Price Theory: Can Canada’s Cannabis Law Defeat the Law of Supply and Demand?
Last week, Canadian Prime Minister Justin Trudeau unveiled the government’s proposed tax rate consumers will pay when Canadian provinces start selling adult-use cannabis sale next July. On products retailing for ten dollars or less per gram, the feds will charge a flat dollar (80 cents US) per gram; for products priced at more than ten dollars a gram, the tax will be 10 percent.
A $10 price is in line with what analysts hope is the public-health sweet spot: high enough to discourage underage use, yet low enough to hobble the black market.
As with much of Canada’s proposed-but-not-quite-final cannabis law, Trudeau’s proposed tax rate may yet be tweaked. But as it stands, the $1 rate implies an average retail price of around $10 a gram, according to analysts, which is roughly in line with what Canadians now pay for federally licensed medical cannabis, according to survey data from Calgary-based CannStandard.
Even more importantly, a $10-dollar price is in line with what government policy analysts hope is the public-health sweet spot: high enough to discourage underage use or adult abuse of cannabis, yet low enough to, as Trudeau himself put it, “remove the black market from accessing the billions of dollars of profits that they do every year off of this.” Trudeau has company. Just weeks before his announcement, officials in Ontario, considered to be the province furthest along in rolling out a retail system, indicated that they’re also targeting a $10/gram price point.
There’s only one problem: Canada’s legal cannabis market won’t be able to hit that sweet spot. By various estimates, the country’s currently permitted growers won’t have anywhere near the capacity to meet the demand—up to 1,000 tons—that forecasters expect by July. “There’s going to be a shortage of supply until more licensed producers come on board,” says Darren Karasuik, vice-president for strategy with MedReleaf, which supplies the legal Canadian medical market.
“Licensed producers are going to charge whatever the market can bear.”Dana Larsen, BC-based cannabis advocate and medical vendor
And as with any commodity where supply lags behind demand, whatever product retailers are able to find “will be quite expensive,” says Dana Larsen, a British Columbia-based cannabis advocate and medical vendor. Policy wonks may think ten-dollars is the sweet spot, says Larsen, but “it’s not up to the province to decide what the price is. Licensed producers are going to charge whatever the market can bear.” And, of course, as long as price stays high, Larsen adds, “the black market will thrive.”
The Inevitable Chaos of Legalization
To some degree, the government’s price dilemma reflects the inevitable chaos of legalization. Trudeau’ government introduced its legalization law, the Cannabis Act (Bill C-45), only this spring, forcing each province to scramble to roll out, by next July, its own system of distribution and retail that is a) tightly regulated and crime-proof; b) meshes with the country’s large existing medical cannabis market, yet is c) competitive enough to undercut black-market operators.
Given these complexities, snags are inevitable. Case in point: although cannabis farmers will be regulated by their respective provincial governments, they currently can’t grow without a federal permit, the acquisition of which can take many months and require heavy consultants’ fees. Such bureaucratic tangles are one reason legal supply is well behind demand.
Some of what ails Canada’s new cannabis law is in its basic framing and conception.
But some of what ails Canada’s new cannabis law is in its basic framing and conception. Where cannabis-friendly states in America have emphasized job creation and tax revenue a big part of their argument for legalization, Trudeau and his political allies justified legalization explicitly as social- and public health policy. Thus, where American states have been largely content to let consumer demand and other market forces determine the price, which governments then levy a tax on, the Canadians have more or less turned that concept on its head: from the start, Canadian policymakers envisioned using taxes to help determine the price consumers pay, with the idea that said price would influence the behavior of cannabis consumers and producers.
“The thing to keep in mind is that the whole rationale for legal cannabis is much different in Canada than it is in California or Washington State or Colorado,” says M-J Milloy, drug policy expert at the British Columbia Center Centre for Excellence in HIV/AIDS.
That difference is neatly summarized in November 2016 report by the federal Task Force on Cannabis Legalization and Regulation recommended in a November 2016 report. “Taxes should be high enough to limit the growth of consumption, but low enough to compete effectively with the illicit market.”
