Last week, the California Department of Tax and Fee Administration (“CDTFA”) reported that between January and March the state earned $60.9 million in tax revenue from the legal adult-use and medical cannabis industry. The $60.9 million figure does not include local tax revenue collected by cities or counties. The breakdown of revenue was as follows:
- Excise Tax: $32 million
- Cultivation Tax: $1.6 million
- Sales Tax: $27.3 million
While $60.9 in new tax revenue may seem like a lot, the figure falls well short of the pace predicted by Gov. Jerry Brown in his 2018 budget proposal. He forecast up to $175 million in tax revenue between January and June of 2018.
The relatively low level of tax revenue aligns with industry reports that cannabis sales in California have been lagging since legalization on January 1, 2018. In April, the Sacramento Bee reported that the cannabis industry did an estimated $339 million in retail sales during January and February. That’s over $40 million less than the $383 million, generated every two months, the state would need to meet the budget forecast of $1.15 billion by year’s end.
Typically, cannabis sales are slower in the winter and spring months than summer, and we should expect a noticeable increase in revenue when the weather warms. While this may account for a percentage of the short-fall, we at ELLO have observed a number of other fundamental issues that are limiting the cannabis industry’s growth in California.
Three Reasons Cannabis Tax Revenue Fell Short of Expectations
For many cannabis industry operators and advocates, the tax shortfall does not come as a surprise. A number of obstacles have emerged that are impeding the California cannabis industry.
Delays in Licensing Preventing Business Operation
California launched a new licensing system with the advent of adult-use legalization and there have been more than a few issues. The state’s multi-tiered system requires permission from the local city or county before a business can earn a license from the appropriate state authority. Some cities and counties are experiencing delays in issuing permission, throwing another wrench into a complex and expensive process.
Delays and confusion are having a measurable impact. As reported by MJBizDaily, cannabis businesses in Los Angeles, the biggest potential market for California cannabis, have struggled to get licenses to operate legally. To date, there are only 146 businesses in Los Angeles County operating under temporary licenses. All of these recipients are long-standing dispensaries that qualified for early priority licensing.
Cultivators, manufacturers and new cannabis enterprises still cannot apply for licenses in Los Angeles, and there has been no guidance regarding when the process will begin.
Delays and difficulties in licensing have either prevented businesses from beginning operation, or existing businesses are operating in a legal “grey area.” Meaning that in many cases, they were legal cannabis businesses under the pre-1/1/2018 laws, but with the onset of the new licensing process, have not been able to acquire licenses to operate. In early April, the Bureau of Cannabis Control sent out nearly 1,000 cease-and-desist letters to cannabis businesses they determined were operating without licenses.
Across California, new and established cannabis businesses are stuck waiting as they seek to operate within regulations. Once the kinks in the licensing process are worked out and hundreds, if not thousands, of businesses join the regulated cannabis market, tax revenue will surely rise.
High Cannabis Tax Rates Credited for Boom in Black Market
Another unexpected obstacle is wide-ranging reports that cannabis legalization in California has actually resulted in a boost to black market operators. This seeming contradiction is attributed to the comparatively high tax rates of California cannabis. Between the 15% excise tax, the cultivation tax, sales tax, and local taxes, the tax rate of cannabis is estimated to be up to 45% in some areas. As a result, cannabis business operators must charge inflated prices for product to maintain profit margins, prices easily undercut by black market operations.
California has a markedly higher tax rate than other states with legal adult-use cannabis markets. In addition, Colorado, Washington, and Oregon have all taken steps to reduce their initial cannabis tax rates, precisely as a response to persistent black market operators.
Currently, California’s lawmakers are mulling AB 3157, legislation that would lower the effective tax rate by cutting the excise tax (to 11%) and eliminating the cultivation tax for a three-year period. It is unknown what effect news of “low” tax revenue from the cannabis industry will have on the progress of AB 3157.
California Municipalities Slow to Accept Cannabis Industry
A key component of Prop 64 was the ability for cities and counties to determine how cannabis legalization laws would be enforced within local jurisdictions. Over the past year, each city and county across California has begun the process of developing local laws. A report by the OC Register in early April found a “crazy quilt of policies” across the state. Less than one in three cities in California (144 out of 482) allow any kind of cannabis industry operation, and only 18 of 58 counties allow cannabis business operations in unincorporated areas. (See a complete database of local cannabis laws.)
This patchwork mix of laws and regulations governing the cannabis industry has created a complex and fraught environment for both businesses looking to get off the ground, and potential customers, who oftentimes must look hard, or travel, to gain access to “technically” legal cannabis.
How Will California Respond to Low Cannabis Tax Revenue?
We are only speculating from here on out, but it is important to express that the “growing pains” illustrated above are far from disastrous … and aren’t even that unusual. Each state that has legalized cannabis has experienced issues and obstacles. There is no formula for creating a cannabis regulatory framework, and the geographic, social and population factors unique to California assured that the system established here would be the first of its kind.
The fear among cannabis industry operators and advocates is that reports of low tax revenue may cause a “knee-jerk” reaction among legislators, or even cool, or alter stances on legalization for legislators whose doubts on legalization were assuaged by the potential benefits of tax revenue.
We are happy to report that, to date, there has been no real discussion of raising taxes, or other drastic alterations to California’s regulatory framework. If anything, it appears that Gov. Brown’s projections were simply too optimistic for a new industry. Even so, the cannabis industry may still meet, or even exceed, those projections by the time the year is over.
Everyone seems to be in agreement that California’s legal cannabis market is in its infancy, and certain difficulties are inevitable. We won’t be able to make any real judgements about revenue, reporting, or even the efficacy of tax rates until the state licensing authorities, and local jurisdictions, have their regulatory systems fully in place and operational.
Once there is an open, level playing field for cannabis industry businesses, there is little doubt that the customers will come. And with those customers, the windfall of tax revenue the state is waiting for. The state’s lawmakers and regulatory authorities simply need to finish their part of the job and allow the market to work.
We at ELLO are working diligently to support cannabis businesses as we develop financial and operational best practices for the cannabis industry. If you have any questions, or would like to schedule a consultation, please contact us here.