Regulating Recreational Cannabis in Canada: An Efficiency Perspective
Samantha Black
Student Number: S3850625
Economics of Regulation
Professor Woerdman
October 28, 2018
Word Count: 3445
When the Cannabis Act came into force on October 17, 2018, recreational cannabis became legal in Canada. This regulatory shift, from prohibition to legalization, is rooted in the belief that prohibition did not achieve its social goals in Canada, and perhaps even worsened outcomes. Legalization, legislators argue, will be more successful. This paper explores this paradigm-shift from an economic perspective, undertaking an ex-ante and ex-post comparative analysis. It bears noting the limitations of this study: it is unavoidably incomplete given the nonexistence of key data. Nevertheless, it provides a useful starting point for the evaluation of Canada’s new regulatory regime.
This paper poses one central question: is legalization the way forward for the regulation of recreational cannabis in Canada? Before turning to this question, it is necessary to briefly discuss the constitutional division of powers. The federal and provincial governments have legislative jurisdiction over specific, and sometimes overlapping, heads of power. This paper concerns the federal regulatory layer because it will affect the entire Canadian cannabis market whereas provincial and municipal regulations, though important, will only affect regional markets. Consequently, this paper focuses on the implications stemming from the regulation of cannabis production, health and safety standards and criminal penalties, as these areas fall within the purview of federal jurisdiction.
In the absence of regulatory intervention, negative externalities, largely related to health and safety, as well as information asymmetry would result. To start, in the absence of any laws which increase the costs of use or implement age-based restrictions, consumption of cannabis would not be deterred or prevented among youth. This is troubling because numerous studies have concluded that earlier consumption is linked to serious and permanent development harms. Without any prohibitory laws impeding access or regulatory licensing laws governing quality control, the safety of cannabis products would be uncertain. Consequently, individuals consuming cannabis would face higher health risks.
Without laws against driving while high, there would be an increased risk of dangerous driving and traffic accidents. Finally, without warning labels on product packaging, consumers would be uninformed about the costs and benefits of cannabis. In other words, regulatory intervention is needed to avoid market failure.
Until recently, Canada’s regulatory approach towards cannabis was a prohibition model, with the exception of medical cannabis. Under the Controlled Drugs and Substances Act and the Criminal Code, it was illegal to possess, sell, produce or export cannabis. Further, under the Criminal Code, it was illegal to drive a motor vehicle while impaired by alcohol or drugs. Adults and youths are prosecuted under the Criminal Code, but youths are sentenced under the Youth Criminal Justice Act.
As of October 17, however, Canada transitioned to a legalization model. This shift required the crafting of the Cannabis Act to provide for the regulatory role of the federal government, the revision of the Criminal Code and Youth Criminal Justice Act to enable decriminalization and the expansion of the Excise Tax Act, 2001 to enable the imposition of a federal excise tax.
Under the Cannabis Act, the federal government is responsible for licensing producers, who must comply with the safety, security and quality standards specified in numerous regulations. Notable standards include the mandatory testing of every cannabis batch destined for sale for microbial and chemical contaminants, solvent residues, the quantity or percentage of THC, THCA, CBD, and CBDA, and unauthorized pesticides. And yet, cannabis edibles cannot be legally sold for up to a year after the Cannabis Act comes into force, i.e. until the federal government crafts and passes additional regulatory controls. For now, Canadians will be able to prepare edibles at home, but will be unable to make retail purchases.
Despite legalization, cannabis is not fully decriminalized under the Criminal Code. Youths will face criminal prosecution for possessing or sharing more than 5g of cannabis. Additionally, the offence of drug impaired driving is extended to account for specific concentrations of THC in the driver’s blood.
Finally, cannabis will be taxed at either $1 per gram or at 10% of the sales price, whichever is higher. Currently, the pre-tax sales price is estimated at approximately $7.50. As such, a flat rate of $1 will apply to cannabis products. The federal government will be entitled to either $0.25 or 2.5% of the total tax revenues received, but total revenue will be capped at $100 million annually for the first two years after legalization. Therefore, the provinces will be entitled to either $0.75 or 7.5%, and any federal revenues beyond $100 million. Additionally, cannabis will be subject to federal sales tax, which is 5%, and provincial sales tax, which ranges from 5% – 15%. Several provinces have elected to impose a sales tax adjustment to align with the upper bracket of 15%.
To evaluate the efficiency of the new regulatory model, this paper will now undertake a qualitative cost-benefit analysis, considering outcomes related to public health, the illicit market, impacts on youth, public safety, and intervention costs and revenues.
Proponents of the prohibition model cite reduced health harms as a key benefit. Studies have consistently found associations between cannabis and mental health illnesses, the deterioration of cognitive functioning (e.g. memory), and risks to the brain development of children and adolescents.
