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Prime Minister Justin Trudeau has proposed a 10-per-cent federal tax on sales of marijuana with 50-50 revenue-sharing with the provinces. Although the proposal was a surprise to provincial leaders, for some time, the federal government has articulated that it is seeking a collaborative approach.

The Prime Minister's proposal features a perfectly reasonable tax rate and revenue-sharing arrangement for recreational marijuana. Our analysis shows that a 10-per-cent tax results in $400-million to $450-million in combined tax revenues and more than 90 per cent of the recreational market being regulated, assuming prices for legal marijuana stay similar to their current level of $7.50 a gram. Higher taxes will not generate increased revenues and will only encourage consumers to switch to illegal supply. Further, harmonized tax rates mean that prices will likely be similar across provinces. This would further minimize the black market, as there would be no profit to be made moving marijuana across provincial borders from a low-tax jurisdiction to a high-tax one.

Mr. Trudeau's proposal should be applauded, if it were to be the only tax on the retail sale of marijuana.

Unfortunately, a number of provincial leaders reportedly objected to splitting tax revenues with Ottawa. Provincial leaders have maintained that the costs associated with public awareness, setting up retail and distribution systems and continuing enforcement of laws and regulations will fall predominantly on provincial balance sheets and that they should be entitled to a larger piece of the revenue pie. While some costs will fall more heavily on the provinces, the federal government faces significant costs associated with licensing and inspecting producers. Mayors from Toronto to Saskatoon have also expressed their desire to get a slice, with some wanting additional levies to fund municipal issues related to legalization.

While all levels of government will certainly face costs as recreational marijuana goes on sale, there is a danger that the division of tax revenue may overshadow the policy priorities that led to legalizing recreational marijuana in the first place. The protection of public health and the minimization of the black market (and its associated criminal activity) are the main objectives of legalization.

Of paramount importance is that all levels of government not forget the key to achieving the main policy objectives is the total price of recreational marijuana. If the pretax price of marijuana were $10 a gram, as targeted in Ontario, a 10-per-cent tax rate would result in $300-million in total tax revenue, but with only half of the market being regulated. If the government imposes GST/HST/PST in addition to the proposed 10-per-cent federal tax, the picture gets even more bleak. Combined revenues would be about $450-million, but only about 40 per cent of the market would be regulated. Put another way, the black market would represent about $3-billion to $3.5-billion of annual recreational consumption.

Further, taxes on retail sales are not the only way that recreational marijuana can contribute to government coffers. Governments may receive licensing revenues if they choose to allow private establishments to retail marijuana, or they may simply create a government monopoly where all profit from retail goes directly to the government (though there are other competitiveness and cost issues associated with crown-corporation retail, the model to be used in Ontario and New Brunswick). There should also be consideration for the additional revenues from income taxes, property taxes and corporate taxes that could be realized by bringing this multibillion dollar industry out from the underground economy. It is true that no one can be sure what the costs of legalization will be, but the peripheral revenue effects are equally uncertain.

Instead of fighting over tax revenues on a product that has minimal fiscal room for taxation, provincial governments should focus on developing retail and distribution systems that will effectively compete with the black market. This should be the primary objective at the outset of legalization and will serve to minimize provincial costs while maximizing the knock-on economic benefits related to the industry as a whole. Provincial leaders should seriously consider the Prime Minister's proposal and not lose sight of the long-term objectives in a short-sighted attempt to boost budgetary bottom lines.

Rosalie Wyonch is a policy analyst at the C.D. Howe Institute. Anindya Sen is the director of the Masters of Public Service program and a professor of economics at the University of Waterloo.