Why Illegality Makes Drugs More Expensive Than Taxes Ever Could

One of the central rationales for making certain drugs illegal is to elevate their price and thereby reduce consumption. It’s astoundingly effective: illegality makes lightly processed plant matter (e.g., cocaine) more valuable by weight than gold.

It has long been understood that part of this price inflation occurs because individuals in the drug trade demand higher wages to compensate them for the risk of arrest. In the current issue of National Affairs, Jonathan Caulkins and Michael Lee note that an additional, less commonly appreciated mechanism is also at work:

…inefficiency stems from having to operate covertly. The precautions required to evade detection make the production of drugs very labor intensive. Grocery-store cashiers, for instance, are more than 100 times as productive as retail drug sellers in terms of items sold per labor hour. Similarly, hired hands working for crack dealers can fill about 100 vials per hour, whereas even older-model sugar-packing machines can fill between 500 and 1,000 sugar packets per minute. This labor intensity of drug production, combined with the high wages demanded for that labor, are what drive up the costs of drugs; by comparison, materials and supplies — glassine bags, gram balances, and even guns — are relatively cheap.

Caulkins and Lee provide a useful comparison point to appreciate the impact of illegality on price: If cigarettes suffered the same legal disadvantage as cocaine and heroin, they would cost about $2,000 a pack. This is a stark illustration of how taxes on a legal drug could never even remotely raise prices as high as does illegality. Even cigarettes taxes that attempt to raise the price per pack of cigarettes to one half of one percent of what their price would be under illegality are widely evaded and create huge black markets.

Comments

  1. Alex F says

    I don’t disagree with any of your main points, but your last sentence leaves me confused. High taxes can’t make cigarettes as expensive as if cigarettes were illegal, because taxes lead to a black market which keeps prices down. But, um, isn’t a black market cigarette illegal? If we took the tax rate to be infinite, and all cigarettes were sold on the illegal black market, then wouldn’t the price to consumers be the same as if cigarettes were illegal? In either case, all cigarettes are illegal.

    I guess the difference you have in mind is that as long as tobacco itself is legal, the penalty for possession/sale of black market cigarettes would never realistically be as high as the penalty for possession/sale of a real illegal drug. So the infinite-tax-black-market would still have lower prices than the cigarettes-illegal-drug-market.

    • Keith Humphreys says

      Alex F.: The policy proposition often put forward is that we can stop the price decrease caused by legalizing an illegal drug but compensating with comparable tax increases. But if no one will pay the sufficient taxes, this can’t be true. And we know it’s not true because even when the tax tries to recover tiny fraction of that price difference, we have widespread evasion.

      On this point “But, um, isn’t a black market cigarette illegal?” the answer is no. If you have truck full of Marlboros without tax stamps, you will not be arrested for the Marlboros, but for tax evasion. They are still legal, indeed the company could reposses them, put stamps on them and legally sell them.

      • aisaac says

        But black market Marlboros could be made illegal with the stroke of a pen. Sort of like how black market oxycodone or adderall will get you arrested.

        If what you said was inevitably true, there would be no market for drugs made or smuggled illegally like heroin and smuggled/cooked amphetmines because of competition from much lower-priced diverted pharmaceuticals, unless there was no legal equivalent.

        And even if it were somehow metaphysically impossible to make it a crime to possess/sell black market legal drugs, the government could put a quota on the number of units that could be legally produced (cap and trade), which would raise the price as high as consumers were willing to bear.

  2. JMG says

    Boy, if thee was ever an example of the argument that proves too much, here it is.

    Shorter: We have to raise the effective price so high for certain drugs that we deal with a plethora of unintended consequences, including mass killings and the evisceration of national civil liberties and epidemics of corruption in high places and low, rather than deal with the problem of over consumption of those disfavored drugs, even when we have examples suggesting that a harm reduction model is fairly effective at limiting harm from the drugs without causing all those bad consequences.

      • Barry says

        Yes, he frikkin’ well did. The whole theme of his argument is that legalization + taxation can’t keep drugs as expensive as now.

        Now, this is either a minor point not worth the electrons to make it, or an argument that we need to keep drugs illegal to reduce consumption, and that the side effects are worth it.

