Legalized Cannabis: Fiscal Considerations

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Summary

In Spring 2017, the federal government intends to introduce legislation to legalize and regulate the cultivation, distribution, sale and consumption of recreational cannabis in Canada. 

The legalization of recreational cannabis will introduce an entirely new sector into the formal economy.  Given the government’s intention to regulate and tax this new sector, legalization will create new government revenues and expenses.  Legal sales of recreational cannabis may begin as early as January 2018.

In 2018, an estimated 4.6 million individuals aged 15 and over will use cannabis at least once, according to PBO projections.  By 2021, this level could rise to 5.2 million. 

In 2018, Canadians aged 15 and over will consume an estimated 655 metric tons of cannabis; by 2021, this could rise to 734 metric tons.  The vast majority of total demand – 98 per cent – would come from the 41 per cent of users who consume “at least once a week” or “daily” (Figure 1).

Annual Cannabis Users and Consumption by Use-Frequency Cohort, Age 15 and Over, Canada excluding Territories, Mid-point Estimates, 2018

When legalization occurs, the government may have little fiscal space to apply tax without pushing the price of legal cannabis significantly above the illegal market price.  Even with only a sales tax, legal cannabis prices in 2018 will likely be as high as illicit market prices in 2015-16. Excise taxes will likely push the legal price above the illicit price observed in 2015-16 (Figure 2).

After-tax Legal and Illicit Cannabis Average Price, Canada

Tax policy decisions will involve trade-offs between two of the federal government’s goals: discouraging consumption among young Canadians and reducing the profits in the illicit cannabis market. 

On one hand, higher cannabis prices discourage consumption, especially among young Canadians who are likely to be more sensitive to price.  Prices must be higher in both the legal and illicit markets if they are to effectively discourage consumption. 

On the other hand, higher legal cannabis prices provide a disincentive for current users to transfer to the legal market.  The higher the premium for legal cannabis over the illicit price, the more Canadians will purchase cannabis on the illicit market (Figure 3).

Estimated Legal Market Share of Resident Cannabis Consumption Volume in Canada, at Various Average Legal and Illicit Prices, 2018  

At the outset of legalization, fiscal revenues from regular retail sales taxes (HST/GST/PST) are expected to be modest – in the hundreds of millions of dollars, rather than the billions of dollars.  About 60 per cent of sales tax revenues will accrue to provincial governments, and the remaining 40 per cent to the federal government (Figure 4). 

As the legal cannabis market matures, the potential to capture fiscal revenues will grow.  Production costs for the legal industry are expected to decline, creating space for government to collect a portion of the cost savings without increasing the legal retail price.  Further, a potential consumer shift to more value-added cannabis products could create a larger tax base.  Finally, as the legal market becomes more entrenched, more Canadians may opt into the legal market, resulting in higher revenues. 

Projected HST/GST/PST Revenues from Resident Cannabis Consumption in Canada, Middle Estimate, 2018 ($ millions)

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