The Blunt Realities of Weed Legalizationby robin s. goldstein and daniel a. sumner
robin goldstein is an economist in the Department of Agricultural and Resource Economics at the University of California (Davis) and the director of the university’s the Cannabis Economics Group. daniel sumner is the Frank H. Buck Jr. Distinguished Professor in the Department of Agricultural and Resource Economics at UC Davis. This article is adopted from their report for the American Enterprise Institute.
Published October 5, 2022
The legal weed industry (we prefer the term “weed” to marijuana) is in a conundrum. By some measures, the industry is growing rapidly: 38 states (plus DC and Puerto Rico) have legalized weed in some way. And in the past five years the number of U.S. states in which recreational sales are legal (to anyone 21 and over, including visitors) has doubled.
Nevertheless, over that period, many legal weed businesses have struggled to survive financially. This is mainly because the legal industry faces stiff competition from a thriving illegal weed industry, which offers similar products at much lower prices. Values for both publicly traded cannabis companies and cannabis index funds have declined. As a result, many investors complain of having lost fortunes in the industry.
Here, we examine the origins and growth patterns of the legal industry in the United States, how we got here and what can be learned from data about differences in the organization of states’ legal weed markets.
A Brief History of Federal Prohibition
The federal government currently refers to weed as marijuana, which it defines as the product of the Cannabis sativa or Cannabis indica plant with more than 0.3 percent THC, the ingredient that’s thought to get people high. Until the 1930s, the product was legal everywhere in America and was known informally as “reefer.” Opponents of its use renamed it “marijuana” to stoke anti-Mexican sentiment and rally support for prohibition.
Their efforts were successful, and the federal prohibition on weed production and sales officially began in 1937 with the Marihuana (sic) Tax Act. For the next 60 years, producing, selling and possessing any amount of weed were crimes in every U.S. state. Today, as many states have legalized weed, some state lawmakers and industry participants who are aware that the term marijuana has a dark history have taken to calling the product “cannabis.” However, that term is imprecise because many THC-free cannabis products that don’t get people high — everything from hemp-fiber rope to edible hemp seed to cannabidiol (CBD) oil — are classified as “hemp” and can legally be sold throughout the United States. We focus on cannabis products defined as illegal under federal law, so we call it weed.
In every state that has legalized weed in some form, federal and state laws and regulations are in direct conflict. Weed has been listed as a federal Schedule I illegal narcotic, like cocaine and heroin, since the Controlled Substances Act was passed in 1970.
The Rebirth of Legal Weed
The transition to legal weed in the modern prohibition era began in 1996 with California’s successful ballot initiative called the Compassionate Use Act. Under this law, any state resident with a doctor’s “recommendation” (not a prescription, but simply a signed letter allowing acquisition and possession of weed) could grow weed and sell it to others who also had doctors’ recommendations without being subject to state or local criminal prosecution.
Over the next five years, several other states, beginning with Alaska, Oregon and Washington, passed similar laws. By 2000, 10 US states had some form of a medical weed system.
In these early years, state rules for medical weed growers, processors and marketers were often vague. Enforcement was highly variable, and most businesses were largely unregulated. But during this period, the medical weed industry faced a major challenge: federal agents continued to enforce federal prohibition laws. Even if they paid their taxes and carefully followed state and local laws, early weed business owners were subject to raids, seizures and long federal prison terms.
In late 2009 (and later reinforced in 2013 through the Cole Memo), the Department of Justice informally agreed not to prosecute medical weed businesses that were operating in compliance with state or local regulations, and not transporting weed across state lines. This policy has been more or less consistently followed since then. In 2018, for example, then-Attorney General Jeff Sessions claimed the DOJ would return to enforcing federal law as written. But in practice, no such enforcement efforts were made.
In 1995 producing and using weed were illegal in all states. By 2022, 74 percent of the U.S. population had access to some form of legal weed in their states and 33 percent to legal recreational sales. But the road was tortuous. After an initial burst of the earliest-adopting states in the late 1990s, few additional states legalized medical weed between 2000 and 2011. This slowdown coincided with a period of heavy federal enforcement against sales of medical weed.
Then, after the DOJ announced significantly reduced enforcement in states with legal weed, many more states began authorizing medical use. In the five years following the 2013 Cole Memo, the share of the U.S. population with access to some form of legal weed grew from 36 to 70 percent, and seven states authorized recreational sales.
The rate at which new states legalized medical weed tapered off after 2018. At the same time, however, medical-only states started transitioning to legal recreational sales at a fast clip.
Where Is Weed Legal?
By mid-2022, 14 states, collectively home to 33 percent of Americans, have legalized recreational sales. Another 24 states plus Washington, DC, and Puerto Rico (collectively home to 41 percent of the population) have passed various forms of medical legalization laws, but have not approved recreational sales. Twelve states, home to 26 percent, still prohibit the sale of weed for any purpose.
The rules guiding access to medical weed vary widely among medical-only states. Some of them have also supported recreational-use ballot initiatives or passed enabling legislation, but they have not yet developed regulations that allow recreational sales to start.
