Thursday, 10 March 2016

Er, No, Cannabis Legalisation Will Not Raise £1bn In Extra Taxes

There was a claim in the UK's Independent newspaper paper recently that Cannabis legalisation in UK would raise £1bn a year in taxes – and they are not even talking about gains to the economy in terms of reduced costs in law and enforcement – they only mean a projected view of the approximate value of the black market drugs trade and the extra tax they think the treasury would get by taxing those transactions. We are told that this conclusion is the result of getting together a so-called 'panel of experts' who apparently came up with 'the most detailed plans ever drawn up for the liberalisation of UK drug laws'.

Alas, if only they'd invited someone who understands economics to join their panel, they would have had a better chance of realising that the headline is, at best, misleading, and at worst, plain nonsense. What they mean when they tell us this is that the economy will be better off to the tune of about £1 billion once the government gets all the tax from what would be legalised drug sales. But the reality is very different. What they've done is simply over-inflate the figure by not understanding the economics of how tax and money are generated. Let me explain.

Of course the economy wouldn't be £1bn better off in taxes with the legalisation of cannabis. The tax generated from drugs involves a lot of tax that would have come in via some other route - it's not going to be a huge net gain. In other words, the tax the drug sellers paid through drug purchases when drug dealing became legalised is simply money that the participants would have paid through spending it by some other means when drug dealing was illegal.

Although there will be some gains to the economy in terms of reduced costs in law and enforcement, and in the reduced cost of production and sales (there will now be no costs in avoiding detection) which will as a result also increase consumer surplus, any money that is spent is tax revenue for the government, whether it is on drugs, food, car parts, or whatever.

What the article writer doesn't get is that legalising drugs will increase tax revenue as a proportion through drug sales, but it will be offset by a proportional reduction elsewhere, as people spending taxable money on drugs will be spending less elsewhere.

Perhaps an illustration will help. Tom is a drug dealer, and Dick buys currently illegal drugs from him at a cost of £100 per week. As things stand, when Dick gives Tom £100, there is no drug-buying tax, because the sale is a black market one. The government legalises drug-buying and slaps a 20% tax on drug sales. Now when Dick gives Tom £100, Tom has to give the government £20, meaning the Treasury is £20 better off, right? Not quite.

Prior to drug-buying becoming legal, it's true that when Dick gives Tom £100 the treasury doesn't collect its 20% tax from the drug deal. But it still collects its tax the next time Tom spends some of that £100. So Tom, having £100 instead of £80, uses the money to buy food, drink, petrol or clothes, at which point the treasury gets its tax. There is certainly no big net gain, it's just that the new law would mean the treasury gets its tax from Tom via the drugs sale, instead from Tom via the sale of food, drink, petrol or clothes. Or suppose, as may happen, Tom doesn't spend it yet, but hides it under the floorboards. Well, then, any 'black market money' that stays hidden under drug dealers' floorboards is money that keeps prices down, until that money is eventually spent, at which point it is taxed.

There is not going to be a £1 billion net gain, or anything like it. Increased tax revenues almost never amount to net gains for the economy - they are simply money transferred from some people’s pockets to other people’s pockets. To show how silly this is, imagine if everyone whose surname begins with A to M gave five pounds to everyone whose surname begins with N to Z. Sure Mr Zimbardo would be better off than Mr Adams in the transaction, but no one sensible would argue that the economy as a whole is better off. There is no net gain, only a transfer of resources.

When it comes to drugs and taxes, once you factor in that drug users will end up paying most of those taxes anyway when they spend the money outside of drug use, and the fact that the transfer almost certainly has administrative and deadweight costs to the economy, it's laughable how much of a mess of the argument the article writer makes.


  1. But couldn't both Tom and Dick both be taxed under the legal status. Dick could pay tax for the cannabis and then Tom could use that money on business upkeep which would likely be taxed, which couldn't happen under the current status. Also couldn't the tax rate also be higher on cannabis than food, drink, etc...

  2. It doesn't really matter all that much at which point the government gets the tax it wants - it still gets it, just from different stages of the transactions. It’s just basic arithmetic, and standard economics. To calculate the increase in tax revenue from a shift in spending, one needs to subtract the reduced tax revenue from the spending categories that are reduced.