When cannabis is first legalized, prices of legal product have historically been several notches higher than the prices of street weed. But as the trends in Oregon, Colorado, and Washington demonstrate, those initial prices begin to drop so sharply, some businesses don’t survive the fall. A report by independent price reporting agency Cannabis Benchmarks found that wholesale prices of cannabis have steeply declined due to an overabundance of weed.

Oregon and Washington state were primarily responsible for the dramatic price drops. One price analyst estimated that Oregon’s pot prices are falling by up to 20 percent a year with room for further decreases. In Washington, while more consumers are purchasing pot, prices are also much lower. Some Washington farmers are getting only a $1 per gram wholesale, a trend that puts those businesses at risk of collapse. 

There are several factors contributing to the fluctuation of weed prices. Here’s a breakdown of the two most influential of those variables: supply and demand and taxation.

Supply and Demand

Before getting into market demand, we have to talk about the actual cost of producing weed. The average startup cost for wholesale cannabis production is about $40 per square foot. However, actual prices can vary widely depending on the market and growing methods. For example, indoor grows tend to be much more expensive to operate than outdoor and greenhouse grows. On the flip side, indoor grown cannabis tends to fetch a higher price than outdoor grown cannabis due to the commonly held belief that indoor grown weed is genetically superior. No matter how a producer chooses to grow their cannabis, they have to make sure they charge a price that covers the cost of production or their business won’t last.

Now let’s talk supply. Cannabis prices tend to be higher the closer to the date recreational sales are launched. That’s because the industry in the newly legalized state is young and comprised of only a handful of producers who, until more producers obtain licenses, monopolize the market. As the industry matures and more businesses emerge and fortify, supply increases. That makes the industry more competitive, and where competition abounds, prices dip so as to attract customers who now have a variety of options to choose from. That’s what’s happened in Oregon and Washington. These states are producing more weed than they know what to do with. There aren’t enough retail stores to sell the oversupply, so farmers are basically selling their flower for the cost of production.

Nevada and California, on the other hand, are still new entries into the recreational market. Nevada has only recently caught up to a shortage problem, and some say that California is well on its way to a shortage of its own. It may be hard to imagine that the Golden State known for having the most abundant harvest of weed in the nation could possibly have an undersupply, but the reason isn’t a lack of producers. It’s a lack of legal producers. There are thousands of illegal growers operating out of California—only a very small fraction of those operations have applied or received licenses. If the state enforces its regulations strictly and keeps black market weed out of the legal market, there won’t be enough cannabis to supply retail stores pretty soon. 

Taxation

Lawmakers and other elected officials don’t get behind the legalization of weed for recreational use because they want their constituents to have fun. They ultimately support legalization because they want to make money. The tax revenue generated from the commercial cannabis industry has surpassed expert predictions in each state that has elected to legalize for personal use.

For example, for fiscal year 2017, Washington state collected $120, 615, 211.27 in excise taxes. Most of that revenue goes toward the state’s public health programs, including Medicaid, community health centers, and substance abuse prevention programs. Nevada is new to the recreational market, but in its first 6 months, the state made over $30 million in tax revenue. The money Nevada generates from cannabis retail taxes goes to the state’s education system and general fund. Colorado amassed $109,002, 969 between January and May, and those funds will be distributed to education and public health programs and substance abuse, mental health, and youth marijuana-use and prevention services.

The reason these states have generated such astronomical amounts is that their regulations layer taxes on top of retail sales. Washington state levies a 37 percent excise tax. Nevada levies a 15 percent excise tax on the wholesale sale, a 10 percent excise tax on the retail sale, and the retail sales tax at the local rate. That adds up to about a 30 percent tax rate. Colorado imposes a 15 percent excise tax on cannabis sales in addition to local tax rates. These tax rates make it impossible for cannabis producers and processors to drop their prices too low. Businesses have to ask for prices that cover their production costs and taxes, plus a little beyond that if they want to make a profit.

Federal prohibition adds another layer of complexity to the situation. As long as cannabis retains its designation as a Schedule I substance, it will be federally illegal. That means the Federal Government won’t impose taxes on cannabis sales (though the Federal Government does still collect business taxes from cannabis businesses). On the one hand, this might seem to make cannabis cheaper. If cannabis has no federal tax on it, prices won’t have to go up to accommodate that additional tax.

On the other hand, federal prohibition makes it much more difficult for entrepreneurs in the cannabis industry to grow their businesses or for new cannabis producers to pop up (legally, that is). That means the industry is less competitive and there is a smaller supply available for consumer purchase. Those are all factors that keep prices up. Additionally, cannabis prohibition costs tax payers billions of dollars each year, which makes it an extremely wasteful and expensive program to enforce.