Morningstar - Winter 2019 - 14

Dispatches

gallon). The U.S. uses 143 billion gallons of
gasoline per year. If you want people to use a lot
less because of an excise tax, you may want
a $4 tax per gallon carbon tax, which would raise
about $572 billion under the current rate of
consumption. If we drive less, less total tax, so
perhaps it would raise $500 billion. Then,
we could have a tax on house heating and air
conditioning, airlines, steelmaking, plastics
manufacture, and so on, to get to a total carbon
tax of $1 trillion per year. Such a giant new
tax would affect many industries, including
automaking, motels and hotels, theme parks, RV
makers, mall retailers. It would also create
new government bureaus to collect and disburse
all that money.

Beware of Rent Seekers
Regulation will
shape who profits from
cannabis.

POLICY

Aron Szapiro

Someone might well say, "Why do all this
by just taxing energy, which creates all sorts of
inequities and cross subsidies? Why not
tax everything?" That is exactly what exists now in
Europe. A VAT is kind of a sales tax on everything.
As happened in France, the tax hinders the
accumulation of savings, stagnates industries, and
forces individuals to band together into unions,
or professional organizations, all competing to get
a bigger share of government subsidy at the
expense of everybody else.

From a policy perspective, cannabis regulation
invites a lot of questions and only the first
signs of answers. However, the way cannabis is
grown, distributed, and sold will depend
on the approach regulators take. Investors need
to keep an eye on a developing regulatory
system that will create many of the winners and
losers in a post-legalization environment.
Investors should be especially vigilant about
tracking the way the nascent cannabis regulatory
structure evolves to reward determined rent
seekers-companies that seek to use regulation
to set up private flow of profits.

How much does the U.S. "need" in more
tax? U.S. consumer purchases are about $13 trillion.
A $1 trillion tax would bring the budget back
into balance, so an 8% VAT would be logical. As
that would provide fiscal space to expand
government programs, we would be back in deficit
in a couple of years, but that can be handled
by a minor adjustment from 8% to 10%, and in two
decades, the 20% VAT will be there to burden
our grandchildren. K

The end of Prohibition and the resultant regulation
of alcohol sales provides an important case study
and offers clues as to how history may repeat itself.
As with the end of Prohibition, an entirely new
business might grow up profiting off regulators'
desires to monitor or curb the sale of legal
cannabis. If regulators follow the alcohol blueprint,
they risk inviting early players to squeeze
into the industry and slam the door behind them,
keeping others out with regulatory barriers.

Ralph Wanger, CFA, ran Columbia Acorn Funds from 1970
to 2003.

Right now, state and federal laws differ as to the
legality of cannabis. A shaky, untenable détente
between federal and state regulators reveals
the challenges of operating in such an ambiguous
environment. Still, we expect Congress to
eventually align federal law with state practice,

A VAT in the USA?

1 Elsner, J.R. 2019. "An Argument Against Regulating Cannabis Like Alcohol." Ohio State Public Law Working Paper 482.
2 Okrent, D. 2010. Last Call: The Rise and Fall of Prohibition. Simon and Schuster.

Morningstar Winter 2019

in a way that will look very similar to the
end of alcohol prohibition in 1933: The federal
government will allow states to decide
on an appropriate regulatory scheme or whether
they wish to legalize marijuana at all. Monitoring
these state approaches to regulation-and
the risks and opportunities they present to various
incumbents or new entrants-will be challenging but important for investors looking to capitalize
on the "green rush."
Lessons of the Past

Alcohol sales were once unregulated. Before
Prohibition, the bar in which people drank was
often the brewer or distiller as well.1 Today,
a "three-tier system" in most states keeps alcohol
manufacturers, wholesalers, and retailers
separate from each other except in cases where
states directly run the distribution and sale of
alcohol. This heavy-handed approach was
designed to keep people from drinking too much in
the years after prohibition, and it worked. As
Daniel Okrent observes:
"In the surprisingly slow growth of post-Prohibition
drinking lay the central irony of Repeal: across
most of the country, the Twenty-first Amendment
made it harder, not easier, to get a drink.
During the latter stages of Prohibition, especially
in the big cities or near the coasts or adjacent
to the Canadian border, little effort was required to
obtain and drink, a bottle, or in some places
even a shipment of liquid contraband, few
questions asked. What was formally illegal was
necessarily unregulated, as if it didn't exist." 2
The end of Prohibition led to a rent-seeking
cartel that exists to this day. The current byzantine
system means an enormous economic benefit
to middlemen to whom manufacturers are obliged
to sell their products and creates enormous
advantages for entrenched incumbents, who can
argue for licensing requirements that make it
difficult for new entrants to the business.
The arguments that industry made more than
85 years ago may still be persuasive to regulators

Morningstar - Winter 2019

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