        • J. Michael Neal says

          No, he frikkin’ well didn’t. What your position involves is ignoring things Keith has said explicitly and substituting for them things that you imagine that he means. What he is saying is that, if you want to legalize drugs, don’t count on artificially high prices to prevent use from exploding. Unless you are prepared to assume that price factors don’t influence demand at all, you either need to accept much higher consumption or to come up with some other mechanism for preventing it.

          There is a wing of the drug reformers, which crawls out of the woodwork on every drug related post, whose commitment to honesty is so slight that they really are the equivalent of the drug warriors when it comes to character assassination.

          • Keith Humphreys says

            J. Michael Neal wrote: There is a wing of the drug reformers, which crawls out of the woodwork on every drug related post, whose commitment to honesty is so slight that they really are the equivalent of the drug warriors when it comes to character assassination.

            This is sadly true. My own solution is that for drug policy posts, when I see the names of said persons I just skip reading their comment and go to people who are consistently substantive, such as yourself.

          • JMG says

            “What he is saying is that, if you want to legalize drugs, don’t count on artificially high prices to prevent use from exploding.”

            And what if your motive is to reduce the harm to the society overall, including the harm caused not by the drugs but by the insane responses to them? Harms that are MORE morally objectionable, because they are inflicted on the unwilling (and often on the entirely innocent nonusers), despite the availability of superior alternatives?

          • John G says

            Keith did not say that drugs should continue to be illegal because of any of the phenomena he mentioned. He didn’t mention that issue at all. I understood the implication of his statements to be that a legal drug trade would not be as lucrative as some proponents of legalization say it will be, because the taxes can’t possibly be high enough to make up the kind of prices that the illegal market charges. Thus a legal drug market, however desirable for other reasons, such as civil liberties, efficiencies, whatever – none of which he mentioned but none of which he denied – will simply not produce the government revenues that are sometimes claimed.

            So: legalize away, but don’t pretend that all the street value of the drugs will find their way into government coffers.

          • J. Michael Neal says

            And what if your motive is to reduce the harm to the society overall, including the harm caused not by the drugs but by the insane responses to them? Harms that are MORE morally objectionable, because they are inflicted on the unwilling (and often on the entirely innocent nonusers), despite the availability of superior alternatives?

            Then my suggestion is that you go back through the archives to find posts where Keith actually addresses that question. Alternatively, you could just continue making things up, but that leaves you looking stupid.

  3. Betsy says

    Wait! Toyour first point about gold — isn’t cocaine’s price largely due to its addictive properties, and not just its illegality? Why is value in comparison to gold a convincing metric? I think the price of cocaine has some slightly different influences. This is not a rationally useful point. It does make a rhetorical splash — more valuable by weight than GOLD! — but is analyically meaninglessmeaningless. … S your assertion that “it’s astoundingly effective” is supported by nothing more than rhetoric, at least in the first paragraph.

    As to the last point – a bit of cause-and-effect confusion here, right? The cigarette example shows that (with cigarettes) price Increases create illegal markets, and not the reverse, that illegality increases price. So it illustrates the impact of *price on illegality*, rather than “the impact of illegality on price” as Caulkins and Lee would have it.

    • Keith Humphreys says

      Betsy: With regard to your first point, you are mixing two things (1) Elasticity and (2) Price. 99% of the price of cocaine is due to illegality. Peter Reuter’s example is that it costs about $15,000 to move a kilo of cocaine from Bogota to the US (protection, payoffs etc.), but if it were legal Fedex could ship it for a hundred or so bucks. As for elasticity of demand, addicted people seem to be less responsive to price than non-addicted people, but contrary to the lore in the other direction, addicted people also reduce consumption in reaction to price increases.

      The cigarette example is a case of a high tax on a legal product can generate illegality, so you are right on that point, if we did not tax cigarettes there would be no black market for untaxed cigarettes. It wasn’t what I addressing but it’s a good observation. What I was addressing was the common argument that if we made an illegal drug legal, we could keep prices constant by substituting taxes for illegality’s effect on price. That is clearly impossible.

