Legal Marijuana Converts Former Laffer Curve Skeptics

Story Stream
recent articles

Colorado is currently debating the optimal tax rate for legalized marijuana. Now that the state will let people legally purchase marijuana for recreational use (medicinal use was already legal), the state wants to collect tax revenue from the new industry. What is fascinating about this is that many people who have probably long argued against the concept of the Laffer Curve are suddenly embracing it.

The Laffer Curve was born when economist Art Laffer pointed out that the tax revenue collected was a function of the tax rate and that this function looked like an upside down bowl. At tax rates of zero and 100 percent, no revenue would be collected. Somewhere in between, the amount of taxes collected is maximized. Laffer further argued that federal marginal tax rates were somewhere above this revenue-maximizing point, so that tax cuts would actually yield a gain in taxes collected.

Tax cuts implemented by Presidents Kennedy, Reagan, and Bush and the tax revenues following those tax cuts seem to confirm Laffer's point, but liberals have long denied this point. They instead argue that tax rate increases produce higher tax revenues. Except, apparently, for marijuana.

As reported in the New York Times by Dan Frosch (April 24, 2013), the politicians in Colorado are openly discussing the fact that if they set the tax rate too high on marijuana, people will buy it on the illegal market and avoid the taxes. If the tax rate is set too low, potential tax revenue that is to be designated for school construction would be left on the table. They are searching for just the right tax rate that will bring in the most new tax revenue.

In other words, they have accepted the Laffer Curve.

The exact same arguments apply to income taxes. If too high a tax rate is levied, people will search for ways around it (loopholes, less work effort, and outright tax fraud). Taxes too low will not produce sufficient tax revenue to fund government. The ideal income tax rate is in the middle somewhere.

That was Art Laffer's original argument. Suddenly his theory has a new group of converts.

Beyond that, people who have never before thought sympathetically about the plight of small businesses are discovering other truths long espoused by conservatives. Supporters of the fledging legal marijuana industry in Colorado are worried that if taxes are set too high, the businesses selling legal marijuana will not be able to earn a profit and they will all go out of business.

Imagine; high taxes are bad for business. Profit is apparently now a good thing, at least if you are earning it selling a substance that is illegal in most states (and according to the federal government).

There is an old saying that politics makes strange bedfellows. This is a classic such case.

Now that liberals have found a business they like, businesses should be protected from excessive taxes. Suddenly people do respond to taxes by changing their behavior. Finally, we have agreement that incentives matter and taxing something means there will be less of the item that got taxed.

Getting liberals to agree with these usually conservative beliefs more broadly is by no means certain. After all, liberals have long held that high cigarette and gas taxes encourage people to change their behavior, convincing people to smoke less and drive more fuel-efficient cars. Yet these same liberals have refused to believe that high income taxes encourage people to earn less (taxable) income.

Conservatives, whether in favor of legalizing marijuana or not, should applaud the liberals who now agree with them that tax rates matter to businesses and people and that the Laffer Curve is a reality. Perhaps this moment of bipartisan synchronicity can be used to reach agreement on implementing these simple economic realities into more important policy processes.

The Congressional Budget Office generally ignores such effects, believing that lower tax rates do not grow the economic pie. Now that Coloradans on both sides of the aisle are convinced that lower taxes at least grow the plate of pot brownies, perhaps we can get the Congressional Budget Office and the Democrats in Congress on board.

Legalizing marijuana is probably not good for the country, but adoption of smarter tax policies certainly would be.


Jeffrey Dorfman is a professor of economics at the University of Georgia, and the author of the e-book, Ending the Era of the Free Lunch

Show commentsHide Comments

Related Articles