census.gov/govs/estimate/0600ussl_1.html. Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with U.S. Department of Labor, “Consumer Price Index—All Urban Consumers” http://www.bls.gov/cpi/home.htm#data
*See Appendix M.

Portion of State and Local Judicial and Legal Budget Devoted to Drug Prohibition

The second main cost of drug prohibition is the portion of the prosecutorial and judicial budget devoted to drug prosecutions. A possible indicator of this percentage is the fraction of felony convictions in state courts for drug offenses. This indicator likely overstates, however, because the judicial and legal budget encompasses domestic relations, civil, and other case types that are unrelated to criminal activity. We therefore use the fraction of felony convictions multiplied by 41.7 percent of the overall judicial and legal budget, to account only for felony and misdemeanor cases. This fraction came from individual state data on judicial workloads for eight states.[11]

The second portion of Table 2 calculates the judicial and legal budget due to drug prohibition.[12] Line 5 gives 41.7 percent of the state and local judicial and legal budget in 2008, which represents the fraction of that budget that is spent on felony and misdemeanor cases. Line 6 gives the percent of felony convictions in state courts due to drug law violations.[13] Line 7 gives the state and local judicial and legal budget due to drug prosecutions, equal to the product of Line 5 and Line 6.

Portion of State and Local Corrections Budget Devoted to Drug Prohibition

The third main cost of drug prohibition is the portion of the corrections budget devoted to incarcerating drug prisoners. A reasonable indicator of this portion is the fraction of prisoners incarcerated for drug offenses.

The third portion of Table 2 calculates the corrections budget due to drug prohibition.[14] Line 8 gives the overall corrections budget. Line 9 gives the percent of state prisoners incarcerated for drug law violations. Line 10 gives the corrections budget devoted to drug prisoners, equal to the product of Line 8 and Line 9.[15]

Overall State and Local Expenditure for Enforcement of Drug Prohibition

Line 11 of Table 2 adds Lines 4, 7, and 10 to estimate total state and local government expenditure for enforcement of drug prohibition. The figures in lines 11 are overstatements of the savings in government expenditure that would result from legalization, for two reasons. First, under prohibition the police sometimes seize assets from those arrested for drug violations (e.g., financial accounts, cars, boats, land, and houses), with the proceeds used to fund police and prosecutors.[16] Second, some drug offenders pay fines, which partially offset the expenditure required to arrest, convict, and incarcerate these offenders. Appendix M shows that this offsetting revenue has been at most $0.5 billion per year in recent years at the state and local levels.

Line 12 therefore shows the net state and local expenditure on drug prohibition for 2008 after subtracting out revenue from seizures and fines.[17] For all drugs, the estimate is $25.7 billion; for marijuana, $5.4 billion; for cocaine and heroin, $11.7 billion; and for other drugs, $8.7 billion.[18]

State-by-State Estimates

Table 3 provides the state-by-state breakdown of state-and-local expenditure on drug prohibition for the year 2008, net of seizures and fines. Appendixes C–G provide state-by-state breakdowns for the components of these estimates.

Table 3
State-Level Expenditures Attributable to Drug Prohibition, Thousands of 2008 Dollars

State

All Drugs

Marijuana

Heroin/
Cocaine

Other

U.S.

25,684,407

5,386,753

11,682,223

8,733,307

Alabama

235,438

49,854

108,937

76,602

Alaska

83,573

15,493

39,360

28,697

Arizona

577,941

128,252

244,486

205,093

Arkansas

156,452

31,082

66,978

58,368

California

5,378,683

959,755

2,437,665

2,102,697

Colorado

352,303

74,038

157,694

120,514

Connecticut

296,033

66,673

144,355

84,932

Delaware

100,469

22,101

48,661

29,690

Florida

1,488,538

269,324

757,908

461,040

Georgia

767,281

170,553

346,789

249,827

Hawaii

104,975

26,674

45,005

33,257

Idaho

95,534

18,731

41,580

35,204

Illinois

574,901

89,261

282,209

203,287

Indiana

347,104

74,265

157,169

115,613

Iowa

154,664

36,607

66,926

51,095

Kansas

165,892

40,646

69,594

55,622

Kentucky

271,032

71,436

112,239

87,309

Louisiana

416,712

91,552

189,688

135,404

Maine

68,972

14,326

30,714

23,920

Maryland

620,413

132,108

320,345

167,874

Massachusetts

480,221

92,326

236,489

151,299

Michigan

768,910

158,914

355,670

254,206

Minnesota

346,809

89,116

143,991

113,629

Mississippi

165,916

36,366

73,996

55,531

Missouri

343,851

93,426

126,532

123,839

Montana

62,562

13,255

27,698

21,596

Nebraska

116,197

32,920

44,322

38,936

Nevada

258,275

53,764

113,639

90,824

New Hampshire

63,308

17,202

26,631

19,461

New Jersey

831,801

183,039

418,332

230,270

New Mexico

181,169

33,112

85,392

62,631

New York

2,370,063

654,247

951,963

763,433

North Carolina

556,719

120,527

264,100

172,018

North Dakota

28,716

6,590

12,285

9,834

Ohio

832,616

204,572

377,656

250,203

Oklahoma

231,650

53,204

96,742

81,670

Oregon

316,804

61,318

138,327

117,114

Pennsylvania

1,016,263

190,445

504,992

320,656

Rhode Island

81,514

20,172

37,884

23,446

South Carolina

260,955

65,333

118,772

76,816

South Dakota

45,287

10,239

19,645

15,397

Tennessee

383,247

96,801

163,584

122,797

Texas

1,673,794

330,606

755,911

587,038

Utah

169,558

31,090

76,291

62,141

Vermont

39,625

8,358

17,395

13,863

Virginia

628,738

125,746

296,411

206,494

Washington

528,774

98,944

231,014

198,728

West Virginia

95,356

20,454

42,956

31,925

Wisconsin

412,066

78,466

191,225

142,311

Wyoming

66,380

12,076

30,217

24,076

D.C.

70,350

11,396

33,860

25,082

Source: Authors’ calculations.

Federal Expenditure for Drug Prohibition Enforcement

This section estimates federal expenditure on drug prohibition enforcement. The estimate relies on data from the Office of Drug Control Policy and equals $16.5 billion for 2007.[19] Adjusting this number for inflation between 2007 and 2008 gives an estimate of $17.1 billion for 2008.

As with state and local revenue, this figure should be adjusted downward by the revenue generated from federal seizures and fines. Appendix M indicates that this amount has been at most $1.5 billion in recent years, implying a net expenditure for the federal government of about $15.6 billion.

