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DEFAY: Hello and welcome everybody. My name is Chris DeFay. A member of the Authors@Google
team here in Santa Monica. Today, I'm pleased to introduce as part of our Tech Talk series,
Beau Kilmer. Our guest is a co-director of the RAND Corporation's Drug Policy Research
Center, which I just learned is over 20 years established, which is great. His primary field
of interests are elicit markets, community corrections, drug treatments, and he used
advanced technologies to help monitor drug and alcohol use among problem populations.
Kilmer's current work includes projects to estimate the economic cost of drug use and
the evaluations of community level effects of drug treatment. Dr. Kilmer joins us today
to discuss the policy implications of marijuana legalization in California nationally and
internationally. There's been a dramatic shift in drug policy in recent years. Ballot initiatives
have been proposed at the state level and--excuse me--and municipalities are today grappling
with how to regulate marijuana dispensaries and enforce existing drug law. Please join
me in welcoming Dr. Kilmer in discussing this fascinating topic.
>> KILMER: Thank you, Chris. And thanks to all of you for being here. So firstly, my
name is Beau Kilmer. I'm the Co-Director of the RAND Drug Policy Research Center. For
more than 20 years, we've been doing work on a variety of issues related to substance
use and drug policy. If some researchers are developing innovative prevention programs,
others doing evaluations and assessments of racial disparities and marijuana arrests,
if some folks are doing kind of high level statistical analysis of data from undercover
drug busts, and with all of these projects, the goal is to provide objective research
and analysis to decision makers. And so lately I've been working on a project looking at
marijuana legalization in California and that this is definitely a team project and I got
to be a part of a great team. I got to work with Jon Caulkins at Carnegie Mellon University,
Rosalie Pacula, who's the other Co-Director of the RAND Drug and Policy Research Center.
I got to work with Robert MacCoun at UC Berkeley and Peter Reuter at the University of Maryland.
And in addition, we actually had a number of students from Carnegie Mellon University
actually doing a lot of the background research and we wouldn't have been able to do this
without them, so thanks. So, as you know, marijuana legalization is a hot topic in California.
And most of the focus right now is on two different proposals. The first proposal is
Assembly Bill 2254, often referred to as the Ammiano Bill. And what this bill would do
is it will legalize marijuana for those who are 21 and older and it would put the California
Department of Alcoholic Beverage Control in charge of regulating the production and distribution
of marijuana and initially they will place a $50 an ounce excise tax on marijuana. Last
year, the California Board of Equalization did an analysis and said that at $50 an ounce
this would bring in $1.4 billion in tax revenue to California each year. The other proposal
being considered is the Regulate, Control and Tax Cannabis Proposition. This is what's
going to be on the ballot on at November 2010. This initiative would also legalize marijuana
for those over--those 21 and older and it would also make it legal to cultivate your
own 5x5 plot in your home. The interesting twist here is instead of having statewide
regulation, it would allow each local jurisdiction to have the power to regulate production and
come up with their own tax rates. And--but--and just to kind of put this in perspective, I
mean what these proposals really are kind of revolutionary. And no other place in the
world have we legalized the production and distribution of marijuana. You know, a lot
of people like to think, "Well, you know, and that, you know, when you go to Amsterdam
it's legal and." No. Well, it's legal to go to a coffee shop in the Netherlands and buy
five grams it's still illegal to produce it. So it's kind of it's legal in the front door,
illegal in the backdoor. So, I mean, to the extent that this hasn't happened in other
places, I mean, it's really unclear about trying to project what would happen. You know,
there's a lot of, you know, a lot of debate and there's actually a lot of rhetoric in
this debate. So, the goal of our analysis really was to just focus on two issues; one,
try to understand how legalization of marijuana in California could influence consumption
and then also look at how legalization could influence public budgets. And I want to make
it very clear that the--we did not--we neither had time nor the resources to do a comprehensive
cost-benefit analysis. I mean, our goal wasn't to, you know, come out and say, you know,
"This would be a good idea for California or this would be a bad idea for California."
