Berkeley’s Free Medical Marijuana Plan Shows Economic Thinking Has Gone to Pot

In 1996, California passed Proposition 215, making it the first state to legalize medicinal marijuana. Its passage, however, did not trump federal law, under which cannabis remains illegal as per the Controlled Substance Act. Due to this illegality on the federal level, private insurance companies, as well as state programs like Medi-Cal, do not cover medicinal marijuana. Thus, many low-income patients are paying significant portions of their income on the drug, expenses that they cannot easily afford.

Attempting to combat this problem is the city of Berkeley. In July the city council unanimously approved an ordinance that will allow low-income persons to receive free marijuana if they have a legal prescription, which is scheduled to go into effect in August 2015. (The program covers individuals with annual incomes below $32,000 and families of four with incomes below $46,000.)

The plan mandates that Berkeley medical marijuana dispensaries give away 2 percent of their product to eligible customers. As Councilmember Darryl Moore put it, “The city council wants to make sure that low-income, homeless, indigent folks have access to their medical marijuana, their medicine.”

Regardless of the merits of medical marijuana, the ordinance as written is emblematic of a problem that plagues many safety net programs: the creation of perverse incentives. This particular plan encourages low-income residents to earn lower incomes in order to qualify for the giveaway. It also takes a toll on an industry that contributes a disproportionate share of the city’s taxes.

The arbitrary income cut-off of $32,000 means that participating patients who earn slightly less than this amount would receive significantly more effective income than those who earn at least $32,000 but who would lose out on the benefits of the free medicinal marijuana. This is what economists mean when they say that low-income citizens pay higher “marginal tax rates” than wealthy Americans, even with an effective tax rate close to 0 percent. They would lose money for every marginal dollar earned that eliminates them from receiving benefits that have income cut-offs.

This problem is prevalent in many poorly designed government safety nets, and is also the reason that many programs use phase-outs to lower the marginal tax rate. Phase-outs mean that earning more money above the income limit would, for example, simply lower the amount of free marijuana that one receives until it is gradually reduced to none. Although phase-outs do not completely fix the problem, they are a better option than a single fixed cut-off.

A second problem has to do with the arbitrary quantity of medical marijuana that the government would require dispensaries to give away: in this case, 2 percent of their product. This is poor policy for two reasons. First, it creates a “cross-subsidy,” which means that the price for paying patrons of the dispensaries will rise in order to cover the loss of profit on the 2 percent of free marijuana. Second, it provides a disincentive for dispensaries to locate their business in Berkeley. The dispensaries could respond by moving to nearby Richmond or Oakland and avoid the loss of sales revenue from providing a free product, which would mean that the city of Berkeley would not receive tax revenue from this heavily taxed drug, and that the intended beneficiaries of the ordinance would not receive the free marijuana as the nearby cities do not have similar laws requiring the free distribution of the medicine.

The Berkeley City Council wishes to see itself as providing a valuable benefit to low-income residents. Unfortunately, its medical marijuana plan has many basic economic problems—blunders that regrettably still exist in many government programs today.