Table 4 allocates this $15.6 billion to different drug categories using the percentage of DEA arrests by drug. The fourth line shows that approximately $3.4 billion of the federal expenditure on drug prohibition is due to marijuana prohibition, $8.4 billion to cocaine and heroin, and $3.9 billion to other drugs.

Table 4
Federal Drug Prohibition Expenditure, Billions of 2008 Dollars

All

Marijuana

Cocaine

Heroin

Other

1. Federal Expenditure (2008)

15.6

2. Number of DEA arrests (2007)

26,550

5,700

12,104

2,116

6630

3. Percentage of DEA arrests, by Drug

100.00

21.47

45.59

7.97

24.97

4. Federal Expenditure, by Drug

15.60

3.35

7.11

1.24

3.90

Sources: The data on the fraction of DEA arrests by drug are from U.S. Department of Justice, Federal Drug-Related Arrests, United States, 2003–2008 (Washington: National Drug Intelligence Center, 2009), http://www.usdoj.gov/ndic/pubs31/31379/appendb.htm#TableB1. Federal expenditures were originally reported in 2007 dollars and were adjusted for inflation to 2008 dollars with Office of National Drug Control Policy, National Drug Control Strategy (Washington: ONDCP, 2009), http://www.whitehousedrugpolicy.gov/publications/policy/10budget/fy10budget.pdf.

The Tax Revenue from Legalized Drugs

In addition to reducing government expenditure, drug legalization would generate tax revenue from the legal production and sale of drugs. To estimate the revenue, this report employs the following procedure. First, it estimates current consumer (retail) expenditure on drugs under prohibition. Second, it estimates the consumer expenditure likely to occur under legalization. Third, it estimates the tax revenue that would result from that expenditure based on assumptions about the kinds of taxes that would apply to legalized drugs.

Consumer Expenditure on Drugs under Current Prohibition

The first step in determining the tax revenue under legalization is to estimate expenditures on drugs under current prohibition. ONDCP provides estimates of this expenditure for 2000.[20] These estimates are controversial and rely on a range of assumptions about the drug market. Many analysts have estimated the marijuana market, in particular, to be 10–30 times larger than the ONDCP estimates.

We make three adjustments to the ONDCP estimates. First, we scale them up by the increase in population and the increase in the overall price level from 2000 to 2008.[21] Second, we adjust for changes in use rates between 2000 and 2008, which varied by drug.[22] Third, we inflate the ONDCP estimates to account for underreporting. Considerable evidence suggests that underreporting of illicit drug use is not extreme in the National Household Survey on Drug Abuse, the data source utilized by ONDCP, but the evidence does suggest underreporting in the range of 20–30 percent.[23] We inflate the ONDCP estimates by 25 percent to account for underreporting.[24]

Table 5, line 1, gives the ONDCP estimates for 2000, adjusted for underreporting. Line 2 gives these estimates adjusted for inflation, population growth, and changes in use rates between 2000 and 2008.

Table 5
State and Federal Tax Revenues from Drug Legalization, Billions of 2008 Dollars

All Drugs

Marijuana

Cocaine

Heroin

Other

1. Consumer Expenditure by Drug, 2000

79.50

13.13

44.13

12.50

9.75

2. Consumer Expenditure by Drug, 2008

121.55

18.15

66.12

21.07

16.21

3. Assumed Percent Decline in Price

50.00

80.00

95.00

95.00

4. Assumed Elasticity

-0.50

-0.50

-0.50

-0.50

5. Percent Decline in Expenditure, Legalization

25.00

40.00

47.50

47.50

6. Consumer Expenditure, Legalization

72.86

13.61

39.67

11.06

8.51

7. Consumer Expenditure, Sin Taxation

91.07

17.01

49.59

13.83

10.64

8. Revenue from Sin Taxation

30.36

5.67

16.53

4.61

3.55

9. Consumer Expenditure Subject to Standard Taxation

54.64

10.21

29.76

8.30

6.38

10. Revenue, Standard Taxation

16.39

3.06

8.93

2.49

1.91

11. Tax Revenue

46.75

8.73

25.46

7.10

5.46

12. Federal Tax Collection

31.17

5.82

16.97

4.73

3.64

13. State Collection

15.58

2.91

8.49

2.37

1.82

Sources: http://www.whitehousedrugpolicy.gov/publications/pdf/american_users_spend_2002.pdf; and http://www.census.gov/popest/states/NST-ann-est.html. Consumer expenditures were originally reported in 2000 dollars and were adjusted for inflation to 2008 dollars with http://www.bls.gov/cpi/home.htm#data and for increase in drug usage based on estimates from Monitoring the Future, 2009, http://monitoringthefuture.org/pubs/monigraphs/vol2_2008.pdf Table 418, State and Local Excise Revenue from Alcohol and Tobacco, http://www.census.gov/compendia/statab/cats/state_local_govt_finances_employment.html;; Table 457, Federal Excise Tax Revenue from Alcohol and Tobacco, http://www.census.gov/compendia/statab/cats/federal_govt_finances_employment/federal_budget-receipts_outlays_and_debt.html.

Consumer Expenditure on Drugs under Legalization

The second step in estimating the tax revenue from legalization is to determine how expenditure on drugs would change as the result of legalization. A simple framework in which to consider various assumptions is the supply and demand model. To use this model to assess legalization’s impact on drug expenditure, it is necessary to state what effect legalization would have on the demand and supply curves for drugs.

This report assumes that the demand for drugs would not shift.[25] This assumption likely errs in the direction of understating the tax revenue from legalized drugs since the penalties for possession potentially deter some persons from consuming. Any increase in demand as a result of legalization, however, would plausibly come from casual users, since most heavy users are already consuming despite prohibition. Any increase in use might also come from decreased consumption of alcohol, tobacco, or other goods, so increased tax revenue from legal drugs would be partially offset by decreased tax revenue from other goods. “Forbidden fruit” effects from prohibition might also tend to offset the demand-decreasing effects of penalties for possession.[26] Thus, the assumption of no change in demand is plausible.[27]

If demand does not shift due to legalization, any change in quantity and price must result from changes in supply conditions. Two main effects would operate.[28] On the one hand, drug suppliers in a legal market would not incur the costs imposed by prohibition, such as the threat of arrest, incarceration, fines, asset seizure, and the like. Other things equal, therefore, costs and prices would be lower under legalization. On the other hand, drug suppliers in a legal market would bear the costs of tax and regulatory policies that apply to legal goods but that black market suppliers normally avoid.[29] This implies an offset to the cost reductions resulting from legalization. Further, changes in competition and advertising under legalization can potentially yield higher prices than under prohibition.

