California Gov. Gavin Newsom’s proposal to eliminate the state cultivation tax on marijuana is a welcome move, according to industry officials.
But they argue the governor’s plan fails to go far enough to help an industry beset by high taxes, burdensome regulations and a robust illicit market.
To compensate for the lost revenue from the elimination of the excise tax, for example, Newsom’s plan would raise the retail excise tax on marijuana purchases after three years, from 15% to 19%.
That and other provisions have triggered criticism of the overall plan from industry officials as well as state lawmakers.
“It’s a nice little Band-Aid for a functionally broken system that needs an overhaul, starting with reduction of taxes across the board,” said Doug Chloupek, the CEO and founder of Juva Life, a cannabis grower and life science research company with a cultivation arm in Stockton.
California Sen. Scott Wiener, a Democrat, agreed, saying the high taxes that marijuana companies currently face in California lead to expensive product at the retail level – which, in turn, drives consumers to the unlicensed market.
In addition to the cultivation and excise taxes, licensed cannabis sales in California are subject to the general sales and use tax, which varies depending on location but averages 8.82% of the final sales price for 2022, according to data from the conservative Tax Foundation.
“The current cannabis tax system in California is badly broken,” Wiener said. “Taxes are so high they’re helping fuel the illicit market.”
How Newsom’s plan would work
As part of his 2022-23 budget plan, Newsom proposed last week to scrap the cultivation tax, which is set at $10.08 per ounce ($161.28 per pound) of flower and $3 per ounce ($48 per pound) of leaves.
After the cultivation tax cut – if Newson’s plan is enacted – if revenue from marijuana taxes doesn’t add up to the $670 million baseline set for funding services such as law enforcement and environmental restoration, the state would backfill that shortfall from the general fund.
Wiener said the state has a large surplus, with plenty of flexibility to backfill that funding.
Meanwhile, the proposed 4-percentage-point increase in the state retail excise tax, to 19%, would kick in after three years.
Newsom also proposed changing which sector collects that tax, shifting that responsibility to retailers from marijuana distributors starting in January.
That’s a sticking point for Wiener, who said he has no problem with scrapping the tax for cultivators – but not if it happens on the backs of retailers.
Newsom’s proposed overhaul would go into effect July 1 if state lawmakers approve the plan.
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California state Sen. Steven Bradford, a Democrat, said if the excise tax goes up it’s “going to have absolutely no impact on what we’re trying to achieve” – namely, replacing the illicit market with the legal one.
He would like to see the excise tax reduced to 5% to drive even more revenue to licensed operators.
To Juva Life’s Chloupek, the moves all sound like merely virtual signaling from the governor at a time problems for California marijuana companies run deep and wide.
“Cannabis is one of the only commodities that the cost of producing it has doubled or tripled in the last five years, and the value has decreased by 50%-90% depending on where you are in the supply chain,” he said.
That means many licensed companies are either returning to the illicit market, going under or putting their companies up for sale, Chloupek said.
A few years ago, cannabis companies in California were valued at two to five times revenue, according to Chloupek. But valuations are now closer to 50% of revenue.
“We’re seeing a mass consolidation because people simply cannot keep their doors open.”
Losing the illicit-market fight
This month, the Reason Foundation, a libertarian think tank, released a 42-page report with findings that California’s illicit cannabis market accounts for roughly two-thirds of total sales in the state.
“From our perspective, one of our primary issues is the fact that we’re competing with a very robust illicit market,” said Amy Jenkins, the president of Precision Advocacy and legislative advocate for the California Cannabis Industry Association, based in Sacramento.
Precision Advocacy and Good Farmers, Great Neighbors – a group comprised of mostly outdoor cannabis growers and auxiliary businesses along California’s Central Coast – helped to commission the report, which is titled “The Impact of California Cannabis Taxes on Participation Within The Legal Market.”
Dale Gieringer, the director of California NORML who wrote the report’s foreword, noted that, based on survey results, the effective tax rate in the state ranged from $42 to $90 per ounce of cannabis – more than the $35 it costs to grow marijuana wholesale.
In its report, the Reason Foundation argues that reducing taxes – and, therefore, retail prices – would convert more consumers from the illicit market to the legal market.
In the foreword, Gieringer noted that “even with substantial tax reductions, the state can expect total revenues to rise substantially in the next two years due to increased consumer demand.”
“Substantive tax cuts therefore seem to be a feasible strategy for reducing demand for the illicit market, while still retaining reasonable revenues for the state programs funded in Prop. 64,” he added, referring to the 2016 ballot measure that legalized recreational marijuana in California.
The Reason Foundation estimates that the various state and excise taxes increase the retail price of legal marijuana by $727 per pound.
That’s not to mention federal and state income taxes and local taxes – as well as the business tax penalty stemming from Section 280E of the U.S. tax code.
Matt Hawkins, the board chair at California cannabis company StateHouse, said regulatory and tax burdens make it harder for businesses to succeed.
“It makes it incredibly difficult for people who aren’t vertically integrated to compete,” added Hawkins, who also is a co-founder and managing partner at Entourage Effect Capital, a private equity investment firm in Dallas.
The struggle to turn a profit in California could lead many mom-and-pop businesses to fail, Hawkins noted, “and most of the industry doesn’t want that.”
The Reason Foundation report analyzed the cumulative effect of taxes assessed at the state and local levels and found that they ranged from $667 to as high as $1,441 per pound in Solano County.
Other top counties were:
- San Luis Obispo: $1,169 per pound.
- Nevada: $1,114 per pound.
- San Diego: $1,061 per pound.
West Hollywood topped the list of select cities for total tax, at $1,034 per pound, followed by Santa Ana, at $1,014 per pound.
“By contrast, the wholesale production costs of cannabis cultivated indoors under the existing regulatory framework calculate to approximately $564 per pound,” the report states.
How it’s done elsewhere
Precision Advocacy’s Jenkins noted that other states such as Colorado, Oregon and Washington have much simpler, and lower, tax rates than California’s.
Jenkins sees that as a main driver for converting consumers away from the illicit market.
“There is real evidence out there that reducing price does drive consumers to legal stores,” she said.
For example, Colorado assesses a 15% wholesale transfer tax and a 15% retail excise tax, while Oregon assesses only a 17% retail excise tax.
The Reason Foundation estimated that these tax rates amounted to $526 per pound in Colorado and $340 per pound in Oregon, which is the lowest in the nation.
“California bears a significant disadvantage in terms of per-pound tax cost of legal cannabis relative to its peers with mature, adult-use markets,” according to the report.
“Media reports have indicated that Oregon, with the lowest per-pound tax cost among states with adult-use markets, has also been most successful in transitioning cannabis sales from the illegal to the legal market.”
Another factor: California has far fewer cannabis retail outlets servings consumers on a per-capita basis.
According to the study, Oregon has 691 active retail businesses and Colorado 420. That’s one retail cannabis store per 6,145 residents in Oregon and one per 13,838 people in Colorado.
California, by comparison, has one retail marijuana store per 29,282 residents.
“There’s a perfect storm in California,” said Tiffany Devitt, board vice president for the California Cannabis Industry Association and head of regulatory affairs for the CannaCraft and March and Ash marijuana companies.
“Cannabis businesses are hurting, price points are dropping. It makes it almost impossible to compete.”
Bart Schaneman can be reached at email@example.com.