      • snoey says

        This does suggest that there is a floor for the illegal price and thus a legal market taxed to that price will tend suppress the black market. The question is at what level. Due to the black market inefficiencies legal drugs could carry a tax intermediate between current illegal price and efficient legal production. What price would depend on the specifics of the drug in question Cigarettes can’t be taxed very highly since the black market is supplied by diversion from other lower tax markets. Legal cocaine taxes would seem to be able to carry a decent percentage of the illegal price. Marijuana would depend on the legal status of home grown. If that is legal marijuana will be cheap – dirt cheap if outdoor growing is safe.

        • Keith Humphreys says

          Part of your implied reasoning I agree with, which is that you could lower smuggling by setting a national tax rate (although states of course would resent the loss of sovereignty).

          On this point:
          Legal cocaine taxes would seem to be able to carry a decent percentage of the illegal price

          I know of no evidence where we have successfully enforced a tax of 10,000% on a commodity, which is what it would take for cocaine. Even if one defines a “decent” percentage of price as only half, that’s a %5,000 tax — where is there any evidence that such a thing has worked for another commodity?

          • snoey says

            “decent” was horribly imprecise, sorry.

            I was trying to think this through from the bottom up. What are the costs of supplying the illegal market and thus what is the maximum legal price that wouldn’t draw black market suppliers.

            Since cigarettes can be supplied by driving a van down I-95 and risking some fines, that price isn’t high. If the tax were uniform and enforced to the point of requiring the tobacco to be grown covertly that wouldn’t be the case.

            Cocaine would still have to be smuggled in from South America and penalties for selling it illegally would probably still be severe, so I’d guess that a $20 or so legal price per gram would capture most of the market.

            I’m not sure tbat agriculture cost basis analysis is revealing. The moonshine market price isn’t related to the price of sugar but to the price of legal booze.

          • Keith Humphreys says

            Snoey: You wrote “If the tax were uniform and enforced to the point of requiring the tobacco to be grown covertly that wouldn’t be the case.”

            If tobacco were legal, no one would have to grow it covertly — the taxes come based on what products it is made into and the manufacturer and distributers paying taxes. The only way what your proposing is possible is if we taxed the very act of growing tobacco, but that seems infeasible even to calculate and impossible to monitor.

            For your cocaine example, if you could do what you propose (and note that is still a 20-fold tax over street price) that’s an 80% or more price drop with that tax. I suspect many people would be upset by the consumption increase such a big drop would trigger. The other potential problem is that middle class people would pay the $20 to avoid law enforcement but lower income people would be drawn by the 95% cheaper untaxed stuff, meaning you would still be disproportionately arresting and incarceration low-income people, just for tax evasion rather than cocaine use.

          • snoey says

            Not sure how this is going to thread.

            The missing component in the legal but taxed scenarios is the level of enforcement applied to illegal/untaxed supply. In my hypothetical on cocaine I was assuming that criminal penalties would remain roughly the same, and I just don’t see anyone selling a dollar gram under those circumstances. Twenty might be high.

            I wasn’t concerned with other effects, just trying to list possible choices. $100 legal cocaine isn’t possible, $10 is. Probably a horrible choice, but possible.

      • Betsy says

        O,Keith, with respect I don’t confuse price and elasticity. See Freeman’s comment below, which makes the point on the relative qualities that might’ve influencing gold, cocaine, or cigarettes differently.

        All iaskofa policy argument is that it nit makeegregiouserrors of logic, such as comparing apples to oranges. False analogies are not convincing, nor are examples that have other variables in play than the one being tested (illegality, for its effect on price). Gold? Authors: *Really*?

  4. James Wimberley says

    The cigarette black market looks a tolerable nuisance. The taxes still raise a lot of money and SFIK the smuggling isn’t violent. And the price stays high; the smuggler pockets much of the tax.

    It would be technically possible to tag each cigarette carton or packet uniquely, perhaps with an easily-scanned RFID chip. Tagging of cannabis packages might be a price the Feds could extract from Colorado and Washington in return for the blind eye recommended by Mark and others. The smuggler can get round this by removing all packaging, but that drives up costs a lot.

    • Keith Humphreys says

      James: You are leaving out a critical policy outcome of our inability to tax cigarettes to their illegality price point (or even to one tenth of it): Cigarettes are cheaply available and hence widely consumed. That’s a big reason why they kill millions of human beings each year. If you could raise the price to illegal levels and burned the resulting tax receipts, government would be way way ahead on health care costs (and many otherwise dead people would be alive of course).