The magnitude of legalization’s impact on price is therefore likely to differ across drugs, given differences in supply conditions and in the degree to which prohibition is enforced. For marijuana, the best available evidence comes from comparisons of prices between the U.S. and the Netherlands. Although marijuana is still technically illegal in the Netherlands, the degree of enforcement is substantially below that in the United States, and the sale of marijuana in coffee shops is officially tolerated. The regime thus approximates de facto legalization. Existing data suggest that retail prices in the Netherlands are roughly 50–100 percent of U.S. prices.[30] This report assumes that legalized prices for marijuana would be 50 percent of current prices. For cocaine, available evidence suggests that prices might fall to 20 percent of the current level; for heroin, the evidence suggests prices might fall to 5 percent of the current level.[31] For other drugs, this report assumes that prices fall to 5 percent of the current level.[32] Table 5, line 3, shows these assumptions.

The effect of any price decline that occurs due to legalization depends on the elasticity of demand for drugs.[33] “Elasticity” is a concept that economists use to describe the degree of responsiveness of consumers to price changes, which can vary considerably depending on the product. Evidence concerning this elasticity is limited because appropriate data on drug price and consumption are not readily available. Existing estimates, however, suggest an elasticity of at least -0.5 and plausibly more than -1.0.[34] Estimates for other drugs, as well as for alcohol and tobacco, generally suggest an elasticity in the range of -0.5 to -1.0. If the demand elasticity equals -1.0, then expenditure will remain constant. If demand is less elastic, then expenditure will decline.[35] This report assumes an elasticity of -0.5, as shown in Table 5, line 4.

Table 5, line 5, shows the implications of these assumptions about the decline in price combined with an elasticity of -0.5 for the amount of expenditure that would occur for legalized drugs, assuming the economic activity in legalized drugs markets is subject to standard income and sales taxation. The estimates in line 5 do not assume the presence of a sin tax on legalized drugs.

Tax Revenue from Legalized Drugs

To estimate the tax revenue that would result from drug legalization, it is necessary to assume a particular tax structure. This report assumes that legalized drugs would be taxed at rates comparable to alcohol and tobacco. This means that the legalized drug market would be subject to “sin” taxation as well as standard income and sales taxation.[36] Imposing a high sin tax can force a market underground, thereby reducing rather than increasing tax revenue. Existing evidence, however, suggests that relatively high rates of sin taxation are possible without generating a black market. Cigarette taxes in many European countries, for example, account for 70–80 percent of the price.[37]

To estimate the revenue from sin taxation, this report assumes that state and local plus federal governments impose excise taxes on legalized drugs at a rate equal to 50 percent of the retail price. This implies that excise taxation accounts for 33 percent of the final price to consumers.[38] An excise tax of 50 percent on top of the legalized, retail price would increase (tax-inclusive) expenditure by 25 percent given an assumed elasticity of -0.5. Line 7 of Table 5 shows total expenditure on legalized drugs under these assumptions, while line 8 shows the revenue from sin taxation.[39]

Legalized drugs would also generate tax revenue because the income earned by the producers would be subject to standard income and sales taxation. The amount of income earned is roughly equal to the amount of expenditure. For most legal goods, tax revenue as a fraction of expenditure is approximately 30 percent.[40] This figure includes the sales taxation of roughly 5 percent imposed by most state governments as well as income taxation imposed by state and federal governments.

This 30 percent tax share is consistent with the estimates derived above on the relation between prices under prohibition and prices in a legalized market since those prices were based on comparisons that incorporated any costs of legal goods due to standard taxation.

This 30 percent should be applied to an amount equal to 75 percent of the legalized, pre–sin tax expenditure. This is because while the sin tax raises expenditure given that demand is inelastic, the 50 percent higher price combined with an elasticity of -0.5 leads to a 25 percent reduction in (tax-exclusive) expenditure. Assuming constant costs therefore means that expenditure should be 75 percent of pre–sin tax expenditure. Table 5, lines 9 and 10, provide these calculations.

Table 5, line 11, adds the revenue from sin taxation and standard income/sales taxation to provide estimates of the total tax revenue that would accrue from a regime in which drugs are legal but taxed and regulated similarly to alcohol and tobacco. For all drugs, the estimate is $46.7 billion. Of this, $8.7 billion would be attributed to marijuana, $32.6 billion to cocaine and heroin, and $5.5 billion to other drugs. In lines 12 and 13, we attribute two-thirds of this revenue to federal tax collection and one-third to state/local tax collection because that is roughly the ratio for existing tax revenues.

State-by-State Estimates

Table 6 provides state-by-state breakdowns of all the estimates provided in this section, assuming these revenues are proportional to population. These should be regarded as subject to more uncertainty than the national estimates due to data limitations. Alternatively, Appendix Table I utilizes the state-level estimates of drug consumption rates from the 2006 and 2007 National Survey on Drug Use and Health to provide state level estimates based on state use rates.[41] Given the sample sizes involved in estimating these use rates, the estimates based on population are plausibly more reliable.

Table 6
State Drug Tax Revenue—Population Method, Millions of 2008 Dollars

State

All Drugs

Marijuana

Heroin/
Cocaine

Other

U.S.

