Big Tax Grab Risks Nipping Cannabis Industry In The Bud

 

Source: Law 360

By Michael Chernis, Chernis Law Group

November 22, 2016

 

On Nov. 8, 2016, California voters passed Proposition 64, the California Marijuana Legalization Initiative. For many California policymakers at the state and local levels, one major attraction of Prop. 64, which legalized recreational marijuana in the state, was its promise as a new revenue source for perpetually underfunded operations.

 

The great paradox of this potential payday, however, is that overly aggressive local policymakers might kill this golden goose before it ever gets a chance to settle in. Heavy-handed new taxes – which some local jurisdictions are already countenancing – could throttle the promising new cannabis industry.

 

Just as problematic, excessive taxes will create massive incentives for what’s called “cross-border arbitrage” (i.e., people running across state, local or tribal boundaries to get a better price) and will sustain a black market for illegal marijuana sales that benefits no one but lawbreakers.

 

Prop. 64 designated any state-level tax revenues would go to youth, health, research, law-enforcement and environmental programs. And those revenues are expected to be hefty – as much as $1 billion annually in tax revenues from a market estimated to grow to $7.6 billion by 2020. Medical marijuana is expected to continue to be worth another $3 billion a year in the state.

 

The Legislative Analyst warned that the $1 billion in such revenues likely isn’t coming “right away.” New companies need to set up efficient production pipelines, and regulators need to scale up operations to oversee operations and collect tax revenues.

 

As well, some medical marijuana products, which have been legal for most of two decades, won’t be incurring sales taxes anymore.

 

These tax benefits are, of course, in addition to tens of millions of dollars in annual savings from reduced criminal justice costs and redeployed law enforcement, according to the state’s Legislative Analyst’s official review of Prop. 64.

 

Now comes the complex and delicate process of implementation, further complicated by a 2015 state law that creates a two-tier licensing system. To operate in a local jurisdiction, a dispensary or other cannabis business will need permits from both the state and that jurisdiction.

 

Some cities and counties are opting not to issue any licenses, blocking all dispensaries and cannabis-related businesses, or have adopted temporary moratoriums while they assess the new regulatory dynamics.

 

Still other cities are moving forward, tantalized by potential revenue opportunities and pushed by residents who want access to a legal and regulated system for cannabis products.

 

Prop. 64 imposes state cultivation taxes of $9.25 per ounce of bud and $2.75 per ounce of leaves, and exacts a 15 percent excise tax. It also allows local jurisdictions to charge their own sales taxes and other fees to recover regulatory costs.

 

Those additional local fees could hamstring this new and delicate industry, especially given federal tax laws. Already, several major cities are proposing hefty additional fees, such as San Diego, which is considering a tax of eight percent to 15 percent.

 

These pricey proposals are coming out despite other states’ legalization experiences, where early attempts to impose a heavy tax regime were nearly disastrous.

 

A May study by the nonpartisan Tax Foundation found that Colorado, Washington and Oregon all had to reduce or modify effective initial tax rates of at least 30 percent, because the resulting high prices fueled a substantial black market.

 

In Colorado, where state and local taxes put the overall effective rate at 29 percent, the state will cut its retail sales tax from 10 to eight percent.

 

Washington’s burden is effectively 37 percent, thanks to sales, excise and gross-receipts taxes set at a level between the rates for cigarettes (104 percent) and beer (11 percent). There, the Tax Foundation says, the state had to sign a compact with a Native American tribe to ensure state fees weren’t wildly undercut by tribal alternatives.

 

The state also had to modify strict zoning regulations to give businesses an adequate array of site options.

 

Oregon, meanwhile, shifted from an impractical tax on harvests to a retail sales tax of 17 percent (with local jurisdictions allowed to take three percent more).

 

A Priceonomics study found that prices in California dispensaries (especially in San Francisco) are already 35 percent higher than those three states.

 

As well, the Tax Foundation found that cannabis-related taxes were slow to come in initially, ramping up only after the states adjusted their approaches. Since the changes, revenues have typically far exceeded projections.

 

California jurisdictions casting about for new revenue sources will be tempted to load up on high taxes in exchange for allowing recreational-use dispensaries in their jurisdictions. But they should tread lightly.

 

The smarter approach keeps cannabis taxes moderate, nurtures emerging cannabis companies into a sustainable industry and watches revenues take off over time. In addition, cities can try profit indirectly from the new industry, through increased employment and real-estate utilization, creating a broader tax base.

 

They can also charge one-time license or annual fees for regulatory compliance. This assures continued growth and long-term rewards.

 

A quick cash grab, by contrast, would defeat Prop 64’s intent, perpetuate the black market and increase law-enforcement burdens. None of us want that.