  5. SamChevre says

    If you could raise the price to illegal levels and burned the resulting tax receipts, government would be way way ahead on health care costs

    I’m pretty sure this is actually false. Non-smokers incur pretty much the same costs as smokers, but later in life.

      • Keith Humphreys says

        SamChevre: Smokers’ children are far more likely to go the doctor/hospital with respiratory ailments they may also be more likely to get cancer later in life, early death by breadwinning smokers strains public finances and the physical and mental health of their families etc. You can’t assess the health impact by looking only at smokers. Further, if a non-smoker lives 20 more years s/he pays more taxes for health services, offseting the government’s cost.

        • SamChevre says

          Further, if a non-smoker lives 20 more years s/he pays more taxes for health services, offseting the government’s cost

          This can’t be right; most of the years gained are at ages over 65, when very few people are paying medicare tax (since it is only on wages).

          • Keith Humphreys says

            SamChevre: You didn’t respond to the point about family members of smokers.

            What you did say, presuming it were correct, doesn’t refute the argument. If most of the years are at 65, by definition some of them are before age 65. Multiply those tax-paying years by hundreds of thousands of premature deaths every single year and you get real money.

          • SamChevre says

            You’ve got multiple factors, and I don’t ahve any particular expertise on most of them.

            But given that the above post shows that quitting smoking measurably raises expected health-care costs for current smokers, it is hard to imagine that the effects on child health are so large as to offset the value of the currently-collected tax receipts. Opposition to smoking is one of those places where the facts don’t support the elites’ preferred polcies, so reality-based arguments are particularly helpful.

          • Keith Humphreys says

            Opposition to smoking is one of those places where the facts don’t support the elites’ preferred polcies

            Don’t know what this means, as the tobacco industries big business and their many political friends around the world are certaintly elites. In any case saying essentially that “they” can’t handle the truth is just not a substantive argument.

  6. Anonymous says

    You might enjoy listening to NPR’s Planet Money podcast #266 (April 2011): “A Former Crack Dealer on the Economics of Dealing.”

    Program description: Lots of fancy economists write about the economics of dealing illegal drugs. Here’s a paper from a Harvard guy. Here’s another co-authored by a couple Chicago guys. One thing missing from those papers: actual drug dealers. So, for today’s podcast, we run some economic theory by Freeway Rick Ross, who was one of the biggest crack dealers in LA in the ‘80s and ‘90s.

    http://www.npr.org/blogs/money/2011/04/13/135354436/the-tuesday-podcast-a-former-crack-dealer-on-the-economics-of-drugs

  7. Tom Wytiaz says

    Keith, while I can appreciate what you are saying, I think the effect of a drug makes a difference as well as the size of the dose. For example, if tobacco produced the same type of intoxication as heroin it would command a completely different price. Even a tiny bit of cocaine would produce more of a high than guzzling a 6-pack of red bull. If red bull were illegal, the price per can would not be comparable with a much stronger substances.

    If you look at something like a price-per-buzz how much cheaper is alcohol than pot? A case of Bud is roughly 20 dollars, the same amount could be spent on a gram of marijuana on the black market. The case of beer would have differing affects depending on a number of factors, as would the pot, but really, buzz for buzz your not really doing much better for the money with the beer. If beer were so much cheaper because of its legal status (as your argument would suggest) how could a case of middle-of-the-road beer be the same amount of money as a gram of high-quality marijuana?

    No, I do not think legal marijuana is going to make it dirt cheap because an ounce of marijuana will alter the mind a heck of a lot more than an equivalent amount of tobacco. Legality aside, I do not think you are giving nearly enough emphasis on the actual effects.

    • Tom Wytiaz says

      To further illustrate my point: cigarettes contain less than a gram of tobacco per cigarette (http://www.cancer.gov/cancertopics/factsheet/Tobacco/cigars); a pack would contain around 20 grams or about 6 “eighths” worth of tobacco. At a street value of 6o dollars an eighth commanded for high-quality marijuana that would be 480 dollars. Much less than the 2,000 dollar price you quoted, yet marijuana is illegal and is constrained by all of the factors you mentioned.

