The Budgetary Implications of Legalizing Marijuana in Oregon. March Abhinav Sivasailam Director of Research, American Victory Coalition

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1 The Budgetary Implications of Legalizing Marijuana in Oregon March 2014 Abhinav Sivasailam Director of Research, American Victory Coalition Ankur Chawla Researcher, American Victory Coalition Abstract We evaluate the effect of Initiative Petition 53, circulated by New Approach Oregon on state and local budgets. The initiative, if approved by voters, would legalize and regulate the possession and cultivation of marijuana by adults, and tax the sales of marijuana and related products. We estimate that Initiative Petition 53 will produce up to $81,694,920 in annual tax receipts for the state of Oregon. We also estimate that Initiative Petition 53 could save state and local budgets up to $89,315,347 in annual expenditures, though this estimate is subject to considerable data limitations and should be interpreted carefully. I. Introduction: Section I: Overview Marijuana legalization impacts the budget of Oregon through two main channels: 1. Expenditures. Legalization reduces the expenditures necessary to maintain the enforcement of prohibition. Due to the lack of flexibility of annual state budget allocations, we consider these savings as the implicit fiscal impact of marijuana legalization. 2. Tax revenue. Results in new tax revenue flowing directly into state coffers. We consider these savings as the explicit fiscal impact of legalization. It is important to note that although legalization can impact budgets in other, less direct manners, we restrict our analysis to expenditures and tax revenue as they are not only the most meaningful channels to predict the total budgetary impact of legalization, but are also the channels for which data is most precisely available. We will consider each of these classes of effects in turn. II. Key Findings: In this paper, we provide several key findings on the potential economic impact of marijuana legalization in Oregon: 1. Marijuana legalization in Oregon can result in state and local savings of over $89 million in annual expenditures. a. These savings are primarily comprised of marijuana-related expenditures in police departments, courts, and corrections facilities.

2 2. Because only about 30% of state expenditures are marginal on a year-to-year basis, one approach is to adjust savings to reflect only marginal costs. If we assume savings in only marginal expenditures, we estimate total savings to be about $26.8 million. However, the total savings (marginal costs + fixed costs) of $89 million is more realistic for two reasons. a. State and local budgets can be optimized for other uses if marijuana is legalized, thus implicitly saving money. b. Explicit savings will converge towards total savings in the long run. 3. The majority of savings in state and local budgets will be from law enforcement budgets around Oregon. As much as $54 million will be saved in police budgets if marijuana is legalized. This is about 4.98% of total law enforcement costs in Oregon. 4. Marijuana-related arrests comprise over 9% of total arrests in Oregon. 5. Savings in judicial expenditures are also substantial. Courts will save about $18 million annual in expenditures, saving about 4.2% of total judiciary costs in Oregon. 6. State and local corrections facilities will save a total of around $17 million in annual expenditures. This represents about a surprising 16.4% of total corrections costs in Oregon. 7. Our revenue model tells us that the state of Oregon would raise about $81 million in revenue for the state of Oregon if marijuana is legalized. 8. Most of the revenue will be raised through the $35 per ounce flat tax on flower (as stipulated in Initiative Petition 53). We estimate the state will raise $78 million in first-year revenue from the tax on flower. 9. According to our numbers, $5 per ounce flat tax on trim will contribute about $3 million in annual revenue in Oregon. Section II: Costs of Enforcing Marijuana Prohibition in Oregon I. Expenditure Approach: The enforcement of prohibition principally implicates three avenues of government expenditures: (a) expenditures on law enforcement, (b) expenditures on the judiciary, and (c) expenditures on the penal system. To approximate the total impact of legalization on government expenditures, we consider the portion of resources expended in each of these categories on the enforcement of marijuana-related crimes. Our method, which follows in the methodological tradition of similarlythemed budgetary impact analyses (Miron and Waldock, 2008; Bates 2004; Kilmer, Caulkins, et al. 2010), is subject to two key practical limitations. First, the data required to estimate impacts based on our method is not often available at sufficient granularity. Second, government budgeting processes lack the flexibility or responsiveness to fully capitalize the potential savings into future budgets. As such, any results we obtain on expenditure savings should be interpreted conservatively: as an upper-bound of value returned to law enforcement, the judiciary, and the penal system, which can be re-allocated to optimally serve taxpayer interests. Adjustment for Marginal Costs: Our method for calculating total savings in expenditures is based on total costs: fixed costs plus marginal costs. In a sense, this can be a problematic manner of evaluating savings, as fixed costs cannot actually be saved in the short-run. For instance, police salaries, which are fixed in the short run, do not fall automatically to accommodate the reduction in enforceable laws. If marijuana legalization occurs, police officers will not be laid off, and their salaries will not be shrunk. This can