Similarly, I mean, we're not trying to tell people how to vote on the initiative. You
know, RAND doesn't take positions on ballot initiatives or a specific, you know, specific
bills being considered. I mean, we really don't have a horse in this race. We just wanted
to kind of provide some objective information to actually help guide the discussion we'll
be having for the next five months here in California. And I'm sure we'll continue to
have this debate and discussion after November. So, today I want to briefly just talk about
how we built this model and then go into some of the key insights. So, you know, we begin
with this logic model where you can see on the left-hand side you've got your choice
variables. You know, when you legalize you make a choice to remove the sanctions for
possession and sales, then you also have to make decisions about the regulatory regime,
the tax rates. On the right-hand side, you have these octagons, are kind of the outcomes
that we cared about, you know, marijuana consumption and also the net impact on state and local
budgets. And as you can imagine, I mean, these policy decisions have direct and indirect
effects. And I'm not going to walk you through each of these different boxes and arrows during
the presentation but I want to make it very clear that we were systematic about this.
And so, for each of these intermediary boxes, we actually not only had to come up with a
point estimate but we also had to kind of come up with a range. And so, when we could,
you know, we looked at the peer review literature for a lot of these boxes. There wasn't a lot
there in the scientific literature. I went to the gray literature, I went to greenhouses,
talked to farmers, talked to people at medical marijuana dispensaries and we did a lot of
different things in order to kind of come up with these ranges. And I mean, while this
is useful in terms of kind of making projections for the model, just the idea of kind of bringing
all that literature together for each of these boxes turned out to yield some of our most
important insights. So now let's talk about some of the key insights. And kind of the
main takeaway from the analysis is that we expect that the pre-tax retail price of marijuana
to drop substantially post-legalization, probably on the order of 80%-90%. Right now if you
want to get an ounce of sinsemilla in California, and this is your high quality marijuana, it's
going to run you between $300 to $450. I just want to make it clear for the analyses; we
actually end up having to convert everything into sinsemilla equivalents because we know
that most of California isn't using sinsemilla right now. But in order to get an idea about
what happens to the price post-legalization, you actually have to make some assumptions
about what would production look like. You know, we just don't know, so we kind of cost
it out four different--in four different approaches. One being, you know, we would allow everyone
to do their own private hydroponic 5x5 plot. Another mode of production we looked at was
allowing residential grow houses, assume it's a $1,500 or 1,500 square foot grow house or
300 square feet, would have be devoted to production. Then you also have greenhouse
farms and then unfettered outdoor farms, you know, we costed it out for each of those.
But ultimately, we had to make a decision about which one we thought would be most likely
in order to do the projections. And we ended up focusing on the grow houses for a few reasons.
First of all, if you're a jurisdiction and you're trying to make money off of taxing
marijuana, the 5x5 plot that's just inefficient, you're not going to get that much. And with
respect to greenhouse farms, your kind of unfettered outdoor farms, you know, we don't
know what the Federal Governments' going to do. But we thought that the Federal Government
would probably have a problem with all these greenhouses and unfettered farms up and down
I-5. You know, I want to make it very clear, we don't know what the Feds are going to do
but we thought, so--we felt comfortable basing in our assumptions on this grow house model.
And with the grow houses are--in fact, with any of these kind of modes of production,
there are a number of reasons why you would expect the cost of production to go down.
First of all, you're getting rid of the risk. Right now, when you buy cocaine, when you
buy heroine, when you buy marijuana, a lot of what you're paying for is actually to compensate
the dealer and everyone else in the supply chain for their, you know, their risk of arrest,
their risk of incarceration. That will go away with legalization. You also have to--and
there's also going to be a decrease risk of asset forfeiture. You also have to think about
automation, too. I mean, right now, when you're trimming buds, that's a very labor intensive
process. I mean, they now have machines, which are much more efficient at doing this. And
we're going to expect those machines not only to be more available post-legalization but
also cheaper. And in fact, people wouldn't necessarily even have to buy them. You could
actually just, you'd probably could just rent some of these machines in order to help trim,
you know, when it's time to actually manicure. And then finally, also economies of scale.
