Establishing stable tax policy is a key component to local cannabis regulatory efforts. Several local governments have proposed cannabis business taxes over 10 percent of gross receipts for each industry sector and the result of this will be;
(i) an increased illegal market,
(ii) failure to attract high quality operators and
(iii) ironically, significantly lower tax revenues for the city.
Improperly set local tax policy may be the single biggest factor determining whether a jurisdiction can successfully generate tax revenue and police the illegal market for marijuana.
Market Driven Development Fees
To avoid multiplicative taxation and attract quality operators, utilize annual property development fees for cultivators, manufacturers and processors. Keep such fees at $15/sq.ft. or less for cultivators and large manufacturers and $25/sq.ft. or less for processors or manufacturers. Allow such fees to be paid quarterly.
Reasonable Gross Sales Tax
If a Gross Sales Tax is used, keep the initial tax rate at 2% or less. Ensure when having voters vote on such tax (as required by Prop. 62/218) ballot measures grant authority to city council to raise and lower such tax to a higher threshold (we suggest 5%).
Constant Moderation of Operating Costs
Review tax and fee amounts frequently and adjust to the extent enforcement costs are rising rapidly, the illegal market rate is spiking or businesses are opting for earby jurisdictions.
As Taxes Rise, So Do Illegal Market Levels
There is a growing body of research highlighting 1) that consumers in the legalized cannabis market are strongly price sensitive, 2) that taxes significantly increase the legalized market’s price premium, and 3) that police enforcement fails to adequately curb the illegal market if it becomes sizable. High local taxes can create a permanent and sizable illegal market in the jurisdiction. The Washington Cannabis Consumption Survey, found if the cost of legal marijuana sold for $4 more per gram, legal sales would make up less than half of the total market. (ii) Growing evidence also shows the marijuana consumers are more price sensitive than other consumer groups. (iii) The charts below demonstrate this effect in both cannabis and tobacco.
The Compounding Effect of California State and Local Taxes
Before any local taxes are assessed, marijuana products sold at dispensaries will be charged a minimum 25.75% effective state tax rate.xv A conservative local tax rate set at 2% of gross receipts for cultivation and retail sales increases the effective tax rate to 29.75%. An aggressive local tax rate at 10% of gross receipts for cultivation, retail sales, and distribution and a 10% retail excise tax increases the effective tax rate to 65.75%.
Before any local taxes are assessed, marijuana products sold at dispensaries will be charged a minimum 25.75% effective state tax rate.xv A conservative local tax rate set at 2% of gross receipts for cultivation and retail sales increases the effective tax rate to 29.75%. An aggressive local tax rate at 10% of gross receipts for cultivation, retail sales, and distribution and a 10% retail excise tax increases the effective tax rate to 65.75%. The figure below demonstrates effective tax rates at different local taxes levels
Tax Revenue Projections
The figure below projects local tax revenue from marijuana businesses, while considering the effect higher prices have on the illegal market and city enforcement costs. The estimates below are conservative on cost as they don’t include incarceration costs. As tax rates increase, so does the portion of
sales that will go to the illegal market, taking revenue away from state and local governments. Higher illegal market rates decrease revenue while increasing enforcement costs. Costs to enforce local laws on unlicensed businesses are high and can often result in expensive litigation for local governments. Finally, there is a growing body of evidence that when illegal market rates approach 40-50%, law enforcement efforts become futile and slowly cease as police move on to more gainful enforcement efforts.
1st Y Axis - Anticipated Revenue (In Millions)
2nd Y Axis - Illegal Market Rate
X Axis - Effective Tax Rate (State and Local)