15,583.33

2,910.87

10,852.17

1,820.30

Alabama

238.93

44.63

166.39

27.91

Alaska

35.17

6.57

24.49

4.11

Arizona

333.14

62.23

232.00

38.91

Arkansas

146.34

27.34

101.91

17.09

California

1,883.81

351.88

1,311.88

220.05

Colorado

253.15

47.29

176.29

29.57

Connecticut

179.44

33.52

124.96

20.96

Delaware

44.75

8.36

31.16

5.23

Florida

939.34

175.46

654.16

109.73

Georgia

496.40

92.72

345.69

57.99

Hawaii

66.02

12.33

45.98

7.71

Idaho

78.10

14.59

54.39

9.12

Illinois

661.22

123.51

460.47

77.24

Indiana

326.82

61.05

227.59

38.18

Iowa

153.88

28.74

107.16

17.98

Kansas

143.61

26.83

100.01

16.78

Kentucky

218.80

40.87

152.37

25.56

Louisiana

226.06

42.23

157.43

26.41

Maine

67.47

12.60

46.99

7.88

Maryland

288.73

53.93

201.07

33.73

Massachusetts

333.03

62.21

231.92

38.90

Michigan

512.68

95.77

357.03

59.89

Minnesota

267.55

49.98

186.32

31.25

Mississippi

150.61

28.13

104.88

17.59

Missouri

302.98

56.59

210.99

35.39

Montana

49.58

9.26

34.53

5.79

Nebraska

91.40

17.07

63.65

10.68

Nevada

133.26

24.89

92.80

15.57

New Hampshire

67.44

12.60

46.96

7.88

New Jersey

444.99

83.12

309.89

51.98

New Mexico

101.70

19.00

70.82

11.88

New York

998.90

186.59

695.63

116.68

North Carolina

472.66

88.29

329.16

55.21

North Dakota

32.88

6.14

22.90

3.84

Ohio

588.66

109.96

409.94

68.76

Oklahoma

186.67

34.87

130.00

21.81

Oregon

194.24

36.28

135.27

22.69

Pennsylvania

637.99

119.17

444.29

74.52

Rhode Island

53.85

10.06

37.50

6.29

South Carolina

229.59

42.89

159.89

26.82

South Dakota

41.22

7.70

28.70

4.81

Tennessee

318.52

59.50

221.82

37.21

Texas

1,246.78

232.89

868.25

145.64

Utah

140.24

26.20

97.67

16.38

Vermont

31.84

5.95

22.17

3.72

Virginia

398.17

74.38

277.29

46.51

Washington

335.65

62.70

233.75

39.21

West Virginia

92.99

17.37

64.76

10.86

Wisconsin

288.44

53.88

200.87

33.69

Wyoming

27.30

5.10

19.01

3.19

D.C.

30.33

5.67

21.12

3.54

Source: Authors’ calculations.

Table 7
Summary of Expenditures and Revenues from Drug Legalization, Billions of 2008 Dollars

All Drugs

Marijuana

Heroin/
Cocaine

Other

Expenditures

State/Local

25.7

5.4

11.7

8.7

Federal

15.6

3.3

8.4

3.9

Total

41.3

8.7

20.0

12.6

Revenues

State

15.6

2.9

10.9

1.8

Federal

31.2

5.8

21.7

3.6

Total

46.7

8.7

32.6

5.5

Source: Authors’ calculations.

Conclusion

Table 7 summarizes all the estimates of expenditure reductions and tax increases for both the federal government and the sum of all state governments. Three aspects of these estimates stand out.

First, the total impact of drug legalization on government budgets would be approximately $88 billion per year.

Second, about half of the budgetary improvement from legalization is due to reduced criminal justice expenditure. But for this component of the impact to show up in government budgets, policymakers would have to lay off police, prosecutors, prison guards, and the like. Because such a move would be politically painful, it may not occur. It is certainly true that reduced expenditure on enforcing drug prohibition can still be beneficial if those criminal justice resources are re-deployed to better uses, but that outcome is difficult to achieve.

Third, only about $17.4 billion in budgetary improvement can be expected to come from legalizing marijuana in isolation. Yet the current political climate gives no indication that legalization of other drugs is achievable in the short term. So the budgetary impact from the politically possible component of legalization—marijuana—seems fairly modest.

None of these considerations weakens the critique of drug prohibition since that critique has always rested mainly on other considerations, such as the crime, corruption, and curtailment of civil liberties that have been the side-effects of attempting to fight drug use with police officers and prisons.[42] What the estimates provided here do provide are two additional reasons to end drug prohibition: reduced expenditure on law enforcement and an increase in tax revenue from legalized sales.

Appendixes

Sources: Uniform Crime Reports Drug Arrest Data 2007. Florida (1995): http://fisher.lib.virginia.edu/collections/stats/crime/. Minnesota (2006): http://www.icpsr.umich.edu/cocoon/NACJD/STUDY/23780.xml.
Notes: For data considerations on the 2007 Crime in the US report: http://www.fbi.gov/about-us/cjis/ucr/crime-in-the-u.s/2007.
Limited arrest data were received from Illinois; i.e., only Chicago and Rockford provided statistics in accordance with UCR guidelines.
No 2007 arrest data were received from the District of Columbia’s Metropolitan Police Department. The only agency (Metro Transit Police) in the District of Columbia for which 12 months of arrest data were received has no attributable population.

No 2007 arrest data were received from Hawaii. However, arrest totals for this state were estimated by the national UCR Program and were included in Table 29 “Estimated Number of Arrests, United States, 2007.”
No 2007 arrest data were received from the New York City Police Department. However, arrest totals for this area were estimated by the national UCR Program and were included in Table 29 “Estimated Number of Arrests, United States, 2007.”

Sources: Uniform Crime Reports Drug Arrest Data 2007. Florida (1995): http://fisher.lib.virginia.edu/collections/stats/crime/. 3. Minnesota (2006): http://www.icpsr.umich.edu/cocoon/NACJD/STUDY/23780.xml.

Sources: Police Expenditure and Judicial Budget: 2005–2006 State Government Finance Data, US Census: http://www.census.gov/govs/estimate/. Felony Convictions: http://ojp.usdoj.gov/bjs/pub/html/scscf04/tables/scs04101tab.htm. Corrections Budget: http://www.census.gov/govs/www/estimate06.html; http://www.albany.edu/sourcebook/pdf/t600012005.pdf. Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with http://www.bls.gov/cpi/home.htm#data. Net S/L Expenditure was calculated using total seizures and fines of $426,393,100. Seizures and fines numbers are explained in Appendix M, and are adjusted for inflation to 2008. Note there is a 9.6% downward correction for police officers without general arrest capabilities and a 58.3% downward correction for nonfelony or misdemeanor trials (see Appendix J).

Sources: Police Expenditure and Judicial Budget: 2005–2006 State Government Finance Data, US Census: http://www.census.gov/govs/estimate/. Felony Convictions: http://ojp.usdoj.gov/bjs/pub/html/scscf04/tables/scs04101tab.htm. Corrections Budget: http://www.census.gov/govs/www/estimate06.html; http://www.albany.edu/sourcebook/pdf/t600012005.pdf. Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with http://www.bls.gov/cpi/home.htm#data. Net S/L Expenditure was calculated using total seizures and fines of $426,393,100. Seizures and fines numbers are explained in Appendix M, and are adjusted for inflation to 2008. Note there is a 9.6% downward correction for police officers without general arrest capabilities and a 58.3% downward correction for nonfelony or misdemeanor trials (see Appendix J).

Sources: Police Expenditure and Judicial Budget: 2005–2006 State Government Finance Data, US Census: http://www.census.gov/govs/estimate/. Felony Convictions: http://ojp.usdoj.gov/bjs/pub/html/scscf04/tables/scs04101tab.htm. Corrections Budget: http://www.census.gov/govs/www/estimate06.html; http://www.albany.edu/sourcebook/pdf/t600012005.pdf Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with http://www.bls.gov/cpi/home.htm#data. Net S/L Expenditure was calculated using total seizures and fines of $426,393,100. Seizures and fines numbers are explained in Appendix M, and are adjusted for inflation to 2008. Note there is a 9.6% downward correction for police officers without general arrest capabilities and a 58.3% downward correction for nonfelony or misdemeanor trials (see Appendix J).

