Legalising cannabis would raise "notable tax revenue" and "lead to overall savings to public services", an internal-Treasury report has concluded.
The paper, seen by The Independent, concluded changing the law on the drug would bring around £500m to £800m in taxes as well as lead to significant savings in policing costs.
Yesterday MPs debated decriminalising the drug after more than 200,000 people signed a petition demanding the issue be addressed.
The Lib Dems also announced the creation of a independent panel of experts to establish how a legalised market for cannabis could work in the United Kingdom. The panel includes former government drug adviser professor David Nutt.
Labour MP Paul Flynn told The Huffington Post that the UK was being "left behind" by many other countries, including many US states, which had decriminalised medicinal cannabis.
"We are in a position rather like America is on gun laws. Most of the rest of the world is baffled by our refusal to reform," he said.
Speaking in the Commons debate, former Tory cabinet minister Peter Lilly said just because some people believed the drug was morally wrong did not mean it should be banned.
"Some years ago, members of the press asked Front Benchers from both parties whether they had ever consumed cannabis. I found that I was one of the very few who had never done so then, and I have not since," he said.
"That may be why I had a clear enough head, when looking at the evidence, to conclude that we need not just to decriminalise cannabis, but to legalise its sale and use."
Lib Dem Health spokesman Norman Lamb said: "There is extraordinary hypocrisy on the issue. Senior politicians are frequently challenged about their use of cannabis and other drugs in their teenage and early adult years.
"Those who admit to such drug use laugh it off as a youthful indiscretion, apparently comfortable with the fact that tens of thousands of their fellow countrymen and women—usually people less fortunate than the politicians who reach the top of Government—end up with a criminal record for doing precisely the same thing. We should be uncomfortable about that."