Economics of Drug Liberalization

1. Economics of Drug Liberalization ECON 3670 Applications of Choice Theory Roberto Martinez-Espiñeira

2. 1 Drug Policy in Europe and the US: An Overview • Europe has continued to move away from stereotypical US-styled ‘war on drugs’ ideology • illicit drug use is seen as a health issue (an addiction, an illness) rather than a crime issue • alternative measures implemented and under debate in Europe include legalization, decriminalization and harm reduction (e.g. medical provision of heroin to addicts)

3. 3 Drug Policy in US • Enforcement of US drug prohibition has increased dramatically over the past three decades • …but widespread perception that US has a uniformly aggressive prohibitionist policy is actually somewhat misleading

4. 3 Drug Policy in US • Policy implementation clearly varies across time, across types of drugs, and across enforcement jurisdictions • E.g. some states are allowing production of marijuana for medical uses and open discussion of legalization has been taking place in some states • However, open marketing of marijuana for general consumption does not appear to be on the horizon, and liberalization regarding the sale of other drugs is not even being considered

5. 5 Evaluating the Alternatives • We will here evaluate the alternative policies available in switching from prohibition to some form of legalization • Government monopoly • Regulation • Sin taxes • Free market

6. 6 Government Monopoly • Would place the production and distribution of drugs in the hands of the state and provide direct control over most aspects of the marketplace • Several US states monopolize the distribution and sale of liquor, and a few also do so for wine • Two other examples of privatized government monopolies are the market for human organ transplants and state lotteries

7. 7 Government Monopoly • Government can directly control the product: • Establish rules for production, distribution and consumption of product and mandate the composition of product (e.g. potency), price, quantity limits, and hours of operation • Establish regulations concerning who is allowed to purchase and consume the product • Methadone often provided free of charge but addicts are required to consume the product on the premises to prevent resale • Methadone clinics, for example, generally only provide the drug to registered addicts

8. 8 Government Monopoly • Results of government monopoly vary depending on whether it is contracted out or publicly run and whether it distributes its product at high prices or gives the product away for free to pre-determined consumers

9. 8 Government Monopoly • State-run liquor monopolies and state lotteries generally provide limited access, high prices, limited product selection, and high levels of tax revenue to the government • Revenues typically range from 30 to 50% of sales but the high prices tend to encourage smuggling

10. 9 Government Monopoly • Most drug maintenance programs remain limited to a small % of all addicts who do see a general improvement in terms of consuming a safer product, better economic status, and lower levels of criminal activity • Overall, however, such programs have potential but have not demonstrated their effectiveness in reducing the many harms of prohibition • They are highly restrictive, offer little in the way of access to legal drugs, and in the case of methadone clinics, diversions of the drug have been known to establish new markets for illicit methadone

11. 11 Government Regulation • It has been suggested that illicit drugs be made legally available but only through a regulated process whereby buyers and sellers meet certain government requirements • Kleiman (1992) argues that alcohol drinkers and marijuana should pay a high tax, have a revocable license, and a limit on the amount they consume • Under his scheme, cocaine users would be registered and could receive a limited amount of cocaine from regulated distributors either at a high price or under therapeutic supervision

12. 12 Government Regulation • Kleiman (1992 cont.) • Tobacco users would be registered, sellers would be licensed, quantities would be limited and heavier taxes would be imposed • Heroin prohibition would be rigidly enforced, but addicts would be registered and placed in maintenance and treatment programs • The cost of administering Kleiman’s approach would be very high and violations would probably be rampant

13. 13 Government Regulation • UK in the 1920s • Adopted a system by which doctors could prescribe heroin to addicted patients for maintenance purposes • MaCoun and Reuter (1999) note that this worked quite well until the mid-1960s, when “…a handful of physicians began to prescribe irresponsibly and a few heroin users began taking the drug purely for recreational purposes, recruiting others like themselves” • Led to a large relative increase in heroin addiction • In response the Dangerous Drugs Act of 1967 significantly reduced access to heroin maintenance, with long-term prescription being limited to a small number of specially licensed drug-treatment specialists • Today, doctors in the UK prescribe heroin to only a very small number of addicts

14. 14 Government Regulation • One good example of where an illegal market was legalized and regulated is the casino gambling industry in the US • Casinos are licensed, regulated, and taxed • Generally, the requirements and taxes are considered normal rather than strict or lax and the results have been quite positive

15. 15 Sin Taxes • Allow drugs to be sold in the market, but impose an excise tax • This sin tax approach is common on alcohol and tobacco products, but is also used in the case of gasoline and a variety of other products • Excise tax has also been called a ‘luxury tax’ when applied to luxury products, for instance, where the sin apparently is conspicuous consumption

16. 15 Sin Taxes • Excise tax has also been called a ‘luxury tax’ when applied to luxury products, for instance, where the sin apparently is conspicuous consumption

17. 15 Sin Taxes • What would a tax like that combined with some type of social security system have in common with: • the fact that hockey players should welcome laws forcing them to wear helmets • the fact that women may be better off if breast implants were banned or the contraceptive pill were banned • the fact that polygamy if women chose freely who to marry would be better for women, but worse for men?

