Cannabis Tax Hikes Are Pushing Buyers Back to the Illegal Market
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A cannabis consumer who sees the price at a licensed dispensary jump 20 percent doesn't necessarily quit buying weed. More often, according to a new peer-reviewed study, they just walk down the street to whoever was selling it before legalization ever happened. That's the uncomfortable finding buried in a study published in the journal Health Economics and publicized by NORML on July 21, 2026: when researchers tracked 1,525 adult recreational cannabis consumers and modeled how they responded to legal-market price increases, they found that 89 percent of the resulting drop in legal purchases got absorbed by a shift toward illicit-market buying rather than reduced consumption overall.
The timing could not be more pointed. Over the past eighteen months, a string of legal states have gone the opposite direction from what this data recommends, hiking excise and sales taxes on regulated cannabis to plug budget holes. Maryland, Minnesota, Maine, New Mexico and Michigan have all raised cannabis-specific taxes since 2025, treating the plant as a reliable, almost painless revenue line. The new research suggests that's a miscalculation. Lawmakers keep approaching legal cannabis like a sin tax on a captive audience -- something like cigarettes or liquor, where demand barely budges. But cannabis consumers have an option that beer and tobacco buyers mostly don't: a fully functioning, deeply entrenched unregulated supply chain that predates legalization by decades and never fully went away.
What the New Study Actually Found
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The study, authored by researchers affiliated with Ohio State University, set out to test something that sounds almost too obvious to need proving: do higher legal-market prices push cannabis consumers toward the illicit market? The answer is yes, but the more useful finding is about magnitude. The researchers confirmed basic price theory first -- when legal cannabis gets more expensive, people buy less of it through licensed channels. That part isn't surprising. What matters is what happens to the demand that disappears from the legal side of the ledger.
Surveying 1,525 adult recreational users about their actual purchasing behavior, the team found that only about 11 percent of the reduction in legal purchases represented consumers genuinely cutting back or quitting. The remaining 89 percent simply moved to illicit-market sources -- unlicensed delivery services, legacy dealers, out-of-state product, or gray-market retailers operating without a license. In other words, tax-driven price hikes aren't shrinking the cannabis market. They're reshuffling where that market operates, and pushing an even larger share of it outside of any regulatory or public-health oversight.
That finding lines up with something the Tax Foundation has been saying for years: roughly 72 percent of cannabis consumed in the United States still moves through illicit or unregulated channels, even in states years into legalization. NORML is using the new study to argue that high excise and sales taxes on regulated cannabis are self-defeating policy -- that every percentage point added to the legal price tag makes the illicit alternative that much more competitive, undermining the entire premise of legalization, which was supposed to move cannabis commerce into a taxed, tested, tracked system rather than leave it in the shadows.
The States That Raised Taxes in 2025-2026
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Despite that growing body of evidence, 2025 and 2026 turned into a banner stretch for cannabis tax increases. Maryland raised its special sales tax on adult-use cannabis by 25 percent. Minnesota went further, hiking its state cannabis sales tax by a full 50 percent. Maine bumped its cannabis sales tax by 30 percent, pushing the adult-use rate to 14 percent effective January 8, 2026 -- a hike Gov. Janet Mills proposed specifically as a tool to help close a state budget deficit, treating cannabis revenue as a line item to shore up finances rather than a market to be nurtured.
New Mexico took the slower-burn approach, raising its cannabis excise tax from 12 percent to 13 percent while locking in scheduled annual increases that will keep climbing through 2030. That's a notable structural choice -- it builds future tax hikes into law now, regardless of how the market performs in the meantime, which leaves regulators with little flexibility to respond if illicit-market displacement accelerates.
Michigan made the biggest and most consequential move: a brand-new 24 percent wholesale tax on cannabis, effective January 1, 2026, layered on top of the state's existing tax structure. Wholesale taxes work differently than retail excise taxes -- they hit cultivators and processors before product ever reaches a shelf, and those costs tend to cascade through the supply chain into retail pricing anyway. Taken together, these five states represent a fairly clear legislative consensus in 2025-2026: cannabis taxes looked like accessible, defensible revenue, especially with state budgets under pressure. The new Health Economics data suggests that consensus rests on shaky economic ground.
Michigan's Wholesale Tax and the Market Fallout
Michigan's legal cannabis sales fell sharply after a tax hike, dropping from $269 million in December 2025 to $226 million in January 2026, even below January 2025's $246 million, suggesting consumers shifted to the illicit market.
Michigan's wholesale tax didn't pass quietly. The Michigan Cannabis Industry Association sued the state almost immediately, arguing that a 24 percent wholesale tax improperly amended the Michigan Regulation and Taxation of Marihuana Act -- the voter-approved 2018 ballot initiative that created the state's legal market in the first place. The industry's position was straightforward: voters approved a specific tax framework at the ballot box, and legislators shouldn't be able to layer a major new levy on top of it without going back to voters. Michigan Court of Claims Judge Sima Patel wasn't persuaded, denying the industry's request for an injunction in December 2025 and allowing the tax to take effect as scheduled on January 1.