And yet, it appears that the prohibitionist model fails to adequately deter consumption, thereby reducing health harms. Indeed, 10% of Canadians, aged 25 years and older, used cannabis at least once in the past year. Consumption is significantly higher among youth: 21% of Canadians aged 15 – 19 and 30% of those aged 20 – 24 consumed cannabis in the past year. Notably, youths in Canada consume more cannabis than youths in countries with more liberal regulatory models. In 2013, 16-17% of youths aged 11, 13, and 15 in the Netherlands reported consuming cannabis in the last 12 months, whereas 28% of youths in Canada reported such consumption.
With respect to health care costs , in 2014 they totalled $200 million. Notably, health care costs associated with alcohol and tobacco were $4.2 billion and $5.9 billion, respectively. Further, cannabis consumption was on par with tobacco consumption. Therefore, relatively speaking, the health care costs of cannabis are not high.
Turning to the legalization model, regulators emphasize that Canada’s public health approach, which promises safe and quality cannabis, will lead to a reduction in cannabis-related health harms. With standardized growing techniques, mandatory testing requirements, and sanitation standards, Canadians will consumer healthier cannabis products, e.g. cannabis products that are not laced with other drugs or additives in the illicit market. And yet, the edibles market, which represents approximately 14% of the cannabis market, is not subject to quality control under the new regulatory model. Citing polls of Canadians and the experiences of other jurisdictions , the federal government and consultants expect a boom in the edibles market following legalization. The absence of a regulatory framework provides a haven to the illicit market, and exposes consumers to serious health risks, such as accidental overdoses and hard-to-detect laced products.
The taxation model under legalization also has significant health implications because it provides the wrong incentives to producers. In taxing cannabis per gram and by sales price, producers will compete to provide the best value. In other words, producers will compete to provide cannabis with high THC levels for the lowest price. To that end, the final report of the Task Force on Cannabis Legalization and Regulation had recommended a tax based on THC potency to encourage consumers to purchase less potent products. Although such a tax scheme would have increased costs associated with testing and verifying THC potency for the purposes of taxation, it is likely that the required infrastructure for such testing will already be in place given the mandatory testing requirements discussed above.
Finally, consumption is expected to increase among current users. Studies diverge on whether legalization will encourage non-users to try cannabis. Regardless, increased use may lead to increased health costs, as evidenced by the experience in Colorado. Since legalization, there were dramatic increases in the yearly rates of emergency room visits (52%) and hospitalizations (148%).
Evidently, there are serious health costs associated with cannabis consumption. Although the prohibition model has failed to adequately minimize these costs, the legalization model does not inspire confidence either. After all, consumption and health care costs will likely increase. There is a possibility that safer cannabis will reduce these costs, but the experience in Colorado suggests otherwise. Further, there are stronger alternatives to the government’s regulatory approach, i.e. with respect to the scope of legalization and the taxation model, indicating government failure.
Turning to the illicit or “black” market, such markets foster numerous social harms, including: organized crime, increased health risks, the distortion of the “true” economy, and corruption of public officials. The existence of an illicit market is a clear cost of prohibition; as cannabis is illegal, the market was pushed underground. In 2016, this market was valued at approximately $7 billion.
Conversely, legalization can reduce the overall size of the black market by providing consumers with access to a safe and competitive cannabis market. Indeed, analysts posit that 63% of cannabis purchases will be made through legal channels. And yet, whether this comes to pass will depend a great deal on the price of legal cannabis as compared to illegal cannabis.
The Task Force recommended the imposition of taxes low enough to effectively compete with the illicit market, but high enough to lower use. The federal government heeded this advice, implementing a modest tax regime as described earlier. As Figure 1 indicates, however, the price of dried cannabis on the illicit market is substantially less in several provinces than the price on the legal market.
Figure 1
The price differential, illustrated in Table 1, may suggest that there will be less displacement of consumption from the illicit market than predicted. First, it is clear that the price of cannabis on the illicit market will drop. After all, under prohibition, the price of cannabis is already higher than would be in a legal market. This reflects the higher supply costs producers face (e.g. the threat of arrest, fines, incarceration etc.) and reduced demand of consumers (i.e. fear of penalties for illegal consumption). Second, the government expects the legal price of cannabis to fall as well, from an average of $7.50 pre-taxes per gram to approximately $6.67 per gram, in response to competitive pressure. Third, it is unclear what legal premium Canadians are willing to pay for legal cannabis. Finally, many other factors will affect prices, such as the costs of complying with regulations, consumption levels, the demand for edibles, and supply shortages.
Although the extent of the benefits under the legalization model are somewhat uncertain, i.e. it is unclear how much or how quickly the illicit market will shrink, there are no discernable benefits of the prohibition model in relation to the illicit market. Further, a large cost of the prohibition model is the creation of the illicit market. The legalization model minimizes this cost through the reduction of its market share.
