As we document in our recent book and companion report, cannabis containing THC, which we refer to as weed, is legal to produce, process, market and use in most U.S. states and all of Canada, despite being designated a Schedule I narcotic under federal law. Further, as a practical matter, weed has long been readily available from illegal sources almost everywhere for half a century or more, and has been widely used for many decades by millions of people across a wide swath of society.

Gradually reduced de facto federal enforcement, along with official memoranda and other public statements from the Department of Justice, have helped “legal” weed take root in states that, beginning in 1996, authorized its use for medical or recreational use (or both). Now, finally, Congress seems willing to accept that prohibiting cannabis cultivation, processing, marketing and consumption is counterproductive.

Given the current situation and trends for state legalization, we see four broad possibilities for how federal weed policy will evolve:

• Return to aggressive enforcement of the federal weed prohibition even in states where a legal industry is fully established, shutting down those industries and prosecuting people by the thousands or millions.

• Continue the current situation of policy contradictions and uncertainty, which allows for capricious federal enforcement and creates legal conflicts that nobody favors.

• Enact federal weed legalization with an elaborate program of federal licensing, regulation and taxation, along with an expanded federal bureaucracy to go with it. 

• Remove weed from the schedule of illegal drugs and make a handful of other edits to federal law consistent with this de-scheduling.

There seems to be no significant support for the first option, so we discuss it no further. Option two, no federal action, may be the likely outcome politically for the near future. But just for kicks, let’s compare the economic implications of the third and fourth options.

Below, we first describe current federal law, regulation and practice. Then we discuss and evaluate options currently being considered for federal policy change.

Federal Weed Policy, 2022

About three-quarters of all U.S. adults have access to legal weed in their home states. Nevertheless, the production, distribution and sale of any amount of weed are federal felonies punishable by severe penalties up to life imprisonment. Mere possession is a federal misdemeanor punishable by jail time for the first offense and, upon the third offense, possession can turn into a felony punishable by up to three years in federal prison.

These federal laws have changed little since the passage of the 1970 Controlled Substances Act. Further, they were periodically and unpredictably enforced against early medical weed providers in the first few states to legalize weed production and distribution in the late 1990s and early 2000s.

Legal challenges to federal enforcement failed to affect federal policy. For example, in the famous case of Gonzales v. Raich in 2005,  despite a scathing dissent from Justice Clarence Thomas, the Supreme Court upheld the legality of actions of the federal Drug Enforcement Agency (DEA), which had seized and destroyed cannabis plants grown by two women suffering from cancer in compliance with California regulations.

Legal weed owners and sellers that fully comply with applicable state laws now seem to face minimal threat of federal arrest. However, the fact that federal law still treats weed as an illegal drug continues to generate costs for state-legal weed businesses and risks for their investors.

For instance, most federally chartered banks (almost all major banks) refuse to work with weed businesses, citing the threat to their federal licenses. Banking restrictions affect the use of credit, and even credit and debit cards, for the purchase of weed from licensed outlets. That means that many weed businesses must continue to deal in cash, with all the associated security concerns, inconveniences and costs.

Another major cost for weed businesses compared to those in other legal markets derives from an oddity in federal tax rules. Under IRS Section 280E, cannabis companies (except testing laboratories) cannot deduct normal business expenses for transacting in weed or growing it because costs involved in trading in an illegal substance are not deductible from gross revenue under federal tax law.

These federal policy-related costs sit on top of the state and local tax and regulatory costs that make competition with illegal weed so challenging. Does this mean federal legalization of weed would be a boon for the legal cannabis industry? The answer is not clear.

Congress has two bills that are now the focus of attention. The first passed the House in the spring of 2022. The second was introduced in the Senate on July 21, 2022. Neither is expected to become law in 2022, but together they indicate the direction of thinking, at least, of the Democratic majority.

House Bill: The Marijuana Opportunity Reinvestment and Expungement Act

Sections 2 and 3 of the House bill include the measures required to remove weed from the federal schedule of illegal narcotics and modify other parts of federal law and administration to conform with this de-scheduling. Sections 8, 9 and 10 ban discrimination against cannabis users and cannabis convicts in relation to federal benefits and immigration, and expunge minor federal weed convictions. Section 13, recognizing the prejudice that was built into the terms “marijuana” and “marihuana,”  replaces those terms with “cannabis” in federal law and regulation.