3 mean little in actual savings in the short run. An alternative, as introduced in Stiffler (2012) is to attempt to separate out marginal costs by multiplying total savings by the proportion of total costs that are marginal. 1 Note that we include adjustments for marginal costs in our tables. However, while there is some marginal value in considering the marginal cost approach, we believe it is more accurate to use the total cost estimates (without adjustment for marginal cost) for a few reasons: 1. We couch budget savings in terms of value restored and not explicit dollars saved. For example, some portion of agency budgets available due to the legalization of marijuana can be re-allocated to other purposes, thus adding value. 2. In the long run, legalization could mean that agencies determine that smaller police budgets, judicial budgets, and corrections budgets are required to enforce the law in the state of Oregon. Thus, we expect that total explicit savings will converge towards the total implicit savings we have estimated in the long term. II. Law Enforcement Expenditures: Previous research suggests that marijuana-related expenditures on law enforcement comprise the largest category of marijuana-related government expenditures (Miron and Waldock 2008). Our method for approximating this expenditure category can be described as prorating the law enforcement resources directed towards marijuana crimes from law enforcement budgets. First, we calculate the percentage of arrests attributable to marijuana prohibition. Second, we multiply that percentage by total state and local expenditures on law enforcement, subject to a correction to account for law enforcement resources that are unrelated to issuing arrests. We use arrest data from 2012, the most recent available. Table 1 details this process. Table 1 Percentage of Oregon Arrests Due to Drug Prohibition 1. Total arrests in Oregon in , Arrests related to the sale and manufacture of marijuana 1, Arrests related to the possession of marijuana 10, Miscellaneous arrests related to marijuana Total marijuana-related arrests 12, % of total arrests that are related to the possession of marijuana % of total arrests that are related to the sale and manufacture of marijuana % of total arrests, marijuana, other % of total arrests related to marijuana % of total arrests, possession 5, % adjusted total arrests, possession Adjusted total arrests 7, Adjusted % total arrests, marijuana Stiffler (2012) draws on related research to conclude that only 30% of total costs are marginal.

4 Lines 1 through 4 describe data publicly available through Oregon s participation in the Uniform Crime Reporting project of the Federal Bureau of Investigation 2. Line 5 is the sum of line 2, 3, and 4. Line 5 is line 3 divided by line 1. Lines 6 through 8 break down marijuana-related arrests as a percentage of total arrests. Line 9 is all marijuana arrests as a percentage of total arrests in the state of Oregon in Line 10 multiplies line 3 by 50%. The logic behind this is to distinguish between stand-alone possession arrests and incidental possession arrests. Consider two individuals arrested for possession of marijuana. Suppose the first individual is arrested under suspicion of a crime unrelated to marijuana but is discovered to possess marijuana upon a routine police search. Suppose the second individual is arrested under the suspicion of marijuana possession alone. In the former case, the volume of law enforcement resources deployed to arrest the individual are unlikely to depend substantially on the legality of marijuana. Whether marijuana is legal or not, the individual would still be arrested. In the latter case, the volume of law enforcement resources deployed to arrest the individual depends a great deal on the legal status of possession. As such, our analysis is only concerned with arrests of the stand-alone class typified in the latter case. Prior research suggests that the fraction of possession arrests that are stand-alone may range from 33 percent to 85 percent (Miron, 2002; Reuter, Hirschfield and Davies, 2001). We have chosen to be conservative in our estimate and adopt an estimate of 50% - nearly 10% lower than the midpoint of the range produced by the existing body of research. It is important to note that we have not made a similar downward correction for arrests pertaining to the sale and manufacture of marijuana. This is simply because the stand-alone vs. incidental dichotomy is much less pronounced among sales and manufacture arrestees as nearly all such arrestees are stand-alone. Line 11 shows adjusted stand-alone arrests of marijuana possession as a percentage of total arrests and is provided for illustrative purposes. Line 12 sums Lines 2, 4, and 10 to show total adjusted marijuana arrests. Line 13 shows total adjusted marijuana arrests as a percentage of total arrests. The second step of our analysis of marijuana-related law enforcement expenditures requires us to determine the total amount of expenditures on law enforcement in Oregon. Table 2 reports the relevant data. Readers should note that Table 2 represents the total spending on law enforcement across the state of Oregon across all law enforcement agencies, be they municipal-level or state-level. Table 2 Total Law Enforcement Expenditures 1. Total law enforcement budget ( ) 1,077,542, Total relevant law enforcement budget 974,097, Relevant law enforcement budget, inflation-adjusted (2014 dollars) 1,013,061, Expenditures, sale and manufacturing arrests 8,104, Expenditures, possession arrests 39,509, Expenditures, other arrests 6,078, Total law enforcement expenditures, marijuana 53,692, Total law enforcement expenditures, adjusted for marginal costs 16,107,684 2 Federal Bureau of Investigation Uniform Crime Reporting,

