Legalising and taxing cannabis could be worth as much as £1.25bn a year to the government, a study suggests.

The report, by the Institute for Social and Economic Research, quantifies for the first time the revenue to be gained from the regulation and taxation of the cannabis market in England and Wales.

It estimates that reduced enforcement costs, such as police, court and prison time and community sentences, could save £300m or more alone, with the remaining three-quarters of the net benefit come from tax revenue.

The paper, co-authored by Stephen Pudney, professor of economics at the University of Essex, balances revenue against potential costs, such as regulatory costs and increased health promotion initiatives.

Pudney said the report was not a definitive attempt to put a price on the cannabis market, but tried to set out what factors needed to be considered if such a policy were to be introduced.

Commissioned by the Beckley Foundation, a thinktank which calls for scientifically-based drug policy reform, the report states: "It is likely that consumption in overall volume terms will rise significantly as a consequence of the switch to legal status and the lower price that results."

Amanda Feilding, director of the Beckley Foundation, which campaigns for scientifically based reform of drugs policy and commissioned the report said:"In these times of economic crisis, it is essential to examine the possibilities of more cost-effective drug policy. Our present policies based on prohibition have proved to be a failure at every level. Users are not protected, it puts one of the biggest industries in the world in the hands of criminal cartels, it criminalises millions of users, casting a shadow over their future, and it creates violence and instability, particularly in producer and transit countries."

Professor David Nutt, director of the neuropsychopharmacology unit at Imperial College, London, and former chairman of the Advisory Council on the Misuse of Drugs, said the report provided strong evidence "that the costs of the current punitive approaches to cannabis control are massively disproportionate to the harms of the drug, and shows that more sensible approaches would provide significant financial benefits to the UK as well as reducing social exclusion and injustice".