All the above provisions are generally consistent with enabling an open and legal national market for weed. Provisions in Sections 5, 6 and 7 of the MORE Act move in the opposite direction. First, as with wine and other alcohol products, these provisions require all production facilities to be registered and bonded with the federal government to facilitate taxation and control. The movement of weed must then be tracked whenever weed products are removed from bonded warehouses. All cannabis businesses must pay a $1,000 per year registration fee. Also, as with alcohol, every weed label must be approved by the federal government and comply with a long list of regulations, including a ban on “indecent or immoral material” on weed packages.

Next, a new federal tax on retail weed sales would be added to all existing state and local taxes. The federal excise tax would initially start at 5 percent and soon grow to 8 percent of the retail price. Finally, in keeping with 2022 legislative trends, the bill adds additional regulations and subsidy programs geared toward social equity and special benefits for small businesses.

Senate Bill: The Cannabis Administration and Opportunity Act

The Senate bill was introduced by Majority Leader Chuck Schumer and Democratic Senators Cory Booker and Ron Wyden. The 296-page bill is twice the length of the MORE Act. And as we write, just one week after the bill’s introduction, the full text has not been circulated. But based on available summaries, the legislation would:

• Remove weed from the Controlled Substances Act.

• Implement a federal track-and-trace system and federal limits on retail purchases.

• Ensure states’ continued authority for prohibitions within their borders.

• Add a list of regulations related to weed and driving.

• Move weed oversight from the DEA to the FDA and the Alcohol and Tobacco Tax and Trade Bureau.

• Explicitly terminate the odd income tax treatment whereby cannabis businesses are not allowed to deduct cannabis business expenses from their gross revenues.

• Establish a new excise tax for “small and mid-sized producers” at 5 percent (increasing to 12.5 percent over several years).

• Establish a new excise tax for larger businesses at 10 percent (increasing to 25 percent).

• Add a special set of “market competition” regulations on top of normal antitrust regulations.

• Introduce FDA regulation of production, processing and marketing, including detailed labeling rules.

• Add a host of additional regulations and programs for entrepreneurship and restorative justice.

Being Careful What You Wish For

Although the two acts are labeled as “legalization” bills, our assessment is that both would more likely add to the economic woes of the legal weed industry and measurably aid the illegal weed industry. Illegal weed already competes with legal weed at much lower prices and has most of the market just about everywhere. Under these bills, the legal weed industry would be further burdened by a new set of excise taxes. The elaborate set of new federal regulations would be layered on top of state and local taxes and regulations that already stifle the ability of legal weed businesses to compete with illegal weed.

The Senate bill, in particular, seems just about perfect if federal legislation aims to ensure that legal weed remains mired in a tax and regulatory morass that benefits illegal weed suppliers. The federal excise tax rates in the bill would add a particularly high hurdle for the survival of legal weed businesses by raising the tax burden to well over 50 percent in many jurisdictions and over 100 percent in others. Prices of legal weed already far exceed those of illegal weed, and many consumers seem to find the benefits of buying from a legal and regulated supplier not worth the added cost. The federal regulations and additional taxes add to the cost differential, with what appear to be few, if any, added benefits for consumers.

Decriminalization Is Enough

Given the extent of state and local regulations and taxes where weed production and use have been legalized, the federal government’s task is quite simple: get out of the way.

States that want to keep weed illegal — and in so doing effectively, if unintentionally, encourage an illegal weed industry — already do that. States that want to impose onerous taxes and regulations already do that. States that want a robust legal cannabis industry to replace the illegal industry are already struggling to find ways to achieve that goal.

The House and Senate bills could be pared back to facilitate legal weed businesses rather than benefiting their illegal competitors. For both bills, the trick is simply to keep the few parts that remove weed from the Controlled Substances Act and then adjust federal law and regulations to be consistent with de-scheduling.

Simple de-scheduling would allow weed to be treated as a normal product, which, for example, would allow interstate commerce in weed among states where it is legal. That by itself would help legal weed (as a whole) compete with illegal weed, which actively trades across state borders. The introduction of legal interstate commerce means the federal government would have the responsibility to ensure that free trade in weed is enforced. Federal courts would need to slap down any attempts by states to erect trade barriers when comparative advantage begins to play its natural role in determining where production would be located.

Important federal policy changes are needed to allow legal weed suppliers to compete effectively and to place added pressure on the illegal industry. However, current legislative initiatives being considered in Washington are likely to make that task more complicated and exacerbate a situation in which criminal enterprises will continue to thrive while legal businesses founder.