I mean, it's one thing if you have one or two grow houses, but if you're able to actually
have 15-16 grow houses then you could start really buying the fertilizer, the nutrients
and kind of the other substances in bulk and so one could imagine that there would be savings
there. So there's a lot of theory about, well, that we would expect the price to be low,
but then we went and just tried to figure it out. Okay, assuming that we have a grow
house and knowing how much lighting it would require, how much labor it would require,
what would actually cost to produce a pound of sinsemilla? The range we came up with was
with--was between $200 and $400 a pound. So, if you're trying to figure out what that retail
price would you'd have to add on your wholesaler markups, retailer markups, distribution. When
all is said and done, we expect that post-legalization--an ounce of sinsemilla pre-tax would run less
than $40. That's a big difference from the $300 to $450 that you see in the market right
now. And just to kind of put this in perspective, some others have tried to estimate this and
our estimate kind of falls in those ranges. The Board of Equalization and Miron, they
both put it at 50%. The head of the--Gieringer here, the head of the California department--California
division of the national organization for the reform of marijuana laws testified last
year. They now hay at 300--you can begin with $300 an ounce, but post-legalization where
it's unregulated, it would only end up being on the order of a few dollars per ounce. So
ultimately, we're most comfortable saying that post-legalization, we expect the price
to drop at least 80%. Leads us to our next point that, you know, we expect the consumptions
are going to increase post-legalization but it's unclear to how much. All right, there
are two reasons for this post-legalization. First of all, you have these non-price effects,
right? For some people, it's going to change the stigma, they'll be more likely to use.
But then you also have to be thinking about advertising and promotion. For those reasons,
you would expect the use to take up a little bit. But then obviously, also when you have
such a large price drop you would expect there to be price effects. We know that users and
potential users are sensitive to the prices of marijuana. But in order to do that, you
really have to really have a good idea about how sensitive consumers are to these price
changes. And for you economists out there, you have to have a good idea about the price
elasticity of demand. The thing is, is what this price drop that you would see in marijuana
is going to be large. And it's something we've never seen before. And so, when you're talking
about changes that large, it actually requires that you know what the demand curve looks
like. I mean, if we're talking about something small the shape of the demand curve does not
matter as much. But for this, it actually--it makes a difference about your assumptions.
And you know, and the thing is we don't know what the demand curve for marijuana actually
looks like. So, for our analysis we focus on two demand curves which are kind of common
in the literature which you learn about in Introductory Econ. You know, constant elasticity
demand and a linear demand curve. But we want to make very clear that we'd--we're not--we
don't know if either of this is correct. But for analysis, we just want to see, "Well,
how would the results change?" You know, depending on ones assumption about the shape of the
demand curve. And the take-away from this chart is that it matters a lot. Your assumptions
about the demand curve are really going to influence your projections about consumption.
On the y-axis here we have the percent increase in consumption post-legalization and on the
x-axis we actually have the percent of consumption that evade sales taxes, because we actually
don't know how much tax evasion is going to be happened. But just focus here at the, you
know, at the y-axis. Assuming that--assuming a linear demand curve, a $50 an ounce tax,
no tax evasion, a perfectly elastic supply curve, we would expect that post-legalization,
the price or the consumption would increase about 76%. Now, keep all of that constant
and just switch out the linear demand curve for the constant elasticity demand curve and
that goes to about 150%. Now, once again, I want to be very clear, we don't know if
either of these is correct, but this assumption actually makes a big difference. And oftentimes,
when individuals are doing these analysis, they just kind of make an assumption and don't
think about it, but we say it actually does matter. Minor assumptions have major implications
when you're thinking about, how to project the effects of marijuana legalization. The
third point is that tax evasion could be a major concern especially if the tax rates
are set too high. I mean, the obvious comparison product here is tobacco. You know that when
tobacco taxes are too high, folks are more likely to buy from the Internet, go to an
Indian reservation. You know, there are these great stories in Canada where a few of the
provinces added on a $3 a pack tax on tobacco and there ended up so much tax evasion they
actually had to repeal the taxes. We do know that--we know that tobacco tax evasion does
happen in California. We don't know how much. I mean, some people have put it at 1% to 4%.