The impact of cannabis regulation on youth extends beyond health concerns; it is tied to the effects of criminalization and academic potential. In 2016, 7,942 youths were charged, recommended for charging or redirected to diversion programs on the basis of cannabis possession. Further, 678 youths were charged, recommended for charging or redirected to diversion programs for cannabis trafficking, production or import/export. Approximately 44% of youths charged with a cannabis-related offence are convicted. The effects of a criminal record on the future of young people in Canada are far-reaching. They include: the permanent stigma of being labelled a criminal, reduced employment opportunities and perhaps even travel restrictions. The criminalization of youth, possible under the prohibition model, is a serious cost.
Under the legalized model, less youth are criminalized because of the 5g exception. Nevertheless, youths will still face criminal prosecution if they possess or share beyond this allowance. Therefore, the new system is an improvement, but only slightly. A better alternative is the regulatory approach to underage consumption of alcohol or tobacco: it is a provincial offence. Youths face many of the same penalties, e.g. seizure of goods, the issuing of fines/tickets, arrest or charges. However, there is one very important exception: provincial offences are not included on criminal records.
With respect the academic potential of users, studies recognize that cannabis consumption at an early age is linked to underperformance. Youths face an increased risk of dropping out of high school and increased likelihood of enrollment in lower levels of postsecondary education. As discussed above, a large percentage of adolescents consume cannabis despite prohibition. And yet, youth consumption is likely to increase under a legalized model. Alongside the 5g exception, households are permitted to grow up to five plants, providing youths with additional opportunities to obtain cannabis. In a cost-benefit analysis assessing the policy of prohibition in New South Wales, Australia and a hypothetical highly regulated-legalized model, the authors’ findings identify loss of educational achievement as the largest cost of the latter model.
Evidently, it is a mixed bag when it comes to assessing each regulatory model with respect to youth considerations. The legalization model is superior when considering the criminalization of youth, whereas the prohibition model is superior when considering educational attainment. Perhaps then, it is too early to determine which system has the edge.
Turning to the outcomes related to public safety, impaired driving is the main concern linked to cannabis consumption. Under the prohibition model, driving while impaired is an offence under the Criminal Code. Regardless, in 2015, 39% of Canadians admitted to driving within two hours of using cannabis in the last year. Apparently, young people are willing to drive while impaired because they “believe that it is difficult for police to detect and charge drivers for driving while impaired by cannabis”. Further, many young people believe that they are more cautious drivers after consuming cannabis. In other words, cannabis-impaired driving is prevalent under the prohibition model.
Drug impaired driving will remain criminalized under the legalization model. However, greater resources are being dedicated to training officers in drug recognition and evaluation. Further, the federal government introduced new offences based on the concentration of THC in the driver’s blood. These measures, accompanied by the “Don’t Drive High” public awareness campaign, suggests that the benefits of the legalization model are greater than the prohibition model: youth awareness of the costs of impaired driving will improve and law enforcement will be more capable of detecting impairment.
Finally, the last consideration of this paper are implementation costs of each regulatory model and expected revenues. To start, enforcing the prohibition of cannabis is expensive. In 2014, criminal justice costs totalled $1.8 billion. With substantial decriminalization, criminal justice costs are expected to plummet. And yet, it is not yet possible to measure the enforcement costs of the legalization model.
Even if enforcement expenditures drop, there will be new administrative costs associated with legalization. They include, but are not limited to, costs associated with: the operation of the licensing apparatus, health, safety and security standards programs, monitoring product advertising and labelling, police training programs, new equipment for testing cannabis impairment and cannabis public health education programs. Indeed, the federal government has allocated $546 million for Health Canada, the RCMP, the Canada Border Services Agency and Public Safety Canada over five years for the implementation of the Cannabis Act. And yet, under the legalized model, tax revenues will lessen the burden of administrative costs. According to the most recent projections released by CIBC, based on legal retail sales of approximately $6.5 billion, the federal and provincial governments will receive approximately $424 million and $1.228 billion in tax revenues, respectively. Evidently, it would be premature to judge which system will cost more; the required data is not available yet. Nevertheless, if criminal justice costs do not plummet, tax revenues will not provide the cushion expected.
To recall, the central question of this paper was: is legalization the way forward for the regulation of recreational cannabis in Canada? The legalization model, quite narrowly, is more efficient. The prohibition model is superior with respect to public health, but the legalization model is superior with respect to minimizing the illicit market and maintaining public safety. And yet, this paper has also revealed that there is government failure with respect to regulatory approaches concerning public health and the impact on youth given the efficiency of alternative approaches within the legalization model. Further, it is not yet possible to fully measure the costs and benefits of each model on youths and intervention costs. Regardless, in undertaking an early cost-benefit analysis of legalization, this paper lends a bit of support, at least from an economic perspective, to the fanfare on October 17.