Sources: Police Expenditure and Judicial Budget: 2005–2006 State Government Finance Data, US Census: http://www.census.gov/govs/estimate/. Felony Convictions: http://ojp.usdoj.gov/bjs/pub/html/scscf04/tables/scs04101tab.htm. Corrections Budget: http://www.census.gov/govs/www/estimate06.html; http://www.albany.edu/sourcebook/pdf/t600012005.pdf. Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with http://www.bls.gov/cpi/home.htm#data. Net S/L Expenditure was calculated using total seizures and fines of $426,393,100. Seizures and fines numbers are explained in Appendix M, and are adjusted for inflation to 2008. Note there is a 9.6% downward correction for police officers without general arrest capabilities and a 58.3% downward correction for nonfelony or misdemeanor trials (see Appendix J).

Sources: Police Expenditure and Judicial Budget: 2005–2006 State Government Finance Data, US Census: http://www.census.gov/govs/estimate/. Felony Convictions: http://ojp.usdoj.gov/bjs/pub/html/scscf04/tables/scs04101tab.htm. Corrections Budget: http://www.census.gov/govs/www/estimate06.html; http://www.albany.edu/sourcebook/pdf/t600012005.pdf. Budgets were originally reported for 2005–2006 and were converted to 2008 dollars with http://www.bls.gov/cpi/home.htm#data. Net S/L Expenditure was calculated using total seizures and fines of $426,393,100. Seizures and fines numbers are explained in Appendix M, and are adjusted for inflation to 2008. Note there is a 9.6% downward correction for police officers without general arrest capabilities and a 58.3% downward correction for nonfelony or misdemeanor trials (see Appendix J).

Source: State population estimates (2008): http://www.census.gov/popest/national/files/NST-EST2008-alldata.csv.

Source: Use proportion (2007): http://www.oas.samhsa.gov/2k7state/AppB.htm#TabB-1.

Appendix J
Adjudications Expenditures Attributable to Misdemeanor/Felony Cases

Since we weight the judicial and legal budget by the proportion of felony cases (and not all cases) that are drug-related, we must accordingly adjust state and local adjudications expenditures to reflect the proportion of cases spent on felonies and misdemeanors. We assume that the proportion of felony cases that are drug-related can be applied to misdemeanor cases as well. There is no aggregate report that reflects the proportion of adjudications expenditures that goes to felony and misdemeanor cases, so we collected data from eight existing state reports.

The unit of measurement for workload varied across reports—for California it was measured by judicial need, and for the other states it was measured in units of time. The fraction of felony and misdemeanor cases for each state was taken by dividing the workload for felony and misdemeanor cases by the workload for all cases. These numbers were then adjusted by state weights based on population. The weighted average for the amount of judicial and legal workload attributable to felony and misdemeanor cases was 41.66%.

Source: All reports can be found at http://www.ncsconline.org/wc/CourTopics/StateLinks.asp?id=87&topic=WorkLd.

Appendix K
Percentage of Incarcerated Drug Offenders by Drug Type (Marijuana)

While there is data available on the fraction of drug sales and manufacturing arrests by drug type, there is no aggregate statistic for the fraction of drug-related incarcerations by drug type. This was problematic for calculating corrections expenditures by drug because offenders are not necessarily incarcerated in the same proportion by drug for which they are arrested. This is because some offenses, such as possession of heroin, might be considered more punishable than others, such as possession of marijuana.

In order to calculate a proportion for drug incarcerations by drug, we looked at prisoner population statistics from every state. Only six states classified drug offenders by type of drug, and of those six, only three were specific enough to make distinctions among heroin, cocaine, and other types of drugs.

In order to use all available data, we first constructed a weighted average (by state population) for the proportion of drug offenders that were incarcerated for a marijuana offense. This number came out to be 8.2%, as demonstrated below.

Sources: California: http://www.cdcr.ca.gov/Reports_Research/Offender_Information_Services_Branch/Annual/CalPris/CALPRISd2008.pdf. Colorado: http://www.doc.state.co.us/sites/default/files/opa/StatRprt_FY09.pdf. Georgia: http://www.dcor.state.ga.us/Reports/Annual/pdf/inmadmFY2009.pdf. Illinois: http://www.idoc.state.il.us/subsections/reports/annual_report/FY09%20DOC%20Annual%20Rpt.pdf. Indiana: http://www.in.gov/idoc/files/CY2009OffenderPopulation.pdf. Minnesota: http://www.corr.state.mn.us/publications/documents/drugbackgrounder.pdf.

Appendix L
Percentage of Incarcerated Drug Offenders by Drug Type (Non-Marijuana)

After the proportion of drug offenders incarcerated for marijuana was calculated, we came up with similar state-level proportions for the three states with data on other drugs, except excluding marijuana. These were then weighted by the populations of these three states. The final proportions were then normalized to account for the inclusion of marijuana. The final weighted share for heroin and cocaine offenders is 51.5%, for synthetic drug offenders is 25.7%, and for all other drug offenders is 14.6%. This is demonstrated in the table below.

Sources: Georgia: http://www.dcor.state.ga.us/Reports/Annual/pdf/inmadmFY2009.pdf. Indiana: http://www.in.gov/idoc/files/CY2009OffenderPopulation.pdf. Minnesota: http://www.corr.state.mn.us/publications/documents/drugbackgrounder.pdf.
* Opiates were categorized as heroin; “cocaine and narcotics” were categorized as cocaine and heroin. When unspecified, drugs were categorized as “other,” even though this category might be overestimated because the original figures might have included heroin, cocaine, or synthetic drugs. “Legend drugs” and “Indiana schedule IV substances” are categorized as synthetic drugs. For Minnesota, it was assumed that half of all drugs categorized as “other” were heroin or opiates.

Appendix M
Revenue under Prohibition from Seizures and Fines

Seizures. In 2007, U.S. attorneys received $1.3 billion of forfeiture. This overstates revenue related to drugs because the figure includes seizures for all reasons, such as violation of gun laws, intellectual property laws, and the like. There may also be double-counting between the DEA seizures and the U.S. Customs seizures.

State and local data on forfeiture revenue are not readily available. Katherine Baicker and Mireille Jacobson, “Finders Keepers: Forfeiture Laws, Policing Incentives, and Local Budgets” (manuscript, Department of Economics, Dartmouth College, 2004), however, estimate using a sample of states that state forfeiture revenue per capita was roughly $1.14 during the 1994–2001 period. This implies aggregate state forfeiture revenue of $342 million. Adjusting for inflation implies a number around $400 million.

