By Malena Castaldi

MONTEVIDEO (Reuters) - Uruguay will exempt marijuana production and sales from taxes in a bid to ensure prices remain low enough to undercut competition from black market pot smuggled in from Paraguay, according to consultants advising the government on a legalization plan.

Congress approved a law allowing the cultivation and sale of marijuana in December, making Uruguay the first country to do so, with the aim of wresting the business from criminals.

"The principal objective is not tax collection. Everything has to be geared toward undercutting the black market," said Felix Abadi, a contractor who is developing Uruguay's marijuana tax structure. "So we have to make sure the price is low."

Uruguay will auction up to six licenses to produce cannabis legally in the next weeks. The government is also considering growing marijuana on a plot of land controlled by the military to avoid illegal trafficking of the crop.

While cigarettes and alcoholic drinks are taxed heavily in Uruguay, the official marijuana trade will operate virtually tax-free, Abadi said. Uruguay does not require a decree or law to exempt a product from taxes.

President Jose Mujica signed a decree outlining the fine print of the new policy this month. It says Uruguayans will be able to buy up to 10 grams of marijuana a week in pharmacies at between 85 cents and US$1 dollar a gram, a price comparable to black-market pot.

An agricultural country of 3.3 million people, Uruguay has come under the spotlight for the marijuana law championed by Mujica, a 78-year-old former Marxist guerrilla whose modest lifestyle and philosophical musings have made him a media darling abroad.

Uruguay has gone further than other countries such as Argentina and Spain, which have decriminalized possession, or, like the Netherlands, which tolerates the sale of marijuana. The U.S. states of Washington and Colorado have legalized the sale of cannabis under license, but federal laws still prohibit sales.

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Colorado imposed heavy taxes on marijuana sales.

Uruguay's experiment is being keenly watched by Latin American peers at a time when the U.S.-led war on drugs faces mounting criticism. Success in Uruguay could fuel momentum for legalization elsewhere.

While relatively prosperous Uruguay has low crime rates, one-third of prisoners are behind bars on drug charges.

(Writing by Hugh Bronstein; Editing by Jeffrey Benkoe)