18. 15 Sin Taxes • the fact that hockey players should welcome laws forcing them to wear helmets • Robert Frank recounts the hockey-player mystery as analyzed by Thomas Schelling (Nobel Prize winner).  In 1978, Schelling asked why, since all hockey players left to their own devices will prefer to play without a helmet, in secret ballots they nevertheless vote strongly in favor of mandatory helmets.  In other words, if the rule is such a great idea, why don't the players just don the helmets on their own?

19. 15 Sin Taxes • the fact that hockey players should welcome laws forcing them to wear helmets • Any individual player believes he can play marginally better without a helmet—seeing and hearing better. All aggressive players would discard their helmets for the perceived competitive advantage:  A slightly higher chance of winning is valued more than the increased safety a helmet provides • But of course, once no one is wearing a helmet, no one has a relative advantage in the game—and all that has been accomplished is to raise the risk level for all.  Thus secret ballots mandate helmets.

20. 15 Sin Taxes • As Frank says: "The invisible hand assumes that reward depends only on absolute performance. The fact is that life is graded on the curve“ • It is not the absolute amount of what you have that counts…it is the relative amount • But conventional economics ignores demonstration effects

21. 16 Sin Taxes • Many legalization advocates explicitly combine legalization with high sin taxes, including Gary Becker • The expectation is that taxes will reduce consumption, although the magnitude of the reduction depends on the elasticity of demand and the size of the tax • Sin taxes will also raise revenues which presumably can be used to enforce compliance • Becker’s preferred policy • Other advocates of a sin tax approach would direct revenues towards prevention and treatment

22. 17 Sin Taxes • Asin tax is relatively politically attractive • Provides politicians with revenues and allows them to continue to condemn the product • Excise tax revenues can be directed to addiction programs or education campaigns against drug use • However, because most revenues are fungible, the overall impact is to increase the purchasing power of government (Shughart, 1997)

23. 18 Sin Taxes • In public debate, sin taxes are advocated not because they are revenue sources but because they raise price and reduce quantity demanded • The political nature of the taxing decision means that this consumption-reducing effect may be mitigated • Level of the tax likely to be high in jurisdictions where many citizens do not consume the product for social, moral, and/or religious reasons • Where the dominant norms of the community do not discourage consumption, most citizens may oppose a high excise tax because they consume the product

24. 19 Sin Taxes • Most sin taxes are paid by the seller creating high compliance costs • Sellers have incentives to avoid such costs, so if they are high (and/or if the tax is so high that it dramatically reduces their sales and revenues), illegal sales will continue, much as under prohibition • Even though selling is not per se illegal, many sales will be illegal because taxes are not collected • Many illegal products may also be produced and sold (moonshiners still produce alcohol in many places in order to sell it in untaxed underground markets)

25. 20 Sin Taxes • Sin taxes are also regressive • In the political arena, this may even be seen as beneficial in that it presumably reduces consumption more effectively among low-income groups • But such taxes create relatively strong incentives for buyers (particularly low-income individuals) to turn to black market sources • In summary, the relative sizes of the legal and illegal markets is a function of the level of taxes and the expected punishment for buying and selling in the illegal market

26. 21 Sin Taxes • Major problem with sin tax approach is the difficulty in setting the tax rate • Low taxes would have little effect on consumption, while high tax rates can lead to illegal markets (the underground production, smuggling, crime and corruption associated with prohibition also occur with significant sin taxes) • Becker, Grossman, and Murphy (2003) suggest that setting the optimal level of expected punishment for illegal market activities will eliminate that market

27. 22 Sin Taxes • Another drawback of sin tax approach which corresponds to a prohibition approach is that, like prohibition, taxes are targeted against consumption in general, not the external harms that some consumption may produce • E.g. tax on red wine in US has the effect of reducing the consumption of red wine over the entire economy but does little to target specifically the potential harms of wine consumption such as car accidents (Mast, Benson, and Rasmussen, 1999)