Fines. In 2007, the total quantity of fines and restitutions ordered for drug offense cases in U.S. District Courts was just under $38.1 million.[1] Assuming the ratio of state/local to federal fine/restitution revenue is similar to ratio of state/local to federal seizure revenue implies that state and local fine/restitution revenue from drug cases is about $10 million.

1 See http://www.albany.edu/sourcebook/1995/pdf/t531.pdf.

Notes

The authors would like to acknowledge a grant from the Criminal Justice Policy Foundation in support of research into the budgetary costs of drug prohibition. The authors also wish to thank Ting Zhang, Saria Sheikh, and Sanja Misra for providing excellent research assistance.

1. Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2010 to 2020 (Washington: CBO, 2010), p. xii; Office of Management and Budget, Analytical Perspectives: Budget of the U.S. Government, Fiscal year 2011 (Washington: OMB, 2010): p. 47.

2. Elizabeth McNichol and Nicholas Johnson, “Recession Continues to Batter State Budgets: State Responses Could Slow Recovery,” Center on Budget and Policy Priorities, May 27, 2010.

3. See Office of the Governor, “2010–2011 Budget Proposal: Solving California’s $20 Billion Deficit”, Fact Sheet, http://gov.ca.gov/index.php?/fact-sheet/14147/. Marijuana would still be prohibited under federal law, which raises constitutional issues as well as complications for estimating the fiscal impact of legalization.

4. See “Yes on Prop 19,” http://www.taxcannabis.org/index.php/pages/about.

5. See, for example, the estimates in Jeffrey A. Miron, “The Effect of Marijuana Decriminalization on the Budgets of Massachusetts Governments, with a Discussion of Decriminalization’s Effect on Drug Use,” Report to the Drug Policy Forum of Massachusetts (October 2002) versus those in Jeffrey A. Miron, “The Budgetary Implications of Marijuana Legalization in Massachusetts,” Report to Change the Climate (August 2003).

6. This report addresses only the criminal justice costs of enforcing drug prohibition; it does not address any possible changes in prevention, education, or treatment expenses that might accompany legalization. The narrower approach is appropriate because the decision to prohibit drugs is separate from the decision to subsidize prevention, education, and treatment. Drug legalization might nevertheless cause some reduction in government expenditure for demand-side policies. For example, legalization would likely mean reduced criminal justice referrals of drug offenders to treatment; this category accounted for 15–50 percent of drug treatment referrals in 2006, depending on the drug category (U.S. Department of Health and Human Services, 2006, Appendix Table D, p. 14). Thus, the approach adopted here implies a conservative estimate of the reduction in government expenditure from drug legalization.

7. For example, under current rules regarding parole and probation, a positive urine test for drugs can send a parolee or probationer to prison, regardless of the original offense. These rules might change under legalization, implying additional reductions in government expenditure.

8. Only 90.4 percent of paid full-time and part-time police officers have general arrest powers. See the 2003 Sample Survey of Law Enforcement Agencies at http://www.icpsr.umich.edu/cocoon/NACJD/STUDY/04411.xml.

9. To the extent it takes additional resources to process an arrestee on multiple charges rather than on a single charge, there is still a net utilization of police resources in such cases due to prohibition. In addition, there is typically a lab test to determine the precise content of any drugs seized when there is an arrest on drug charges, implying utilization of additional resources due to prohibition. A different issue is that in some cases, police stops for non-drug charges that discover drugs and produce an arrest on drug charges might not have led to any arrest in the absence of the drug charge (e.g., because of insufficient evidence).

10. Jeffrey A. Miron, “The Effect of Marijuana Decriminalization”; Peter Reuter, Paul Hirschfield, and Curt Davies, “Assessing the Crack-Down on Marijuana in Maryland,” (manuscript, University of Maryland, 2001). Minchin Lewis, Report on the Syracuse Police Department Activity for the Year Ended June 30, 2002 (Department of Audit, City of Syracuse, 2004) reports that in 2002 the fraction of stand-alone arrests was 90.5 percent in Syracuse, New York.

11. Appendix J contains more information on the methodology employed to arrive at this percentage.

12. These calculations are for the aggregate of all state and local expenditure in this category because state-level data on the percent of prosecutions due to drug laws are available.

13. This figure is not available by drug. The calculations here assume that the fraction of felony convictions by drug equals the fraction of sale/manufacturing arrests by drug. One study suggests that this assumption overstates judicial and legal budget due to marijuana prohibition because marijuana charges are less likely to be prosecuted than other drug charges. See Beau Kilmer et al., “Altered States? Assessing How Marijuana Legalization in California Could Influence Marijuana Consumption and Public Budgets,” Rand Drug Policy Research Center Occasional Paper no. 315, 2010.

14. This report excludes the capital outlays portion of the corrections budget since the available data do not indicate the average rate of such expenditures. This biases the estimates downward. Further, these calculations are for the aggregate of all state and local expenditure in this category because state-level data on the percent of prisoners due to drug laws are not available.

15. The proportion of drug offenders who are incarcerated by drug is not necessarily equivalent to the proportion of sales/manufacturing arrests by drug, since certain drugs might be considered more serious than others. This proportion, however, is not available for all states. In order to come up with an estimate of percentages by drug, we gathered individual state data on incarcerated drug offenders from six state-specific reports. All six included information on the number of marijuana prisoners, but only three reports contained information on the number of incarcerated prisoners for heroin, cocaine, and other drugs. Appendix K gives more information on this weighting methodology.

16. Most seized assets are ultimately forfeited.

17. Since these data are not available by drug, the estimates assume that seizure and fine revenue are roughly proportional to gross expenditure.

18. Inflation rate data used throughout the paper are from the U.S. Department of Labor, Consumer Price Index—All Urban Consumers (Bureau of Labor Statistics, http://www.bls.gov/cpi/home.htm#data). As a check, it is useful to compare the estimate provided here to that derived from an alternative methodology. Office of National Drug Control Policy, State and Local Spending on Drug Control Activities, Washington, 1993, reports survey evidence on drug prohibition enforcement by state and local authorities for the years 1990/1991. Adjusting these data for inflation and the percent attributable to drug prohibition yields an estimate similar to that reported above. The 1990 estimate is $23.02 billion for state and local drug expenditures on police/adjudications/corrections combined, and the 1991 estimate is $24.96 billion.

