This is an October 30, 2014, update, of a mid-August post:

Rates of $35 an ounce for potent flowers, $10 an ounce for less potent leaves, and $5 per immature plant: Those are the tax rates in Oregon’s Measure 91, which recently qualified for the November 2014 ballot. A reader asks: Are they too high? Are they too low? And how about the rate of $50 per ounce, reducible by regulations for (presumably less potent) parts of the plant, in Alaska’s Ballot Measure 2 (http://ballotpedia.org/Alaska_Marijuana_Legalization,_Ballot_Measure_2_(2014),_Full_text_of_initiative)? I’ll answer a different question. Alaska has an advantage other western states is that its internal laws don’t freeze voter-passed tax laws. Oregon’s law gives no advantage to voter-passed laws, and its 3/5 supermajority requirement for tax increases is less burdensome than some states’ rules.

How about those rates? To beat around the bush, the three hardest words in the English, according to Think Like a Freak, provide my answer. (Digressing further, the authors of that book, and of Freakonomics, feature my friend and Center for New Revenue board member Joe Murphy here: http://freakonomics.com/2012/12/06/the-things-they-taught-me-full-transcript/.)

The three words are: I don’t know. I don’t think anyone knows for sure what numbers to pick for static tax rates. I started studying marijuana taxes about five years ago — here is an excerpt from a long article I wrote for State Tax Notes magazine in 2011: “Even if tax writers set the best possible rate, bootleggers will react to and take advantage of it if it is static. Bootleggers will know the market better than tax-writers, at least at first, and they tend to be more entrepreneurial, more flexible, and less risk-averse than government. A tax mechanism providing nimble tweaking from the outset will facilitate trial and shorten the pain of error.”

I have some clear ideas about tax structure: I think taxing weight is better than taxing price; taxing potency (THC) would be better, if we can measure it reliably enough to avoid disputes. But we can’t, at least so far. For me, at least, figuring out what to tax seems easier than picking numbers for how much to tax.

As a tax lawyer, I don’t think static tax rates make sense in the long run, but the other revenue options are increasable rates and monopoly – and prohibition. Increasable rates require delegation of taxing authority, which is hard to imagine in a time of distrust of government. (We don’t sit still for taxation without representation; that’s one reason for the inclination to use “fees” rather than “taxes” – or use the “fee” label, anyway.) That’s why I think a state retail monopoly, like 17 states use for liquor, makes sense. A monopoly can adjust prices consumers pay from moment to moment. But monopoly gets little respect in the USA, as folks say it can’t be done. (I’m not willing to give up on monopoly, so need to show that state marijuana monopoly in the face of a federal green light is not like nullification or interposition.) Anyway, in Oregon and in Alaska, for now, monopoly is not on the table and is not going to be. The choice is static rates or prohibition.

At first, static marijuana taxes will probably be too high, as start-ups struggle with new and fresh issues, pay for one-time acquisitions of risk capital (the most expensive kind), get licenses, and make expensive mistakes that they won’t make again. In the early days, after-tax prices from the legal sector may be too high to compete effectively with the illegal sector – the black market. Colorado is still having problems with the black market, despite a tax burden less than cigarettes bear.

Later on, marijuana taxes are likely to be too low, as innovation, the profit motive, mechanization, and economies of scale kick in to drive pre-tax prices so low that the after-tax price draws the ire of worried parents and even the federal government, concerned about interstate leakage as well as youth use. The New York Times editorial series put it this way: “One important way to curb use is to tax marijuana heavily, following the post-Prohibition template of replacing criminalization with regulation and taxes.” Some people in the marijuana movement don’t see curbing use as a goal – but lots of people do.

So if and when pre-tax prices drop, and the black market fades away, taxes can rise to what the market will bear in the long run. We don’t know what rate will beat the black market in the long run, or at any particular moment in time. Part of the reason we don’t know is that the effectiveness of a tax rate depends on how effectively the jurisdiction enforces the laws against illegal commerce – tax evaders. Some kind of crackdown on evaders needs to happen for a tax plan to work. All depends on enforcement.

A more significant issue is exemption for medical use. Restricting medical use to really sick people is important for a tax plan.

Bootleggers, who become, under legalization, tax evaders, will not disappear without a push. Marijuana won’t legalize itself, and the black market won’t euthanize itself. In the years just after repeal of Alcohol Prohibition, there was a concerted effort to eliminate large-scale, well-organized bootleggers who benefited from economies of scale. That involved putting a few big time operators in jail – and confiscating their stuff. (Legalization won’t be Utopia. The question is whether any particular proposal is better than prohibition. Tax evasion is bound to be a problem. The Drug War may end, but we’ll always have Drug Skirmishes.)

Even if there were zero enforcement, Oregon would collect some revenue at a rate of $35 an ounce. Some folks like to obey the law; others will appreciate testing and labeling on the legitimate product. If something goes wrong with an illegal product, purchasers have no legal recourse. So the legal product will bear a price premium. People prefer the legal product, even if it’s more expensive. And it almost certainly will be.

So the question about the initial tax rate being too high or too low strikes me as the wrong question. A more useful question is, “What happens when it turns out the rate is wrong?” Here, Alaska has the trump card, whenever the Legislature is willing to play it. Unlike Colorado with its Taxpayer Bill of Rights and California with its Proposition 13, unlike Washington (which requires a 2/3 supermajority to amend initiatives for two years), Alaska law does not tie the hands of its Legislature. Alaska can change the tax rate through the regular order. This ought to give folks comfort – or at least more comfort than folks in other states can get. The Legislature can step up and change the rate as circumstances change.

Oregon, meanwhile, has a 3/5 supermajority requirement for tax increases. (http://www.taxpolicycenter.org/taxfacts/Content/PDF/state_supermajority.pdf). Oregon’s law still is easier to amend than Colorado’s, which requires voter approval for any tax increase generally, and whose marijuana law is Constitutionalized, or California’s, which requires a 2/3 supermajority. California doesn’t let the Legislature amend voter-passed measures.

When Alcohol Prohibition was repealed in 1933, Congress deliberately set the liquor tax low, with a plan to drive out big-time, organized bootleggers. Tax on Intoxicating Liquor, Hearings Before the Committee on Ways and Means, House of Representatives and the Committee on Finance, United States Senate, 73d Congress, Interim, 1st and 2d Sessions 124 (Dec. 11-14, 1933). And the plan worked. Congress kept increasing the tax rate on alcohol. Tun Yuan Hu, The Liquor Tax in the United States, 1791-1947: A History of the Internal Revenue Taxes Imposed on Distilled Spirits by the Federal Government (New York: Columbia University, Graduate School of Business 1950). The plan worked for a while, that is. In recent years, lack of indexing has caused a dramatic and I think unfortunate decrease in real (as opposed to static, dollar-denominated) alcohol taxes.

The Oregon Initiative has a weak indexing rule — indexing for just 25 percent of inflation. (Alaska’s initiative does not index at all – that’s even worse.) Oregon would repeal the state’s not-all-bad income tax conformity, for state returns, to Federal Tax Code 280E. Alaska keeps its federally conforming anti-advertising rule.

Taxing flowers and leaves seems at different rates seems worth a try, but it’s an experiment. I haven’t studied the initiatives in their entirety – just looked at the tax parts. But to answer a small question, in Oregon’s Measure 91 and in Alaska’s Ballot Measure 2, I have no number to suggest to improve their initial tax rates.