      Different substances command a different price regardless of manufacturing processes. What sort of penalties would have to be imposed to actually drive the price up to 2,000 dollars a pack, and furthermore who would pay that price for a product that isn’t really getting you high?

      • Keith Humphreys says

        Tom Wyiatz: Thanks for taking the time to dig up this information and for your thoughtful comments more generally. I agree with you that dollars per hour of intoxication is a useful metric in drug policy analysis. Caulkins et al have some nice work along this line in their recent book.

        It is important to remember however that “getting high” is not the only reason people use drugs. The cigarettes that smokers consume in the morning are rewarding because they reduce withdrawal, ditto the first shaky drinks for an alcoholic. Depending on the addictiveness of the substance and how long a person has been using it, negative reinforcement (i.e., returning to feeling normal) can be what is prized by the user.

        I agree with you entirely that different substances command different prices regardless of manufacturing processes. That does however make illogical analogical arguments about illegality effects (i.e., if drug A costs 10 times drug B, and drug A drops in price when legalized, it is still reasonable to argue that the price of drug B will fall if legalized albeit from a different point and to a different point than A).

        • Tom Wytiaz says

          Keith, thank you.

          If I read your last paragraph of your comment to me correctly, should I read it “that does not, however, make illogical arguments…” It seems to me the sentence makes more sense with the “not” otherwise you’re refuting the example of cigarettes/cocaine/heroin. Or maybe I am missing something?

          Cigarettes used to be much cheaper; the price has gone up dramatically in the last 10-20 years. I wonder if any additional taxes on the product which is already much more expensive than it used to be would be dodged simply because it is reaching the price point where people will either quit buying them altogether, or search for alternative means. If cigarettes were still two dollars a pack and taxes raised them to three, people would probably be more likely to weather the storm rather than look for a dealer.

          I think the same type of thing could be applied to marijuana. People would be thrilled to pay 20 dollars for a gram at the store. 10 dollars would feel like a black-Friday doorbuster. Lowering the price any more than that would be dumb because you could get so much more for it. It could easily be taxed up to that price point and everyone could be making money. I don’t see a whole lot reasons to go into black market dealing and taking a big risk if your making much less than you once were, but are assuming much of the same risks as before.

          People seem to have a knack at making money and selling products for as much as they think they can get. It makes more sense to me that pot will be sold for as high a price as it can be rather than dirt cheap because people will pay–we know they will pay about 20 a gram now.

          • Keith Humphreys says

            Tom: It’s funny, I read that sentence multiple times thinking something was wrong, but missed the blindingly obvious lack of a “not”.

            In terms of the “people will pay” argument, it depends of course on who the people are. One of the myths of pot is that it is mostly smoked by middle to upper middle class people who toke now and then. That was true 30 years ago but we know (Caulkins book well summarizes this) that it isn’t true now. The bulk of pot in this country is consumed by working class and poor people who smoke frequently. Their willingness to pay a premium to avoid law enforcement is very low because it’s much more economically painful — they consume a lot and they don’t have disposable income. That is why I am worried that we might end up with a system where in practical terms the middle class occasional years effective buys of arrest risk by paying the tax but the people on the bottom of society are still at as much risk as they were before because they will buy untaxed black market weed.

  8. paul says

    We’re mixing two things here, and in ways that are important. First: how does illegality affect the price because of the risk premium that producers and distributors charge to cover the odds that they’ll end up in jail. Think of this as a sort of self-financed disability/retirement insurance, badly implemented.

    Second: how does illegality affect the price because of the structure of production? Large industrial operations are in general easier to trace, and so carry much high risk of prosecution (not to mention risks of appropriation by competitors).

    This distinction is important because legalization implies industrialized production, which implies a different structure for the illegal market. If you had to grow tobacco covertly, make your own paper, shred the leaf by hand, and employee trusted compatriots to roll cigarettes in thousands of tiny safe houses all around the country, a pack of cigarettes might well cost in the $2000 range. But illegal cigarette distributors just divert the legal product and take advantage of the manufacturing efficiencies already in place. The same would likely happen for legalized drugs, unless regulators put enormous enforcement efforts into monitoring supply chains.