5 Line 1 represents data collected from the US Census Bureau s survey of state and local governments and refers to the total amount of dollars expended on law enforcement agencies throughout the state of Oregon by all state and local agencies in 2011, the latest state budget data available 3. Line 2 adjusts this total expenditure downward by 9.6% to reflect law enforcement resources that are unrelated to issuing arrests. The 9.6% adjustment reflects the fact that only 90.4 percent of paid police officers have general arrest powers (Miron and Waldock, 2008). Admittedly, this adjustment may still overstate the proportion of law enforcement resources expended towards arrests; however it may be the most reasonable estimate possible given data limitations. Line 3 adjusts line 2 for inflation. Line 4 multiplies line 3 of Table 2 by line 7 of Table 1. Line 5 multiplies line 3 of Table 2 by line 6 of Table 1. Line 6 multiplies line 3 of Table 2 by Line 8 of Table 1. Lines 4, 5, and 6 are provided for illustrative purposes. Line 7 represents line 3 of Table 2 multiplied by line 13 of Table 1. That is, line 7 represents the portion of arrests that are marijuana-related multiplied by the total volume of law enforcement expenditures. Accordingly, line 7 represents our approximation of the volume of resources saved under legalization or lost under prohibition. III. Judicial and Legal Expenditures: The second largest category of implicit costs associated with marijuana prohibition is the portion of the prosecutorial and judicial budget devoted to marijuana prosecutions. Our analysis in this area should be interpreted cautiously. Oregon s limited data concerning the allocation of judicial and prosecutorial resources forces us to make numerous assumptions and extrapolate from the data available in other states. It is very well possible that the actual impact on judicial budgets is far less than we estimate. Our estimate, at root, multiplies the percentage of felony convictions in state courts for marijuana offenses by total judicial allocations. We assume the percent of felony convictions in state courts due to marijuana law violations is 9.64% (Miron and Waldock, 2010). 4 The total judicial budget, as obtained by the Census of State Governments, 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% of the overall judicial and legal budget. 5 Table 3 Total Judicial Expenditures 3 The data on budgets is from the US Census Bureau, Budgets were originally reported for and were converted to 2014 dollars with 4 The calculations in Miron and Waldock (2010) assume that the fraction of felony convictions by drug equals the fraction of sale/manufacturing arrests by drug. Kilmer et al (2010) believe this assumption overstates judicial and legal budget due to marijuana prohibition because marijuana charges are less likely to be prosecuted than other drug charges. 5 See Miron and Waldock (2010). This fraction comes from individual state data on judicial workloads for eight states.