Board of Equalization came out about 10 years ago saying it ranged between 12% to 27%. We
don't know exactly where that is but we know that it happens. But to kind of put this in
perspective, in no state is the excise tax for an ounce of tobacco more than $5. It was
being promote--it was being--and initially introduced with the Ammiano Bill as a $50
an ounce tax, that's pretty high. And just forget about ounces for a moment, let's actually
think about pounds. The finance--if you assume that the tax is going to be $50 an ounce,
the financial reward for not paying that tax is going to be between $800-$850 because you
also have to account for the sales tax. I mean, that's more than they actually cost
to buy a pound of marijuana from Mexico right now. So, you know, there's a lot of uncertainty
here and we don't come up with a specific point estimate, but we do want to make it
very clear that if you do set the tax too high you could have this--you could have a
fair amount of evasion. And what's interesting about that is not only will evasion reduce
the amount of revenue going to the state, but all other state or local governments,
but when you have more evasion that means that the consumers are actually facing a lower
price, so you actually expect more of an--a larger increase in use. Fourth point's all
about criminal justice costs, in terms of how much money we actually spend enforcing
marijuana laws in California. The take-away here is--and if you're thinking about this,
be thinking about hundreds of millions of dollars not billions. You know there are--you
know, a lot of people like to say, you know, if we were to legalize marijuana we would
free up all these resources and we'd use that money for, you know, education, we could use
it for, you know, other services. Right now, there are--kind of before we looked into this,
there were two other estimates out there about how much California spends enforcing marijuana
laws. One put it at 200 million; the other one put it at close to two billion a year.
And that's an order of magnitude difference. So, we thought, "Okay, let's just figure this
out," I mean, this is not rocket science. Give me the number of arrests, the number
of people incarcerated, information about adjudication, we can throw on some unit costs,
I can get a pretty good ballpark figure of what it would it be. And when we did that,
we estimated that probably each year less than $300 million is spent enforcing marijuana
laws. You know, in terms of--these are funds spent by the state and the local governments.
But what we also have to remember is that this doesn't necessarily mean savings. It
means it's not as if, you know, if it were to be legalized that money is going to go
back into the general fund. That money is probably going to stay with the local law
enforcement, stay with Department of Corrections. Now, no--maybe, the case of that money will
be better spent, I mean, that's something we didn't look at. But just when people are
talking about this, I mean, yeah I'd be thinking--be thinking in the millions not in the billions.
And finally, the revenue estimates that the Board of Equalization came up with, that $1.4
billion, we can think of a number of reasons why that number could actually be dramatically
lower or dramatically higher. First of all, there are four reasons why one could expect
the tax revenues coming into California to be less than $1.4 billion. First of all, tax
evasion. We don't know what it's going to be but the tax rate is set high enough we
expect there to be evasion when the Board of Equalization did this analysis, it assumed
there'd be no evasion. So, should we expect there would be no evasion, you'd expect that
to lower it. Also, we expect a larger drop in prices. So, if there is--if consumer pays
a lower price that means the sales tax revenue is also going to be lowered than what was
projected. Third, one thing that we account for is the fact that there could be the shift
for--shift to higher potency marijuana use post-legalization. Right now, we think most
of the marijuana consumed in California is commercial grade, not sensimilla. But it's
going to become so cheap post-legalization we expect that most individuals who are smoking
will be smoking sensimilla. And to that extent, you don't have to spend as much to get the
same high per an hour. So, you would actually--you have to make an adjustment when you're doing
these calculations. And so, once you do that--once you've account for the fact that that the
excise tax is based on weight, you would expect that amount to go down. Finally, the tax rate
may not be $50 an ounce. You'll never--that's what was initially proposed in the Ammiano
Bill. That's when it seems they have a lot of currency but it's very clear that the--with
the ballot initiative, it allows each of these jurisdictions to come up with their own estimates.
