What’s Going On With California’s Cannabis Tax?

California’s authorities are planning to simplify the state’s approach to taxing and regulating cannabis, Governor Gavin Newsom’s administration has revealed.

Gov. Newsom announced the intention himself as he unveiled the state’s annual budget proposal last Friday. The proposal included several relevant provisions, the most major of which involves a complete restructuring of the state’s cannabis licensing system, and a change to the point of cannabis tax collection.

The announcement follows the implementation a state cannabis tax hike that came into effect on January 1.

Governor Newsom’s new ‘streamlining’ plans, explained

The largest change proposed by Gov. Newsom is the establishment of a single agency that will control the state’s cannabis licensing system.

At present, the Bureau of Cannabis Control, the Department of Food and Agriculture, and the Department of Public Health all have some involvement in the issuance of cannabis licenses. The new proposal would see the relevant part of each agency consolidated into a single Department of Cannabis Control by July 2021.

“Establishment of a standalone department with an enforcement arm will centralize and align critical areas to build a successful legal cannabis market, by creating a single point of contact for cannabis licensees and local governments,” read one statement on the change, authored jointly by the three current California cannabis licensing authorities.

Gov. Newsom is also proposing changes to how the state collects cannabis tax.

Previously, it was the responsibility of the final distributor of the cannabis product to cover cultivation excise tax and retail excise tax. The new proposal would have the first distributor assume responsibility for the cultivation excise tax and move the retail excise tax onto the retailer.

“Moving the incidence of this tax to the retailer will eliminate the CDTFA’s [California Department of Tax and Fee Administration’s] requirement to estimate product mark-up and set wholesale tax rates,” explained the licensing authorities. “The changes will reduce the tax collection burden on the cannabis industry and simplify the tax collection process.”

Newsom’s administration is also considering making further changes to the cannabis tax structure, including altering the number of taxes and its rates in order to strengthen the state’s legal cannabis market. Members of the state government are currently consulting with stakeholders and industry players over these potential future proposals.

The final cannabis-related segment of the Governor’s budget proposal concerned the allocation of funds collected in the state’s cannabis tax fund. The allocations remain unchanged from the 2019-20 annual budget. Sixty percent of the fund will go towards substance abuse education and prevention programs, 20 percent will be invested in cleaning up the environmental impact of illicit cannabis cultivation, and the final 20 percent is earmarked for general public safety-related activities.

California, cannabis tax, and the illicit market

California is the single largest legal cannabis market in the world. It's cannabis sales for 2019 are estimated to had exceeded $3 billion USD – more than the combined value of the more mature cannabis markets in Colorado ($1.6 billion) and Washington state ($1.1 billion).

But despite this apparently vast market, the true scale of the Californian cannabis market is much larger; expert analysis of the state’s illicit cannabis market estimates that 2019 could have seen up to $8.7 billion worth of black-market sales alone.

Tackling the illicit market is a top priority for California’s lawmakers, but so far the state has struggled to find the right balance between regulation, taxation, and enforcement that would tackle the illicit market while allowing legal cannabis retailers to thrive.

Legal cannabis is already expensive in California. Stringent testing requirements and expensive licenses mean that legal cannabis retailers have to charge significantly more than the cannabis prices seen on the illicit market in order to stay in operation. But with such a large illicit market, California’s tax revenue from cannabis is a fraction of what experts predicted ahead of the state legalizing the drug. As a result, the cannabis sold on the legal market is also being subject to increasingly steep tax rates.

January’s cannabis tax hike saw the tax rates on wholesale cannabis rise from 60 percent to 80 percent as of January 1. The state’s tax administration say that the change was necessary in order to ensure that cannabis products continued to be subject to the 15 percent excise tax set out in state law.

But local dispensaries worried that the tax hike could see even more customers turn to the illicit market, as they now have to consider whether to raise the sale price of their products in response.

“$22,600 a year for our annual license for the city. $96,000 for the state. And then an additional 15 percent tax to the state. So, you add that all up, the profit margins are pretty, pretty slim,” Philip Blurton, owner of the All About Wellness dispensary in midtown Sacramento, told Fox40.

“We’re going to absorb as much of it as we can here at All About Wellness, but we can’t absorb it all.”

All About Wellness employee Zack Mills added, “You know, somebody has $50 set aside in their budget for [cannabis] and now if it’s going to be $60. That definitely hurts them in the long run.”

“I mean, when you can get twice as much marijuana from your neighbor or whoever for a third of the price, why would you come in here?” Mills challenged.

Is there a better way?

The Newsom administration says that they are in consultation with the industry over other potential changes to the cannabis tax system – but what might these be?

Last month, the California Legislative Analyst’s Office came out with a new proposal for the states cannabis tax, arguing that cannabis products should be taxed according to their tetrahydrocannabinol (THC) content.

Under its proposal, the existing cultivation tax would be scrapped completely and replaced with a tax dependent on potency.

If taken on board, California would become the first state to implement a cannabis tax rate that is based on potency, but the concept isn’t completely new. In Canada, cannabis edibles and concentrates are already taxed according to their total THC content.

It’s not known for sure what potential additional changes the Newsom administration is considering in its discussions with stakeholders, but in the budget, the administration does pledge to reveal more details on its planned reforms for cannabis regulation and taxation by the spring of 2020.