Association for Public Policy Analysis & Management

Although tax economists frequently come out against gross receipts taxes because these taxes encourage inefficiently high levels of vertical integration, there is no empirical evidence examining the existence and magnitude of this effect, nor its consequences for market efficiency. Such evidence is crucial as more and more states are considering the adoption of gross receipts taxes. We quantify these effects using data from the Washington state marijuana industry, which has two distinct advantages: (1) we are able to track the entire vertical supply chain daily, which is normally an insurmountable obstacle, and (2) there was a large (25%) gross receipts tax imposed on marijuana in Washington state for one year that was subsequently eliminated, which creates a clean natural experiment. We find that the short-run elasticity of vertical integration with respect to the intermediate good tax wedge is 0.1 and the long-run elasticity is more than 3 times as large. Moreover, there are large production increases in response to the elimination of the intermediate goods tax wedge -- this elasticity is 0.73.