However, the revenue's actually could be a lot higher than $1.4 billion if California
is actually able to make money off of sensimilla being exported. So, in addition to the report
that we have online we actually have nine additional working papers which provide the
background calculations for a lot of what we're doing. And in one of those chapters
by Brittany Bond and Jon Caulkins, they actually estimate smuggling cost. What it costs to
smuggle marijuana from Humboldt as well as from Mexico. And so, assume that we have this
big price drop, assume that the tax is going to be $50 an ounce, add on this smuggling
cost, we still expect that sensimillia coming from California will still be competitive
with a lot of the sensimillia being sold in the rest of the country. So, there is a chance
that California could actually make a lot of revenue if individuals who come to California,
they buy it, then they take it back. But the big question is, is, you know, someone from
Michigan drives to California, loads up their car full, you know, several pounds. Are they
going to buy it and pay taxes? Are they going to buy it above board? Or are they going to
try to buy it on this gray market? That's what we don't know. But there are actually
is this possibility that California could make a fair amount of money if they can make
money out of these exports. But so much of that's really going to depend on what the
Federal response is. And we don't know what the Feds are going to do. You know, in one
hand the Feds could step up enforcement or they could do what they did in the '80s when
they wanted to raise the minimum legal drinking age. They didn't pass a law saying, you know--you
know, "The drinking age has to be 21." What they said is, "If you want all of your Federal
Highway Funds, your drinking age better be 21." And so there--you can imagine something
like that happening with this. I mean, that and I mean right now, I think California gets
at least $3 billion in Federal Highway Funds. I mean, assume that, you know, they would
lose 10% of that. Even if they lost 10%, there'd be 300 million. I mean, that could offset
or more than offset some of the revenue coming in. On the other hand, like I said if the
Feds are kind of--are kind of hands-off about this and they don't get involved, it actually
could make it easier to make money off of exporting it to--marijuana to other states.
And in that case actually, California we would expect more money to come in. Like I said,
we don't know what the Feds are going to do and we also don't know what the other states
would do too. We don't know how Nevada would react if all of a sudden people just kept
driving across the border and then heading back to Vegas to sell. So, in terms of conclusions,
decision makers, whether they are policy makers or voters, you need to be skeptical of the
estimates that claim precision. If someone comes up to you and says, you know, "Legalization
we think is going to increase consumption by this amount or, you know, is going to bring
in this much in revenues." And they feel that that number is pretty precise, be skeptical.
We saw that there's a lot of uncertainty here, not only with respect to tax evasion but also
with the shape of the demand curve. This is such a large drop that--I mean, it requires
a lot of assumptions, there's a lot of uncertainty there. Second, we know that consumption is
going to increase but it's unclear by how much. I mean, with our models we can't rule
out increases of 50% to 100%, perhaps more, but we don't really know. But one thing to
kind of keep in mind is if you took the prevalence rate that we have today in California for
the number of people who smoke pot in the past 30 days, which I think is 6.5%, if you
were to double that, you know, and assume 100% increase and say it was at, you know,
close to 13%, we'd be back to where we were in 1978. So, I mean, there has--that is a
world that we've seen before. I mean, granted marijuana now is more--is stronger. I mean,
we have less disco, but I mean, we actually have seen a world where there has been many
more marijuana smokers. And I want to be very clear, we don't--we're not necessarily saying
that we think it's going to double but, you know, you're going to be seeing more of these
estimates coming out for the next five months. So we--for us, this is actually a useful bright
line for thinking about how to interpret, you know, what that world could possibly look
like. And finally, the evidence base for this analysis is severely limited. You know, so
much of the Economics Literature is all focused on marginal changes. You know, if there's
a $3 increase in the price of marijuana, how does that influence consumption? These are
all marginal. And you realize that legalizing marijuana in California would not be a marginal
change. So to that extent, it really calls into question how much we can actually rely
on the existing literature in order to inform our projections about marijuana legalization
in California. With that, I'll close. I look forward to your questions and comments. And
I guess I'm supposed to say that this concludes our videotaped portion of the talk. So, thanks.
Thank you.