6 1. Total judicial budget ( ) 438,899, Total relevant judicial budget 183,020, Relevant judicial budget, inflation-adjusted (2014 dollars) 191,028, % of felony convictions, marijuana violations Total judicial expenditures, marijuana 18,415, Total judicial expenditures, adjusted for marginal costs 5,524,553 Table 3 calculates the judicial and legal budget due to marijuana prohibition in Oregon. Line 1 gives us the total judicial budget in Line 2 gives 41.7% of Oregon s total state and local judicial budget in 2010, which represents the fraction of that budget that is spent on felony and misdemeanor cases. Line 3 adjusts the relevant judicial budget for inflation to 2014 dollars. Line 4 gives the percent of felony convictions in state courts due to marijuana law violations. Line 5 give the judicial and prosecutorial budget devoted to marijuana crimes, equal to the product of Lines 3 and 4. IV. Corrections Expenditures Expenditures related to the incarceration of individuals charged with marijuana-related crimes comprise the last major category of marijuana-related costs. As with the judicial impact analysis, our estimates concerning impact to corrections budgets are severely limited by lack of available data. We make quantitative assumptions based on data available from other states where needed. As such, it is possible that the true savings to the penal system is far less than we project. In fact, though it is possible that savings approach zero, we are unable to confirm nor deny such claims. Again, our method mirrors the method used to calculate marijuana-related expenditures for law enforcement and for the judiciary. First, we consider the proportion of incarcerations that are principally marijuana-related. Second, we multiply that figure with the total corrections budget throughout the state. Our analysis here borrows heavily from Miron and Waldock (2010). Because the state of Oregon does not publish data pertaining to the portion of prisoners imprisoned for marijuana-specific offenses, Miron and Waldock compute a weighted average based on the states that do publish such data. They approximate that 1.57% of prisoners are incarcerated for marijuanarelated offenses. Table 4 Corrections Expenditure 1. Total corrections budget ( ) 105,009, Total corrections budget, inflation-adjusted (2014 dollars) 1,096,044, % of prisoners, marijuana charges Total corrections expenditures, marijuana 17,207, Total corrections expenditures, adjusted for marginal costs 5,162,368 6 The data on budgets is from the US Census Bureau, Budgets were originally reported for and were converted to 2014 dollars with

7 Table 4 documents our analysis. Line 1 represents data collected from the US Census Bureau s survey of state and local governments 7. Line 2 adjusts for inflation. Line 3 represents the multiplier computed by Miron and Waldock. Line 4 multiplies line 2 and line 3 for total corrections expenditures due to marijuana prohibition. V. Total Expenditures: We consider total prohibition-related expenditures to be a simple function of marijuana-related expenditures on law enforcement added to those of the judiciary and the corrections system. The resulting sum is $89,315,347, the total cost of marijuana prohibition in the state of Oregon. Section III: Tax Revenue from Marijuana Legalization in Oregon I. Revenue Context: Having considered the budgetary impact of marijuana legalization through the channel of expenditures ( implicit fiscal impact ), we now turn to an analysis of the revenue streams that can be expected under legalization ( explicit fiscal impact ). We shall assume that taxes on marijuana will reflect those specified in Initiative Petition 53, namely a $35 per ounce tax on retailed flower and a $10 per ounce tax on retailed trim. There is an additional $5 per ounce tax on undeveloped plant sales that we do not analyze. II. Legalization-related Tax Receipts: Table 5 Tax Receipts from Flower 1. Number of past-year users 460, Inflated users 552, Total consumption, lower, pre-legalization 51,336, Total consumption, upper, pre-legalization 64,032, Total consumption, mean, pre-legalization 57,684, Total consumption, pre-legalization, ounces 20,34, Price per ounce, pre-legalization Price, post-legalization, Rand estimate Price, post-legalization, Netherland analogue Price, post-legalization, mid-range Elasticity Tax per ounce Total price per ounce Total consumption, post-legalization 22,382, Total Tax 78,337,595 7 The data on budgets is from the US Census Bureau,