28. 23 Free Market • Very few economists advocate a completely free market in drugs • Most favor replacing one form of government intervention (prohibition) with a different form(s) of intervention • But let us turn to the case where supply of and demand for a drug would be determined solely on the basis of market forces

29. 24 Free Market • Advocates of legalization are quick to emphasize all of the costs of prohibition but often downplay or dismiss the increased consumption expected under legalization • The supporters of prohibition rest much of their case on the increase in consumption that would be experienced with legalization, but neglect to consider that legalization would remove the costs of prohibition

30. 25 Free Market • Prohibitionists suggest that once prohibition is lifted, consumption of drugs will skyrocket because of a lack of legal restriction, a significant decrease in price, and the use of commercial advertising promoting their use • lower prices would increase consumption among current consumers • but more importantly it would increase the number of consumers

31. 26 Free Market • Prohibitionists point to the experience of the Netherlands • From the mid-1980s, Dutch drug policy developed from the simple decriminalization of marijuana to the active commercialization and promotion of it • Although legal restrictions remained, the result was a rapid increase in the number of marijuana users • In 1984, 15% of 18-20 year-olds reported having used marijuana at some point in their lifetime • By 1992, the figure had more than doubled to 33% • This does not control for additional factors at work, but MacCoun and Reuter (1999) note that it is consistent with evidence from other markets (alcohol, tobacco, and legal gambling) that commercial promotion of such activities increases consumption

32. 27 Free Market • In a free market, many abstainers would not use drugs (mainly hard ones even if they were legal) • Those who only refrain because of the legal threat would probably use the drugs responsibly for fear of running afoul of other legal threats such as DUI laws or the loss of their job or reputation

33. 28 Free Market • In fact, many legalization reformers suggest that there will be little or no increase in consumption because illegal drugs are readily available and competitively priced against their legal counterparts • Heroin and cocaine can be bought quite cheaply in certain places and are often available inside government prisons, so a case can be made that prohibition does not really restrict the availability of illegal drugs to any significant degree (Miron, 2004) • However, remember that buying illegal drugs involves more than just price and availability, namely going to prison, losing your job, or overdosing on drugs, and that these threats do diminish the actual number of drug consumers

34. 29 Free Market • Moving from prohibition to a completely free market would likely lead to an increased consumption of drugs for five reasons: • Current consumers would face a lower price and increased quality • New consumers would enter the market due to the lifting of criminal sanctions and the improved safety of the product • There would be a substitution from drugs that are currently legal and heavily taxed, such as alcohol and tobacco, into newly legalized drugs which are not • Legal products would tend to be sold in lower potency forms so that the quantity of product as measured by weight or volume sold would increase • There would be surge in demand for the legitimate medicinal uses of marijuana, cocaine, and heroin that are currently prohibited or restricted

35. 30 Free Market • There are some major aspects of free markets that are either absent or greatly curtailed with prohibition and will be either established or expanded with legalization • These aspects will influence and moderate behavior so that the free market for drugs would be neither a ramped-upped version of the illegal market or a free-for-all orgy of intoxication

36. 31 Free Market • Informal constraints on drug use and abuse • informal social sanctions such as embarrassment, expressions of disapproval, resentment, ridicule, rejection, ritual, and shaming can have a powerful effect on behavior and can be even more effective than legal sanctions, especially under the right circumstances (Zinberg, 1987) • Sanctions imposed by peers, mentors, and guardians are particularly powerful in moderating bad behavior

37. 32 Free Market • Constraints on the behavior of suppliers • Suppliers would want to promote their products with the most cost-effective advertising but would be prevented from making false and fraudulent claims for their products – consumers can sue! • Similarly, any supplier who sold dangerous or deadly products would be subject to lawsuits for negligence

38. 33 Free Market • Problems with free market approach • Drugs would still be available to children, although the products would generally be in safer forms • We would expect the number of deaths due to drug overdose to decline despite overall increases in consumption • but there would still be people who harm their health via drug abuse, just as with alcohol and tobacco products today • Problem is exacerbated by bulk of medical services being paid for via government and insurance (moral hazard) in that individuals can place themselves at greater risk of drug abuse and other health risks given that the government will pay for their medical and hospital expenses in event of overdose, accident, etc.

39. 34 Free Market • Drug use and driving automobiles • Even though marijuana, cocaine and heroin may be less intoxicating and pose less of a threat than alcohol, they could still impose negative externalities if the overall level of intoxicated driving were to increase • This need not occur, however. If marijuana consumption increases in a free market, for instance, with no change in alcohol consumption, then the level of danger and number of accidents could increase, but if marijuana is a substitute for alcohol, the negative consequences of intoxicated driving could decline even with increased marijuana consumption