19. Office of National Drug Control Policy, National Drug Control Strategy (Washington, 2009), pp. 14 and A1, http://www.whitehousedrugpolicy.gov/publications/policy/10budget/fy10buget.pdf. This consists of expenditures in the following categories: Department of Defense ($1,242.7 million); Department of Homeland Security ($2,934.8 million and $65.0 million for other expenditures); Department of Justice ($2,921.1 million and $4,996.7 million for other expenditures); ONDCP ($421.7 million); Department of State ($1,125.7 million and $3.0 million for other expenditures); Department of Transportation ($2.7 million and $25.7 million for other expenditures); Department of Treasury ($57.3 million and $1,546.8 million for other expenditures); D.C. Court Services and Offender Supervision ($78.5 million); Department of the Interior ($6.6 million); and The Federal Judiciary ($1,025.3 million). Patrick Murphy et al., Improving Anti-Drug Budgeting (Santa Monica, CA: Rand, 2000) examine the methods used by ONDCP to estimate this expenditure. They conclude that methodological problems render parts of the estimates biased, by substantial amounts in some cases. However, these issues do not imply major qualifications to the data considered here. Murphy et al. find that the anti-drug budgets of the Coast Guard and the Bureau of Prisons are accurate reflections of the resources expended, whereas the reported expenditure of the Department of Defense probably underestimates its anti-drug budget. The overestimates that they identify occur for demand-side activities. The 2003 National Drug Control Strategy adopted a new methodology for estimating the federal drug control budget. This new methodology implies a substantial reduction in supply side expenditure (Office of National Drug Control Policy, National Drug Control Strategy, pp. 33–34). For the purposes of this report, however, the old methodology is more appropriate. For example, the new approach excludes expenditures on incarceration of persons imprisoned for drug crimes.

20. Office of National Drug Control Policy, What America’s Users Spend on Illegal Drugs (Cambridge, MA: Abt Associates, 2001); Table A, p. 3.

21. Inflation data came from http://www.bls.gov/data/inflation_calculator.htm, and population data from http://www.census.gov/popest/states/NST-ann-est.html.

22. Usage rates have increased slightly between 2000 and 2008. Prevalence rates for usage of all illicit drugs have increased from 30.8 percent to 33.8 percent; for marijuana usage, from 27.9 percent to 28.6 percent; for cocaine, from 5.4 percent to 6.0 percent; for heroin, from 0.4 percent to 0.5 percent; for other drugs, from 11.6 percent to 14.3 percent. See Monitoring the Future 2009, p. 151, http://monitoringthefuture.org/pubs/monographs/vol2_2008.pdf.

23. Beau Kilmer and Rosalie Liccardo Pacula, Estimating the Size of the Global Drug Market: A Demand-Side Approach—Report 2 (Santa Monica, CA: RAND Corporation, 2009), http://www.rand.org/pubs/technical_reports/TR711/.

24. Some evidence suggests that underreporting is lower for marijuana than for harder drugs, but for simplicity we apply the same adjustment across drugs. This could mean our marijuana estimates are too large.

25. To be explicit, we assume no shift in the demand curve. If the supply curve shifts, the quantity demanded will change.

26. The “forbidden fruit” effect refers to the idea that some people use drugs because they are illegal. If drugs are made legal, these consumers might well stop spending their dollars on drugs.

27. Regulation aimed at drug use and sale (e.g., age limits on purchase or licensing and zoning restrictions on sale) might also reduce demand relative to prohibition because legal sellers face a stronger incentive to obey such regulation than underground sellers, who are already hiding their actions from authorities.

28. Jeffrey A. Miron, “Do Prohibitions Raise Prices? Evidence from the Markets for Cocaine and Heroin,” Review of Economics and Statistics 85, no. 3 (2003): 522–30.

29. The underlying assumption is that the marginal costs of evading tax and regulatory costs is zero for black market suppliers who are already conducting their activities in secret.

30. Robert MacCoun and Peter Reuter, “Interpreting Dutch Cannabis Policy: Reasoning by Analogy in the Legalization Debate,” Science 278 (1997): 47–52. Authors report gram prices of $2.50–$12.50 in the Netherlands and $1.50–$15.00 in the U.S. They speculate that the surprisingly high prices in the Netherlands might reflect enforcement aimed at large-scale trafficking. Lana D. Harrison, Michael Backenheimer, and James A. Inciardi, “Cannabis Use in the United States: Implications for Policy,” in Peter Cohen and Arjan Sas, eds., Cannabisbeleid in Duitsland, Frankrijk en do Verenigde Staten (Amsterdam: Centrum voor Drugsonderzoek, Universiteit van Amsterdam, 1995), pp. 231–36. Harrison et al. note that ONDCP data on marijuana prices in the U.S. are similar to prices charged in Dutch coffee shops. Office of National Drug Control Policy, The Price of Illicit Drugs: 1981 through Second Quarter of 2000 (Washington: Abt Associates, 2001b) reports a price per gram for small-scale purchases of roughly $9 in the second quarter of 2000, while European Monitoring Centre for Drugs and Drug Addiction, Annual Report 2002 (2002), http://annualreport.emcdda.u.int/pdfs/2002_0458_EN.pdf, suggests a price of 2–8 Euros per gram, which is roughly $6 on average. Various web sites that discuss the coffee shops in Amsterdam suggest prices of $5–$11 per gram in recent years. These comparisons do not adjust for potency or other dimensions of quality. Kenneth W. Clements and Mert Daryal, “Marijuana Prices in Australia in 1990s” (manuscript, Economic Research Centre, Department of Economics, The University of Western Australia, 2001) report marijuana prices for Australia that are similar to or higher than those in the United States. Since Australian drug policy is noticeably less strict than U.S. policy, this observation is consistent with the view that legalization would not produce a dramatic fall in price.

31. The results in Jeffrey A. Miron, “Do Prohibitions Raise Prices?” pp. 522–30 come from two kinds of evidence. The first is analysis of the relation between farm gate prices and retail prices for “similar” goods such as coffee or chocolate. The second is examination of prices for legal versions of currently illegal drugs, such as those for medical versions of cocaine and opiates like morphine.

32. The report assumes a 5 percent value for other drugs because direct evidence is not available, and this assumption errs on the conservative side.

33. The elasticity of demand is the percentage change in the quantity demanded that results from a one percentage point change in the price. For example, an elasticity of -0.5 means that if price falls by 10 percent, the quantity demanded will increase by 5 percent. An “elastic” demand curve is one for which the elasticity is large (in absolute value).

