Taxing the Potency of Sin Goods: Evidence from Recreational Cannabis and Liquor Markets

Cannabis is legal to purchase for over 28 percent of U.S. citizens. A central argument used in public campaigns for cannabis legalization has focused on the tax revenue that legal cannabis markets could generate. Recently, some policy makers and politicians have debated switching from traditional ad valorem taxes to taxes on potency, aiming to reduce the potential externalities associated with highly potent products. In this paper, we construct a theoretical model to predict the implications of a potency-based tax in an environment with market power. We then estimate the demand for cannabis potency based on administrative records of sales and potency from Washington state. We finish by conducting counterfactual analyses comparing revenue and potency outcomes from potency-based taxes versus the traditional price-based taxes.