License Quotas and the Inefficient Regulation of Sin Goods: Evidence from the Washington Recreational Marijuana Market∗

This paper studies the welfare impacts of license quotas in markets for “sin goods.” License quotas not only affect market structure and reduce total sales, their implementation also creates allocative costs. Retail licenses are often restricted by geography, meaning licenses are not necessarily allotted to areas where they are most valuable. Furthermore, licenses may be distributed to firms randomly; hence, the most profitable potential entrants are not necessarily license recipients. A difficulty in studying license quotas is finding credible counterfactuals of unrestricted entry. Therefore, I first develop a three stage model that endogenizes firm entry decisions and incorporates spatial demand. I then estimate the model using a new firm-level data set from the Washington recreational marijuana market and use data on the participants in a marijuana retail license lottery to simulate counterfactual entry patterns. I find that allowing firms to enter freely at Washington’s current marijuana tax rate increases total surplus by 21% relative to a baseline simulation of Washington’s license quota regime. Geographic misallocation and random allocation of licenses account for 6.6% and 65.9% of this difference, respectively. Moreover, I study tax policies that directly control for the marginal damages of marijuana consumption. Free entry with tax rates that keep the quantity of marijuana or THC consumed equal to baseline consumption increases welfare by 6.9% and 11.7%, respectively. While free entry with a non-uniform sales tax consistent with Washington’s geographic license restrictions increases efficiency by over 6%. ∗I am grateful to my advisors Katherine Ho, Francois Gerard, and Tobias Salz for their guidance. This paper benefited from conversations with Michael Riordan, Chris Conlon, Wojciech Kopczuk, and Zach Brown. Lin Tian, Jing Zhou, and Nandita Krishnaswamy also provided helpful comments. I also thank Brian Yauger, Jerry Derevyanny, and Logan Bowers for all their helpful insight into the inner workings of the Washington recreational marijuana market. All mistakes are my own. †Columbia University, [email protected]