Critics say the government’s heavy emphasis on price targets doesn’t sufficiently recognize that non-price factors, such as product quality or availability, can have equally large effects on consumer and producer behavior.
Legalization advocates and industry players in Canada have no problem with the Canadian government’s larger policy goals. They do, however, worry that “social policy pricing”, as some have called it, may not be the best way to meet those goals. Beyond its insensitivity to actual market conditions, critics say, the government’s heavy emphasis on price targets doesn’t sufficiently recognize that non-price factors, such as product quality or availability, can have equally large effects on consumer and producer behavior.
For example, industry officials have long argued that product diversity is just as critical as price in encouraging consumers to jump from the black market to the legal market. Yet under Canada’s proposed law, adult-use sales would be limited largely to dry bud, some oils, and seeds for personal use. Still unclear is the status for things like edibles, vape oils or capsules—products that are currently readily available on the black market.
“If you walk into any illegal dispensary in downtown Toronto or Vancouver or any online dispensary, you’ll see a product selection that is akin to any fully stocked dispensary in downtown Denver or downtown Seattle,” says MedReleaf’s Karasuik. “Price not withstanding, product is a big part of the whole equation, too.”
Will the Market Iron Out Legislative Inconsistencies?
Presumably, many of these inconsistencies will be ironed out as Canadian lawmakers finalize the recreational law and as provincial governments roll out their respective retail programs—all under the watchful eye of commercial players and their lobbyists. As Karasuik notes, “Part of the issue here is ensuring we move as quickly as possible to a system where we’re allowed to sell in a regulated legal channel those same products that are currently for sale in an unregulated, illegal channel.” And, in fact, under amendments proposed last week, edibles and other concentrates would become legal a year after retail sales for dry flower begin.
But other inconsistencies may remain until they are, in effect, corrected by the marketplace. Take, for example, the steps some in government have advocated for keeping cannabis prices from falling too low, which some Canadian policymaker fear is inevitable if Canadian growers follow their U.S. counterparts into large-scale, low-cost operations and “predatory pricing”. (At one point last year in Colorado, according to Arcview, legal cannabis was selling for less than $6 a gram.)
The Canadian task force went so far as to suggest that if predatory pricing made cannabis too cheap and attractive, provinces should use “mechanisms such as a minimum price.” That includes using taxes to counter any price declines. As more efficient farmers drive down wholesale prices, taxes could be raised to keep retail prices constant, thereby protecting consumers from overly cheap weed while serendipitously boosting government revenues. Or as Jean-Denis Fréchette, the federal Parliamentary Budget Officer, put it, more diplomatically, in a report last year: “Production costs for the legal industry are expected to decline, creating space for government to collect a portion of the cost savings without increasing the legal retail price.”
As much as Canadians seem to want to avoid many aspects of the U.S. system, they would do well to observe the way that system has responded to different taxing systems.
Yet advocates fear such a plan could easily backfire and undermine government efforts to kill the black market. Larsen, for example, says many producers currently supplying the medical and black markets will have little incentive to embrace a tax system that essentially pockets any extra margin they’re able to generate by being more efficient. “The current licensed producers are selling directly to patients for five to ten dollars a gram,” says Larsen. “So why would they instead wholesale it to a province at half that price just so the province can mark it up?”
In fact, as much as Canadians seem to want to avoid many aspects of the U.S. system, they would do well to observe the way that system has responded to different taxing systems. As Tom Adams, editor in chief of Arcview Research, observes, it’s probably not coincidental that Washington State, whose 37 percent tax is the highest in the United States, also has the largest remaining illicit market of any of the three early-adopter states, with about half of the cannabis sold coming from the black market.
The key lesson from America, Adams says, “is that you’re not free to set prices or taxes wherever you want to try to achieve other government goals, because we have an illicit market that has been thriving since the 1960s and is quite content to stay outside the law.” And keep in mind, says Adams, that resistance to an overbearing government tax system won’t come solely from cannabis producers.
“Part of the appeal for cannabis consumers all these years has been the ‘sticking it to the man” aspect,” Adams says. And in both the U.S. and Canada, Adams says, “we have a whole bunch to consumers who will be glad to keeping doing that it prices are too high the legal market.”