34. See Charles T. Nisbet and Firouz Vakil, “Some Estimates of Price and Expenditure Elasticities of the Demand for Marijuana among U.C.L.A. Students,” Review of Economics and Statistics 54 (1972): 473–75. Their estimates that use survey data imply price elasticities of -0.365 or -0.51 in the log and linear specifications, respectively, while the purchase data imply price elasticities of -1.013 and -1.51. The estimates based on purchase data are plausibly more reliable. Moreover, as they note, these estimates are likely biased downward by standard simultaneous equations bias. Clemens and Daryal (1999) estimate a price elasticity of -0.5 for drugs using Australian data. Estimates of the demand for “similar” goods (e.g., alcohol, cocaine, heroin, or tobacco) suggest similar elasticities. Rosalie Liccardo Pacula et al., “Drugs and Youth,” National Bureau of Economic Research Working Paper no. 7703 (2000). Pacula et al. summarize the literature on the relation between drug use and factors that can affect use, such as legal penalties. They conclude the evidence is mixed but overall indicates a moderate response of drug consumption to “price.” The papers summarized do not provide measures of the price elasticity. The results reported by Pacula et al. suggest an elasticity of drug participation between 0.0 and -0.5; this understates the total elasticity, which includes any change in consumption conditional on participation. The literature since Nisbet and Vakil is thus consistent with the elasticity estimate assumed above.

35. The phrase “if demand is less elastic” can be read as “if demand is less responsive (to price).”

36. R. Keith Schwer, Mary Riddel, and Jason Henderson, “Fiscal Impact of Question 9: Potential State-Revenue Implications” (Center for Business and Economic Research, University of Nevada, Las Vegas, 2002). Schwer et al. estimate the tax revenue from marijuana legalization in Nevada assuming “sin” taxation. Their estimates are not readily comparable to those presented here because they consider the situation in which one state legalizes marijuana while other states and the federal government prohibit marijuana. The same comment applies to Scott W. Bates, “The Economic Implications of Marijuana Legalization in Alaska” (report for Alaskans for Rights & Revenues, Fairbanks, Alaska, 2004), who estimates the tax revenue from marijuana legalization in Alaska. See Stephen T. Easton, “Marijuana Growth in British Columbia,” Public Policy Sources, Fraser Institute Occasional Paper no. 74, 2004. Easton estimates the tax revenue from marijuana legalization in Canada under the assumption of sin taxation. His estimates are comparable but modestly higher than those presented here, adjusted for the different size of the U.S. and Canadian economies. See Michael R. Caputo and Brian J. Ostrom, “Potential Tax Revenue from a Regulated Drug Market: A Meaningful Revenue Source,” American Journal of Economics and Sociology 53 (1994): 475–90. Authors provide estimates for the overall economy that are similar to those obtained here.

37. U.S. Department of Health and Humans Services, Reducing Tobacco Use: A Report of the Surgeon General, Tobacco Taxation Fact Sheet (2000), http://www.cdc.gov/tobacco/data_statistics/sgr/sgr_2000/00_pdfs/CDC-60100788-Tax.PDF. But see Patrick Fleenor, “Cigarette Taxes, Black Markets, and Crime: Lessons from New York’s 50-Year Losing Battle,” Cato Institute Policy Analysis no. 468 (2003).

38. These assumptions imply an amount of sin taxation as a percent of expenditure that is similar to what currently occurs in the U.S. for alcohol and tobacco. In 2007, federal excise tax receipts from alcohol and tobacco were $8.6 billion and $7.6 billion, respectively (See Table 457 of U.S. Census 2009, http://www.census.gov/compendia/statab/tables/09s0457.pdf), and state and local excise tax receipts from alcohol and tobacco were $5.7 billion and $15.8 billion, respectively (See Appendix Table A of U.S. Census 2007, http://www2.census.gov/govs/estimate/0700ussl_1.txt ). This implies total excise taxation on alcohol and tobacco of $14.3 billion and $23.4 billion, respectively. In this same year, consumer expenditure on alcohol and tobacco were $54.9 billion ($457 per consumer unit for 120,171 units) and $33.8 billion ($323 per consumer unit for 120,171 units), respectively (See U.S. Department of Labor 2007, ftp://ftp.bls.gov/pub/special.requests/ce/standard/2007/cusize.txt). These figures imply that excise taxation accounts for roughly 26 percent (alcohol) and 69 percent (tobacco) of expenditure.

39. These amounts are not necessarily attainable given the characteristics of drug production. Small scale, efficient production is possible, so the imposition of a substantial tax might encourage a portion of the market to remain underground. Whether such production is illicit depends on the details of a legalization law. Plausibly, growing small amounts for personal use would not be subject to taxation or regulation, just as growing small amounts of vegetables or herbs is not subject to taxation or regulation. The evidence suggests that the magnitude of such production would be minimal. In particular, alcohol production switched mostly from the black market to the licit market after repeal of Alcohol Prohibition in 1933. The assumption of a constant demand elasticity in response to a price change of this magnitude is also debatable; more plausibly, the elasticity would increase as the price rose, implying a larger decline in consumption and thus less revenue from excise taxation.

40. In 2001 total government receipts divided by GDP equaled 29.7 percent. See the 2003 Economic Report of the President, http://www.gpoaccess.gov/usbudget/fy04/pdf/2003_erp.pdf, Tables B-1 and B-92, pp. 276 and 373.

41. Tables can be found at http://www.oas.samhsa.gov/2k7state/AppB.htm#TabB-1.

42. See Jeffrey A. Miron, Drug War Crimes: The Consequences of Prohibition (Oakland, CA: Independent Institute, 2004); James Ostrowski, “Thinking about Drug Legalization,” Cato Institute Policy Analysis no. 121 (May 25, 1989).

Cato Institute

Founded in 1977, the Cato Institute is a public policy research foundation dedicated to broadening the parameters of policy debate to allow consideration of more options that are consistent with the traditional American principles of limited government, individual liberty, and peace. To that end, the Institute strives to achieve greater involvement of the intelligent, concerned lay public in questions of policy and the proper role of government.

The Institute is named for Cato’s Letters, libertarian pamphlets that were widely read in the American Colonies in the early 18th century and played a major role in laying the philosophical foundation for the American Revolution.

Despite the achievement of the nation’s Founders, today virtually no aspect of life is free from government encroachment. A pervasive intolerance for individual rights is shown by government’s arbitrary intrusions into private economic transactions and its disregard for civil liberties.

To counter that trend, the Cato Institute undertakes an extensive publications program that addresses the complete spectrum of policy issues. Books, monographs, and shorter studies are commissioned to examine the federal budget, Social Security, regulation, military spending, international trade, and myriad other issues. Major policy conferences are held throughout the year, from which papers are published thrice yearly in the Cato Journal. The Institute also publishes the quarterly magazine Regulation.

In order to maintain its independence, the Cato Institute accepts no government funding. Contributions are received from foundations, corporations, and individuals, and other revenue is generated from the sale of publications. The Institute is a nonprofit, tax-exempt, educational foundation under Section 501(c)3 of the Internal Revenue Code.

CATO INSTITUTE
1000 Massachusetts Ave., N.W.
Washington, D.C. 20001
www.cato.org