Vertical Integration and Production Inefficiency in the Presence of a Gross Receipts Tax

We quantify the effects of a gross receipts tax (GRT) on vertical integration for the first time. We use data from the Washington state recreational cannabis industry, which has numerous advantages including a clean natural experiment: a 25% GRT imposed on cannabis firms was subsequently replaced by an excise tax at retail. We find the short-run elasticity of vertical integration with respect to the intermediate good net- of-tax rate is -0.15 and the long-run elasticity is more than twice as large. We find these incentives lead to large output losses – production increases by 23 percent when the GRT is eliminated.