The current and contentious public health policy of legalizing marijuana has an impact on people's lifestyles as well as the health and welfare of communities. In 2023–24, 15% of Americans reported using marijuana, and 47% said they had used it at some point in their life, making it the most commonly used controlled substance in the United States, according to Gallup.
States began enacting legislation to legalize marijuana for medical purposes in 1996, despite the fact that marijuana usage is still prohibited under federal law. As of the November 2024 election and the addition of Nebraska, 39 states, three territories, and the District of Columbia have now enacted such legislation. Residents' acceptance of marijuana is changing as a result of its legalization for medical use, which is also changing public perceptions of its health and legal risks.
While there are numerous studies on the social and health effects of the increased marijuana usage brought about by marijuana liberalization, less is known about how marijuana liberalization has affected state finances. In the paper “Marijuana liberalization and public finance: A capital market perspective on the passage of medical use laws,” published in the Journal of Accounting and Economics, Gus De Franco, the Emanuel T. Weiler Professor at Purdue’s Mitch Daniels School of Business, investigates the impact of medical marijuana law (MML) enactment on the borrowing costs of state governments.
The study, which is coauthored by Stephanie F. Cheng from Tulane University and Pengkai Lin from Singapore Management University, approaches the research of municipal borrowing costs from a viewpoint where investors base their pricing decisions on the predicted financial conditions and economic prospects of bond issuers. From that perspective, considerations pertaining to the short- and long-term financial sustainability of local governments should be reflected in municipal bond pricing.
According to the study, states' borrowing costs rise by 7 to 9 basis points when state-level legislation legalizing marijuana for medical purposes is passed piecemeal. In dollar terms, using the 7 basis-point increase, MMLs increase a state's interest cost by $7.35 million for the average annual total issuance amount.
“Using a sample of available trading data between 2005 and 2018, we also determine that after MML passage, states' trading spreads increase by 8 basis points,” De Franco says. “Further, MMLs lead to a 0.2-notch downgrade of states' credit ratings and a 4-basis point increase in the underwriter's gross spreads, which is consistent with the idea that underwriters charge higher fees because they assume riskier bond inventories. These results imply that municipal bond investors perceive MMLs as creating a net economic cost rather than a net benefit.”
The research finds that increased consumption is a significant mechanism that explains the higher state bond spreads, which is in line with economic theory on substance use that suggests legalizing marijuana increases local consumption of the drug by increasing its availability and lowering its perceived risks. It also demonstrates that states spend more on marijuana-related expenses, such as public welfare, police, and prisons, after passing such legislation.
Nebraska just became the 39th state to legalize medical marijuana. What does that potentially mean for its borrowing costs and residents’ perception of municipal bonds as an investment?
The study further finds that MML-induced increases in marijuana use have the potential to change a local government’s likelihood of default by impacting its financial stability. “On the one hand, state governments that enact MMLs probably spend more money to uphold the legislation and lessen the possible adverse social and economic effects of rising marijuana usage,” De Franco says. “Legalizing medicinal marijuana, on the other hand, has the potential to attract more inhabitants, generate additional employment, and launch new market sectors.”
The relationship between MMLs and states' increased fiscal burdens is examined as well. As a comparison, states’ expenditures on parks, recreation, natural resources and highways — all of which are unlikely driven by marijuana use — are not linked to MML passage. However, the passing of MMLs is linked to increased spending on public welfare, police and corrections —areas that previous research has linked to marijuana usage.
“We also provide preliminary evidence on states’ recreational marijuana laws, suggesting that consistent with anecdotal evidence that marijuana tax revenues are modest, the borrowing costs for several states that further legalized marijuana for recreational use continue to remain at the elevated levels after such laws are passed,” De Franco says. “These findings are relevant to policymakers at both the state and federal level and to residents interested in evaluating the overall cost of liberalizing marijuana.”
