I-502: Show me the money

April 12, 2013

If you were working a $30,000 a year job would you quit in exchange for a $15,000 a year job? The answer to that for most of us would be no, yet Washington State’s I-502 assumes black-market cannabis producers will do just exactly that.

Abbreviations, conversions and the math I used to reach the following figures have been included at the end of this article.

I-502 is the Washington State initiative from 2012 that legalized cannabis for recreational use, retail sale and of course to be taxed by the state. In a prior article I brought up the DUI aspect of I-502 and the 5 nanogram intoxication level. In this article I will take a look at tax revenues and shutting down black-market producers, both subjects having been presented to voters as reason for casting a ballot favoring this measure rather than opposed.

The rate of cannabis consumption needs to be looked at first when talking about taxes and production. Even though it has no real comparison with tobacco, news reports and this initiative have used it, so, for this article I shall also. To compare the two lets look at a single pound of cannabis.

1 pound of cannabis = 16 ounces = 128 eighths = 448 grams = 896 half gram joints, smoked once a day, every day, day after day, week after week, every month, month after month, without pause, ever, takes about 2.5 years to consume.

A non-filtered 100 mm length tobacco cigarette on average weights .68 grams. Your typical pack-a-day smoker during the same time period will consume about 27.2 pounds worth of cigarettes.

1 .oz, or 56 joints, is the legal possession limit and represents one purchase every two months for someone who consumes a joint every single day. As a social weekend activity, say two joints each weekend, that 1 .oz purchase is made once every seven months. For a casual user of 3-6 times a month, call it an annual purchase.

The common tobacco model should raise some obvious red flags when used to project tax revenue. Even a cursory glance shows that it will be either high or absurdly delusional. Using the above cannabis consumption rates, a realistic “cash windfall” tax projection for my city, per average user is $4.44 annually.

Our city’s council members could pan-handle more than that during lunch breaks downtown.

The only meaningful tax projection I can see stemming from I-502 is not in earnings but savings from all the arrests, bookings, court dates and imprisonments that will no longer take place. I think that would make a more coherent and factual argument when using cash as a reason to support this initiative.

Going back over the last 50 years of prohibition and taking out every budget increase that used “marijuana” to justify itself is huge, and no longer needed. Showing how all our property taxes are going to go down with reduced law enforcement budgets would get more public support I’m sure.

However, even if I-502 turns out to be, at best, revenue neutral, we will still be putting the black-market producers out of business right? That is the other main reason being pitched to support I-502.

For starters, unlike tobacco that can be bought anywhere, anytime, retail cannabis outlets are going to be few, far between and heavily regulated. That might not be much of a factor for someone living in the Seattle area that has a local transit system, but for the rest of the state it is worth including into the equation.

Not many people are going to drive 3 hours round-trip into town and back to pick up only the 1 ounce possession limit. People living in rural Washington can’t even do a Costco type run where they pool together money and a shopping list for whomever is going. Each person must go themselves or carpool. So obviously, anyone who can’t, does not own a car or simply won’t spend $400 per ounce, all things considered, is going to buy from the current black-market.

Tax projections supporting I-502 assume 100% of cannabis consumed in Washington State will be purchased from legal retail stores. This, in a state where 40% of all tobacco cigarettes and 100% of all recreational cannabis consumed is ALREADY being purchased from the black-market.

So, three hours on the road, gas money, snow and all the rest to buy your legal ounce? Or, call up the gal you’re getting it from already, have it delivered to your door and then go halves on a pizza once she gets there.

Real tough choice.

Since the passage of I-502, the suggested starting retail price of $12 per gram has been reported numerous times and works out to $42.00 per eighth. At first glance this seems comparable to the black-market price of $11.42 per gram or $40.00 per eighth. And most users I feel when given the choice are going to purchase from a retail store if it’s only a few dollars difference.

The math after that starts to break down though. Currently in Washington State an ounce of cannabis on the black-market is $240. Unlike the black-market, legal retail stores don’t give bulk purchase discounts and will cost $336 per ounce, or $362.88 after 8% sales tax. What consumer is going to willingly pay $122 more for the exact same product just for giggles?

Really, I would like to know. I have this floating bridge for sale you see…

Anyway, the disparity compounds even further when looking at a one pound purchase. Currently in Washington State a black-market producer can expect, at minimum, $2500 per pound. A pound purchased from a legal retail outlet will cost $5376 per pound at $12 per gram, with sales tax, $5806 per pound.

Now what black-market producer is going to stop what they are already doing, register as a legal producer, and make half of what they were before? As I started this article off with, who is going to quit a $30,000 a year job for a $15,000 one?

A legally produced pound of product will earn the licensed producer $1344 per pound. For a black-market producer making $2500 per pound who becomes legal they will have to produce twice the product as before just to get back up to $0.