If states’ goals are to reduce the illegal market, make weed safer, increase tax revenues or cut crime, then they may do better by looking at the rollouts in markets like Oklahoma.
Legal vs. Illegal Weed
Weed differs from most agricultural products in that most of the product grown and sold comes from illegal suppliers. We can think of no other comparable consumer market where legal and illegal products compete side by side and the illegal segment of the market has the bigger market share.
The obvious explanation is that from the consumer’s perspective, legal and illegal weed are close substitutes. Once the two products are removed from their packaging, they both look, taste and feel like weed. Legal weed does have a few packaging and quality advantages for which some people are willing to pay a premium. Most significantly, the label for a legal product indicates its potency and that it has been verified as safe by a certified testing lab.
The contents of legal and illegal weed packages are most similar for “flower,” meaning buds. Vape pens and cartridges are a smaller but growing segment of both the legal and illegal markets. On the high and esoteric end of the market, certain tinctures, resins and other designer forms of weed are found only in the legal market. But these specialty products make up a small percentage of sales. Most weed consumed in America is smokable flower.
Because of a lack of data, studying illegal markets in quantitative terms is difficult. So our estimates of legal versus illegal quantities are rough even in California for which the most comprehensive data on legal weed sales are available. Some of our ongoing work is on sizing the legal and illegal markets based on comparing state reported production and sales tax collections with evidence from federal drug-use surveys.
One problem with estimating legal and illegal quantities is that people are known to underreport their own drug use when filling out government surveys. Nobody knows how much underreporting there is, how it changes over time, or how it is affected by local or state legalization, which may remove some of the social stigma that drives underreporting.
Another issue of considerable interest in policy circles is whether legalizing either medical or recreational weed increases overall use. Higher legal weed prices increase the likelihood that consumers will purchase illegal weed. When there’s no legal weed, they consume only illegal weed. But the overall effects of legalization on total weed consumption are unclear and may depend on legalization’s impacts on prices.
Moreover, anecdotal evidence provides some support for the hypothesis that legal weed tends to be stronger (higher in THC) than illegal weed. This suggests that simply measuring the total quantity of weed consumed (in pounds of flower, for instance) may be a misleading indicator of legal versus illegal shares.
Differences Among and Within States
Legal weed regulations are not only a state patchwork of licensing schemes, regulations and tax regimes, but also a local patchwork of these factors in every state.
Medical-only states vary most widely with respect to rules. Some require licenses and heavily regulate medical weed businesses; others have loose guidelines with almost no oversight. Some medical-only states have big, recreationallike industries, while others have small industries because they severely limit the number of licenses or the list of medical conditions for which doctors can recommend weed. Some medical-only states require vertical integration in the production and delivery of the products. Some states allow retail delivery, while others do not.
Recreational-sale states also vary considerably, but as a rule, they all require compliance with extensive regulations and impose high taxes.
Beyond the divide between medical and recreational sales, legal weed systems differ among states in other important respects. Some states introduced and implemented systems for licensing and legal sales almost immediately after the enabling legislation was passed. Others have taken years. Several states, including California, have “dry regions”— cities or whole counties where some or all weed businesses are prohibited.
Tax rates for legal weed, including taxes levied by both local and state authorities, range between 10 and 100 percent, with many variations in local taxes and fees. Taxes are sometimes placed on each stage in the marketing chain—for example, between producers and retailers and between retailers and consumers. In general, taxes are higher in states with legal recreational sales. Some states tax sales of recreational weed but not medical weed.
States that permit recreational sale generally have more retail stores than medical-only states do. Oklahoma is a major exception because, while it allows only medical sales, its population of about four million has access to 948 retail medical weed storefronts -- meaning there are about 238 shops for every million residents. Oklahoma’s retail store density is thus more than 12 times that of California.
We largely attribute this surprising finding to regulatory differences. A license to sell weed in Oklahoma is cheap and not much harder to get than a hunting or fishing license, and weed taxes are low. In California, getting local and state approval for a storefront can take years and cost millions of dollars. To further complicate matters, local prohibitions make it impossible to enter the legal market in many rural regions and some more populated areas, like most of Orange County, California.
Prices for legal weed also vary widely among states. The median price of an eighth of an ounce of flower (the most common packaging) is about $25 in Oklahoma, compared to about $50 in Nevada and $55 in Massachusetts. The variation in prices within states is equally striking. While the median price for an eighth is about $45 in California, the range runs from $20 to $75.
Where We’re Headed
In legal weed states, there is a lot of opportunity to make policy adjustments that would allow the legal industry to become more competitive. States that have legalized weed more recently have often modeled their regulations after the early adopters, including California. However, if states’ goals are to reduce the illegal market, make weed safer, increase tax revenues or cut crime, then they may do better by looking at the rollouts in markets like Oklahoma.
Oklahoma’s vibrant, competitive industry is working as expected, and legal weed can compete a lot better against illegal weed in Oklahoma than in states like California and Massachusetts, where a comparable package of legal weed costs twice as much. Of course, everything’s cheaper in Oklahoma than it is in Massachusetts, and the regulatory and tax differences between the two states extend well beyond weed.