The sales data that followed arrived fast enough to function as a real-time case study. Michigan's legal cannabis market posted just $226 million in sales in January 2026 -- its lowest monthly total since late 2022, a period when the market was still comparatively immature. Sales fell 16 percent from December 2025 and came in 8 percent below the same month a year earlier, meaning the market wasn't just seeing a seasonal dip -- it was shrinking on a year-over-year basis for the first time in a while.
What makes Michigan instructive is the speed of the effect. This wasn't a slow multi-year drift; it was a visible drop within a single month of the tax taking effect, in a market that had previously been one of the fastest-growing and most price-competitive in the country. If the Health Economics study is right that most displaced legal demand goes underground rather than disappearing, Michigan's illicit and gray-market cannabis trade almost certainly picked up whatever the licensed market lost that January -- even though that side of the ledger doesn't show up in any official sales report.
California Tried the Opposite Approach
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California ran the experiment in reverse. Facing years of data showing its legal cannabis industry struggling against a dominant illicit market, state lawmakers passed AB 564, which reverted California's cannabis excise tax back down to 15 percent -- reversing a scheduled increase that would have pushed the rate to 19 percent. The bill goes further than a one-time rollback: it includes a moratorium blocking any further excise tax increases through 2030, giving licensed operators several years of price certainty to plan around.
Lawmakers were unusually candid about the reasoning. The stated goal wasn't abstract tax fairness -- it was explicitly about helping licensed sellers compete with the illicit market that still dominates California cannabis commerce. Legal sales account for only about 40 percent of total cannabis consumption in the state, meaning the majority of California cannabis transactions still happen entirely outside the regulated system, generating no tax revenue and no product testing. Taxable cannabis sales had already slid from roughly $1.5 billion down to $1.2 billion before the rollback passed, a trajectory that alarmed both industry groups and the legislators who'd need that tax revenue to materialize.
The scale of California's untaxed market is staggering on its own terms. The state's Department of Cannabis Control estimates that illicit cultivation produces around 11.4 million pounds of cannabis annually statewide, with a 2024 wholesale value pegged at roughly $7.9 billion. That's a shadow economy larger than many countries' entire licensed cannabis industries, operating in a state that has had legal recreational cannabis since 2016. California's bet with AB 564 is that a lower, more stable legal tax rate will claw back some of that volume over time -- a bet that Michigan's January numbers suggest has real teeth behind it.
DC's Tax Fight Shows the Politics Are Shifting
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Washington, DC offers a smaller but telling window into how this debate is playing out among lawmakers directly. The District's FY27 budget proposal includes the Medical Cannabis Tax Rate Amendment Act of 2026, which would raise the medical cannabis sales tax from 6 percent to 10.25 percent -- nearly doubling the rate patients pay on their medication. That's notable timing, because earlier this same year, the DC City Council rejected a separate proposal that would have sharply raised taxes on retail adult-use cannabis purchases, judging that hike too likely to backfire.
That split decision -- squeeze the medical side while backing off the recreational side -- suggests DC lawmakers are absorbing at least some of the lesson from Michigan and California, even as budget pressure keeps pulling them back toward cannabis as an easy target. Advocates have pushed back hard on the medical proposal specifically, arguing that patients are usually the most price-sensitive segment of any cannabis market: many are on fixed incomes, buy more frequently for chronic conditions, and have the least cushion to absorb a near-doubling of their tax rate before looking for cheaper unregulated alternatives.
The broader pattern across all these states is one of legislators increasingly aware that illicit-market blowback is real, even as short-term budget math keeps nudging them toward cannabis taxes anyway. Rates, structures, and even what counts as legal vary enormously by state, and in some places cannabis remains fully illegal regardless of tax policy elsewhere. Anyone trying to figure out what they'll actually pay, or what's legal to buy at all, should check current state and local rules directly rather than assume last year's numbers still hold -- this is one of the faster-moving corners of state policy right now.
Put the state-by-state picture together and a ceiling starts to come into focus. Push the legal price too high relative to the illicit alternative, and consumers don't disappear -- they route around the regulated system entirely, taking their money, and any hope of quality testing or public health oversight, with them. That's not a hypothetical anymore; it's what the Health Economics data shows nationally and what Michigan's January sales figures show in one state, in real time.
California and Michigan are now running a live natural experiment that other legislatures would be wise to watch closely before their next budget cycle. One state bet that a lower, locked-in tax rate would claw back market share from an entrenched illicit trade. The other bet that a new wholesale tax could be absorbed without much disruption, and got a sharp, fast answer in the sales data instead. Neither state has years of post-policy data yet, but the early signals are about as clear as this kind of policy question usually gets.
Don't expect this fight to settle down anytime soon. State budgets remain tight heading into 2026 and 2027, and cannabis taxes will keep looking, on paper, like an easy lever to pull -- a levy on a product many voters still view ambivalently, attached to an industry with less lobbying muscle than alcohol or tobacco. But the more data that piles up showing those hikes just feed the illicit market instead of state coffers, the harder it will get for lawmakers to justify the next increase without a real answer for where that displaced demand goes.