After that point all the startup costs such as permits, building leases, zoning inspections, barb wire fences, certified guard towers, licensed machine gun operators, 24 hour a day video surveillance, time share on the aerial drone monitoring your growing district and god knows what else all have to be paid for by producing even more product.

The projected starting annual sales figure of 180,000 pounds of product is based on current usage models and accounts for no increase in costs under a legal system. Doubling production to break even and then tripling it to cover overhead and profits means that a staggering 540,000 pounds, or 270 tons, would need to be produced and then sold annually through legal outlets.

Which does leave the unanswered question of who the hell is going to buy all this dope?

In order for the state to render a black-market pointless it would need to sell at a net retail price of $8.60 per gram, $30.10 per eighth, just to start taking over market share. And then go down from there. However, even at $8.60 per gram, that still leaves a legal price of $3852 per .lb compared with a black-market price of $2500 per .lb which works out to only $5.58 per gram.

Less than half the suggested legal starting price of $12.

The current model being pitched to the public for supporting I-502 is to match the black-market price, then jack that price up over 200% in order to undercut them.

Doomed to fail.

In my opinion the only market projected to get a “cash windfall” from the current version of I-502 is the black one.

If Washington is really serious about severely reducing black-market cannabis production then it should allow people to simply grow their own and adopt a hands off laissez-fair approach to legal retail.

Without this option a consumer is faced with only two choices;

(A) Pay over 200% more for your product

(B) Call up your usual supplier and ask her what she wants on her pizza.

Abbreviations

1 pound (.lb)
1 ounce (.oz)
1 eighth of an ounce (1/8th)
1 gram (g)

Conversion

3.5 grams per eighth
8 eighths per ounce
16 ounces per pound

Producer to Consumer Chain

* $14 per 1/8th = $1792 .lb = Producer $1344 / State $448 (25% tax)
* $1792 + 30% distributor markup = $2329.60 + 25% tax = $2912 .lb = Distributor $537.60 / State $582.40
* $2912 + 30% retail markup = $3785.60 + 25% tax = $4732 .lb = Retailer $873.60 / State $946.40
* $4732 + 8% sales tax = $5110.56 .lb, $319.41 .oz, $39.93 1/8, $11.41 g

legal retail price of $39.93 1/8th * black-market $40.00
legal retail price of $319.41 .oz * black-market $240.00
legal retail price of $5110.56 .lb * black-market $2500

Local sales tax revenue $378.56 per .lb ($23.66 per .oz)
State tax revenue $1976.80 per .lb ($123.55 per .oz)
* 6.5% of local sales tax goes to the state also

Gross Income Totals

legal producer earns $1344 .lb
legal distributor earns $537.60 .lb
legal retailer earns $873.60 .lb
black-market producer earns $2500 .lb

All prices assume a very high quality, medical grade product. A pound of common brown bud, or ditch weed, costs only about $100 or .23¢ a gram.

This article was originally published April 11, 2013 and was rewritten after accounting errors were pointed out by some helpful readers. Thank you!

The West Report
The opinions expressed in The West Report are the author’s own. Feel free to repost or share, we just ask you credit or link to this article as a source.
Advertisements

4 Responses to “I-502: Show me the money”


  1. You’ve forgotten another key element. Federal Taxes.

    US Code – Section 280E: Expenditures in connection with the illegal sale of drugs, states:
    “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

    This means that Federal Taxes will be levied on the gross selling price of the product, not on the after expenses profit profit that is earned after expenses like other businesses.

    Thus, you can safely estimate that Federal Taxes, impossible to avoid because of I-502’s strict reporting requirements, will eat up most of the revenue earned by 502 authorized businesses. Until this changes (not likely anytime soon) there is very little economic incentive to operate under 502 and huge incentives not to.

  2. itznu Says:

    Op is right on a lot of stuff. HOWEVER, all state offices and business models rely on data so flawed that it is barely better than guessing. Also, 502 markets comprise a tiny percentage of the total market where mmj and blackmarket have around 1/50th of the operating costs and competition is indirect. Ive seen huge downturns in the blackmarket profitability since 502, but profitability for 502 producers and processors is still an uncertain future event.

    • Shawn West Says:

      After two years this post has been my site’s most popular. Just about everything I predicted has been just about right on. The legal price has come down to something realistic in the last few months so we’ll see going forward how that affects the market. Personally I have not seen any reduction in the blackmarket and everyone I know still avoids the legal shops. The exception is again the last few months when prices have been rock bottom with some deals almost 1/2 the price of blackmarket.

      Was getting ready to type a follow-up then rolling medical into recreational happened. I don’t think that will affect the blackmarket at all since according to the LCB only about 12% of the blackmarket could be traced back to medical. It might help producers / suppliers though. The stats in a few months should be interesting.


Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s