Tax Revenue Not Guaranteed if California Legalizes Pot

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By Laura Mahoney

Nov. 3 — Californians are poised to legalize recreational use of marijuana Nov. 8, but the promise of $1 billion in new annual tax revenue for state and local governments is far from guaranteed.

Polls in recent months have consistently predicted voters will approve Proposition 64, the Adult Use of Marijuana Act. Most recently, the Public Policy Institute of California said Oct. 27 that 55 percent of likely voters support it, and the Field Poll found in September that 60 percent intend to vote in favor.

Supporters have raised $22.3 million, outgunning the $1.6 million raised by opponents, according to the California Secretary of State. Major donors to the Proposition 64 campaign include philanthropist Sean Parker, who has given more than $2 million, and marijuana delivery company Weedmaps.

Support, Opposition

The measure has many high-profile supporters including Parker, who founded Napster and is a former president of Facebook Inc. Lt. Gov. Gavin Newsom (D), music entrepreneur Russell Simmons and actor Tim Robbins also back it.

Opponents include U.S. Sen. Dianne Feinstein (D); state Sen. Mike McGuire (D), who represents swaths of Northern California known as the “Emerald Triangle” because of the prevalence of the illegal marijuana industry; and many law enforcement agencies and local governments. The opponents argue the measure will allow television advertising of marijuana, increase driving under the influence of marijuana, and pave the way for corporate entities to take over the market at the expense of small businesses.

Medical Use Already Legal

Although medical marijuana has been legal in California since 1996, Proposition 64 would legalize recreational marijuana and hemp. It would also designate state agencies to license and regulate them.

It would impose a 15 percent excise tax on retail sales of marijuana, and cultivation taxes of $9.25 per ounce of cannabis flowers and $2.75 per ounce of leaves. The taxes would take effect Jan. 1, 2018.

Inclusion of a tax on cultivators differs somewhat from the approach other states have taken in legalizing recreational marijuana. Colorado and Oregon tax only wholesalers or retail sales and have seen their revenue meet or exceed projections. Washington started with a 25 percent tax on growing, processing and retailing of marijuana, but dropped that scheme in favor of a flat tax on retail sales.

Potentially $1 Billion Annually

The California Legislative Analyst, which provides the fiscal analyses of state ballot measures, estimates the measure could bring in revenue ranging from the high hundreds of millions of dollars to more than $1 billion a year. Revenue is expected to be lower in the first few years - while the state gradually licenses marijuana business and those businesses get up and running.

Local governments also can impose their own taxes on marijuana in addition to state-imposed taxes, but how much they do so remains to be seen. The Legislative Analyst’s Office projects local revenue of tens of millions of dollars a year.

At the same time, medical marijuana products now subject to sales and use tax would be exempt starting Nov. 9 if Proposition 64 passes, resulting in a loss of revenue.

Many Uncertainties

The LAO has cautioned that revenue from and costs of the measure are subject to many uncertainties. Reduced legal risk could increase demand and make the marketplace more efficient, driving down prices. Regulatory costs and taxes could increase prices.

If the U.S. Department of Justice prosecutes state-licensed marijuana businesses because marijuana is still illegal at the federal level, revenue would be lower than projections, the LAO said. Cities and counties could ban marijuana businesses, foreclosing the possibility of tax revenue in those areas.

Proposition 64 would mandate how revenue that does materialize is spent. It would be deposited into a new California Marijuana Tax Fund, and would be used first to pay for state regulatory costs not covered by licensing fees.

Next, 60 percent would be used for youth programs, such as drug treatment and prevention; 20 percent would be used to clean up and prevent environmental damage from illegal growing of marijuana; and 20 percent would be spent to reduce impacts of drug use on health and safety, such as driving under the influence.

Medical Marijuana Revenue

Taxation of medical marijuana was murky for several years following its legalization for medical uses. But the state collected about $58 million in sales and use tax on the products in 2015 and $50.5 million through the first half of 2016, according to the State Board of Equalization.

The SBOE offers a tax guide for medical cannabis businesses, which includes information about obtaining permits and licenses, and rules for growers and dispensaries.

The SBOE, which administers the sales and use tax, has cautioned that full compliance with existing and proposed tax and licensing rules under the state’s medical marijuana laws isn’t likely. At least some of the illegal marijuana industry will remain underground and can’t be counted on to deliver tax revenue.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at LMahoney@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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