8 Table 5 contains our analysis for tax receipts from sales of marijuana flowers. Line 1 refers to data collected from surveys by The Substance Abuse and Mental Health Services Administration (SAMHSA). 8 SAMHSA conducts regular surveys to assess the prevalence of marijuana use nationwide. Notably, these surveys are known to systematically underrepresent the true prevalence of past-year use. Kilmer and Pacula (2009) report that as many as 20 percent of users fail to report their consumption of marijuana in the past year. To account for underreporting, we inflate line 1 by 20% and tabulate the result in line 2. Line 3 and line 4 represent estimates of the total volume of consumption statewide in These estimates derive from prior research that has attempted to evaluate the average annual consumption volume of past-year users. Line 3 represents the lower bound average annual consumption of 93 grams reported by Kilmer and Pacula (2009). As such, line 3 multiplies line 2 by 93 grams. Line 4 represents the upper bound average annual consumption estimate reported by the United Nations Office on Drugs and Crime (UNODC) of 116 grams. As such, line 4 represents line 2 multiplied by 116 grams. Line 5 reports the average of line 3 and line 4. Line 6 converts line 5 into ounces, as the tax rates specified in Initiative Petition 53 are in terms of US customary units. Line 7 lists the average market price per ounce of marijuana in Oregon and is derived from direct market surveys. Line 8 represents the price of an ounce of marijuana after legalization as estimated by a survey of the grey literature on marijuana cultivation (Kilmer, Caulkins, et al., 2010). This estimate is likely biased downwards as it does not reflect microeconomic changes in the marketplace, business costs such as advertising, sticky wages for laborers, and risk premium associated with federal-level illegality of marijuana. Line 9 represents the price of an ounce of marijuana after legalization as estimated by Miron and Waldock (2008). Miron and Waldock estimate that the price of marijuana will plunge 50% after considering that the price of marijuana in regions of low marijuana enforcement (such as the Netherlands) is up to 50% lower than in the United States. This estimate is likely biased upwards in that the risk premium associated with marijuana consumption and sale would be higher in regions of low enforcement than in areas of complete legalization. Line 10 reports the average of line 8 and line 9. It is important to note that this average is higher than the prevailing price per ounce in Colorado, where the cultivation and sale of marijuana is legal, and where average prices per ounce remain near pre-legalization levels (~$200). This price stickiness is likely driven principally by market adjustment inertia that is, companies require additional time to build up sufficiently sophisticated infrastructure to leverage economies of scale. For our purposes, the price stickiness implies that our revenue estimates may be biased upward in the short-run. Line 11 reports the price elasticity of demand for marijuana. That is, line 11 reports the percentage change in quantity demanded that is likely to be observed from a 1% change in price. We obtain the value of from Kilmer et al (2010). Kilmer et al observe that, while there is little data available on the direct price elasticity of demand for marijuana, there is however data available on the participation elasticity. Specifically, there is data available to suggest that for a 10% decrease in the 8 The Substance Abuse and Mental Health Services Administration,

9 price of marijuana, there will be a 3% increase in users. Note that the number of users is distinct from the total amount consumed. Kilmer et al then observe that, for tobacco, the participation elasticity is 1.5 to 2 times smaller than the price elasticity of demand. Assuming that the elasticity of marijuana is comparable to the elasticity of tobacco, and accounting for income effects, they arrive at a price elasticity estimate of Line 12 notes the flat tax per ounce of flower from the New Approach Oregon legislation. In line 13, we sum line 10 and line 12 and parenthetically note that this sum represents a 26% reduction from the pre-legalization price of marijuana. Line 14 projects the level of consumption for marijuana after factoring the price elasticity of demand at the lower price. Line 15 multiplies line 13 by line 14 to arrive at the total tax receipts from flower. Table 6 Tax Receipts from Marijuana Trim 1. Tax per ounce of trim Average plant yield, flower (oz.) Average plant yield, trim (oz.) Total plants, annual 1,398, Trim yield, annual 335, Total receipts, trim 3,357, Total receipts, trim and flower 81,694,920 Table 6 considers the tax receipts from retail trim sales. Line 1 notes the flat tax per ounce of trim from the New Approach Oregon legislation. Line 2 and Line 3 denote the average yield per plant of flower and trim, and is derived from a direct survey of market participants. Line 4 calculates plants per year, which represents the amount of plants necessary to produce the consumption level of flower in Table 5, Line 14. Line 5 multiplies this plant amount by the per plant trim yield. Line 6 multiplies Line 5 by the relevant tax. Line 7 adds the total tax receipts from flower sales and trim sales. Unlike our analysis of legalization-related expenditure savings, the results of which we interpret as an approximate upper-bound of implicit value, we interpret the results of our legalization-related revenue analysis as a credible lower-bound. To wit, Line 7 of Table 7 is biased downwards in two important ways: 1. As there is no reliable data with which to estimate the volume of immature plant sales, we neglect to incorporate the additional tax receipts from the $5 per plant tax on such sales, as stipulated by Initiative Petition We neglect increases in marijuana consumption attributable to non-price effects. For instance, it has been speculated that marijuana consumption could increase when the social and legal stigma surrounding that consumption is removed. Prior research on the fiscal impacts of marijuana legalization has considered the non-price effect to be as high as 35 percent. 9 As the empirical evidence for non-price effects is scant, we have chosen to estimate consumption ignoring such effects. 9 Stiffler (2012) uses 14 percent, Kilmer et al (2010), uses 35 percent.

10 3. We neglect to consider the ancillary channels through which total tax receipts could rise. For instance, since legalization is likely to be accompanied with net capital inflows into Oregon, we can similarly expect gross state income to rise. With this rise, income tax receipts will naturally increase as well.