For the last couple months, the California Department of Tax and Fee Administration has been issuing information pertaining to the upcoming effective date of the taxation of recreational marijuana. This stems from the Nov. 8, 2016 passage of the ballot initiative Proposition 64, the Control, Regulate and Tax Adult Use of Marijuana Act. In accordance with Prop 64, using and growing marijuana for personal use became lawful on Nov. 9, 2016. The act is also the mechanism by which the sale and taxation of recreational marijuana is to become lawful, on Jan. 1, 2018. We discussed the details of Prop 64 when it passed, noting that it was expected to generate millions in tax revenues, which will be spent on administration and enforcement, drug research and treatment.
California’s taxation scheme
In one of the Department of Tax and Fee Administration’s recent publications, a Tax Guide for Cannabis Businesses, the department reminded stakeholders that the applicable taxes are these:
- The 15 percent excise tax will be imposed on purchasers of cannabis and cannabis products. Retailers of cannabis and cannabis products are required to collect the 15 percent excise tax from the purchaser based on the average market price of any retail sale and pay it to their cannabis distributor.
- The cultivation tax will be imposed upon cannabis cultivators on all harvested cannabis that enters the commercial market. Cannabis cultivators are required to pay the cultivation tax to either their distributor or their manufacturer. The rate of the cultivation tax is:
- $9.25 per dry-weight ounce of cannabis flowers that enter the commercial market.
- $2.75 per dry-weight ounce of cannabis leaves that enter the commercial market.
In addition, a June 2017 amendment to Prop 64 established that distributors must collect the excise tax from retailers, and the cultivation tax from cultivators or manufacturers. Distributors must report and pay the cannabis excise tax and the cultivation tax to the Department of Tax and Fee Administration.
A different publication, Know Your Tax Rates and Responsibilities, reminds taxpayers that sales and use tax permit registration became available online on Nov. 20, 2017. This allows for remote registration for all the necessary tax permits for cannabis businesses on the department’s website.
Black market sales
A Fitch Ratings report tallying the legalization of the cannabis market in the United States as of August 2017 pointed out that marijuana was “legal in some form in 30 states where 64 percent of Americans reside.” What is more, marijuana taxation has “been central to nonmedical legalization, as a way to gain public support and discourage consumption, similar to other vice taxes.”
Fitch observed that marijuana taxes are highest in states with legal recreational marijuana, the market for which “appears to dwarf” that of medical cannabis because there are more potential customers. Tax rates range from 10 percent to 20 percent, up to 50 percent when state and local taxes kick in.
Fitch summarized the effective tax rates of non-medical cannabis as follows:
- Alaska: 10-20 percent
- Oregon: 20 percent
- Massachusetts: 24 percent
- California: 35-45 percent
- Colorado: 36 percent
- Nevada: 36 percent
- Washington: 50 percent
In a late September 2017 press release, Fitch considered California’s relatively high tax rate, warning that it will “encourage black market sales and limit potential local government revenues.” Fitch predicted that the tax rate would buttress the black market and keep illicit marijuana pricing competitive “into the long term.” California is not the only state to contend with this problem; Colorado, Washington and Oregon all have lowered their tax rates to resist the black market for marijuana.
Many think that legalization will hold back the rise of a black market for marijuana. But in an August 2017 guest editorial for the Denver Post, Jeffrey Miron, the director of economic studies at the Cato Institute and the director of undergraduate studies in the Department of Economics at Harvard University, argued that even if “[m]ost consumers prefer, other things equal, to purchase from legal suppliers,” excessive taxation and regulation could also encourage illegal sales.
Will marijuana be like cigarettes?
The cigarette market offers an example of how robust a black market can be for a legal product. In its November 2017 report, Cigarette Taxes and Cigarette Smuggling by State, 2015, the latest year for which the figures are available, the Tax Foundation maintained that “[o]ne consequence of high state cigarette tax rates has been increased smuggling as people procure discounted packs from low-tax states to sell in high-tax states. Growing cigarette tax differentials have made cigarette smuggling both a national problem and in some cases, a lucrative criminal enterprise.”
Key findings of the report include the following:
- Excessive tax rates on cigarettes approach de facto prohibition in some states, inducing black and gray market movement of tobacco products into high-tax states from low-tax states or foreign sources;.
- New York has the highest inbound smuggling activity, with an estimated 56.8 percent of cigarettes consumed in the state deriving from smuggled sources in 2015.
- New York is followed by:
- Arizona (44.8 percent of consumption smuggled)
- Washington (43.7 percent)
- New Mexico (41.4 percent)
- Minnesota (35.9 percent)
- New Hampshire has the highest level of outbound smuggling at 71.9 percent of consumption, likely due to its relatively low tax rates and proximity to high-tax states in the northeastern United States.
- Following New Hampshire is Idaho (22.5 percent outbound smuggling), Virginia (20.7 percent), Delaware (20.3 percent), and West Virginia (18.4 percent).
- Vermont, which imposed a cigarette tax increase from $2.62 to $2.75 in midyear 2014, has seen a decrease in how much is smuggled out of the state, from 10.4 percent to 5.5 percent of consumption.
The Tax Foundation’s report cites a number of corroborating studies to assert that “smuggling rates generally rise in states after they adopt cigarette tax increases.” However, some states do see a reduction of black market activity when their neighbors have higher cigarette taxes.
Miron, the Cato and Harvard scholar, does not analogize the black market for cigarettes with marijuana. However, there is commonality among the two, which suggests that the latter will mimic the former. What some characterize as excessive taxation is one point of similarity. Another is the restrictive regulatory framework; with marijuana, this means limits on the number of retail outlets, the specific products they can sell, the amount customers can purchase per visit, the location of stores, home deliveries, the availability of retail licenses, and age.
Cigarettes and other tobacco products are also regulated, though differently from marijuana. For instance, the Food and Drug Administration, by way of the Tobacco Control Act, is authorized to impose rules on sales to youth, warning labels, ingredient disclosures, among other things, and subjects manufacturing and processing facilities to registration and bi-annual inspections.
One significant point of differentiation between the cigarette and cannabis markets is the fact that marijuana is still illegal at the federal level. Even so, Miron opines that this poses an ongoing obstacle for defeating a cannabis black market: “federal law must legalize marijuana so that marijuana businesses can access the legal banking sector and comply with federal tax codes without putting themselves at a competitive disadvantage.”
Ultimately, Miron concludes that “legalization [of pot] without excessive regulation or taxation is the only way to eliminate the black market. And this approach has the added virtue of maximizing tax revenue from legalized sales, minimizing enforcement costs, and respecting the freedom of those who wish to consume marijuana.”
As of Aug. 1, 2017, there is a federal legalization effort in place: New Jersey Sen. Corey Booker’s bill, the Marijuana Justice Act, would decriminalize marijuana throughout the United States. Senator Ron Wyden of Oregon became a co-sponsor on Dec. 19, 2017.