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Legislature's Advisor Suggests Major Overhaul of Cannabis Taxes

The Legislative Analyst's Office has proposed taxing product based on potency.

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The details of a highly anticipated state government report on cannabis policy, issued last week, are almost secondary, despite them turning out to be rather remarkable. What was most important to cannabis businesses and customers was the acknowledgement that the state's policy regime is dysfunctional, especially when it comes to taxes, and needs a complete overhaul.

And that's just what the report from the Legislative Analyst's Office indicates. An independent, apolitical body that advises the state legislature, the LAO "has done a good job giving policy makers and advocates a starting point for conversation in the new decade," said Hezekiah Allen, chairperson of Emerald Grown, a growers co-operative and an advocate for growers' interests. Assemblyman Rob Bonta (D-Alameda), who has been trying and failing to get a tax-relief bill passed, said the report "delivers a clear message that the status quo is not working." The California Cannabis Industry Association issued a statement lauding the LAO not so much for its particular policy recommendations, but because it concluded that a major redo is needed. Ditto the United Cannabis Business Association, which represents retailers. In a statement, UCBA President Jerred Kiloh said the report "represents the foundation for the work that we must now do to identify an appropriate level of taxation that will move buyers away from the illicit market. "

The LAO report, titled "How high? Adjusting California's cannabis taxes," contains a radical recommendation: that the state eliminate all current taxes and base future levies on potency. That is, the more THC in a given product, the higher the tax.

The notion, which raises a lot of questions about viability, is still being kicked around in the corridors and conference rooms of cannabis companies and industry advocates. But in general, most industry people seem to think it would at least be better than the current situation, which plops a whopping 15 percent tax on all retail sales, on top of a similarly high cultivation tax, and on top of any local taxes. The Cannabis Industry Association said the recommendations "mirror legislative priorities that CCIA's membership have been advocating for over three years, including removal of weight-based taxes."

Referring in particular to the elimination of the cultivation tax, Bonta said the report "indicates that my legislative approach could be the most effective to reduce the influence of the illicit market."

The tax regime since cannabis was legalized for recreational use in 2018 has been a disaster, and an existential problem for large swaths of the industry. Over the past few months, several companies have announced layoffs, which you don't want to see in a brand-new industry that's been showered with investor cash. The state's tax revenues are well short of what the government had budgeted for. The illicit market continues to thrive, and people are starting to worry that it will be years before the state has a stable cannabis industry.

One reason most people are issuing platitudinous reactions to the report is that nobody is sure how it would work. Measuring THC levels in the plant itself is at this point as much an art as it is a science. California would be the first state to implement such a tax scheme. "I don't see how it would even work," said the head of sales at an East Bay dispensary who asked not to be identified. And Debby Goldsberry, executive director of Magnolia Wellness in Oakland, said only this about the idea: "Wow, that is a complicated proposal." She suggests simply eliminating the cultivation tax and leaving the sales tax where it is.

Canada taxes cannabis products according to potency, but only for concentrates and edibles, where the components are much easier to measure. Bud is taxed by weight.

The LAO suggested a tax on THC content of between $0.006 and $0.009 per milligram. In most case, that would yield an effective tax rate substantially lower than the current one. A rough estimate would put it at less than half of the current rate for a typical bag of gummies.

The LAO had a backup suggestion as well: a tiered, "ad valorem" tax that would be based on either potency or product type.

The thorny issues of implementation aside, the report is generally being accepted as a starting point. "The discussion of overhauling the tax is encouraging," Allen said. "I'm glad some of the policies that growers have supported for years — such as a tiered tax, or a potency-based tax — were included in the discussion." But, he said, a potency tax "is especially challenging because changes are needed urgently, but the policy is complex, with several variables to consider. It is policy best not crafted in a hurry."

For that reason, Bonta has pledged to re-introduce his bill in the coming legislative session to temporarily cut the sales tax by four points and eliminate the cultivation tax. "We must take action to not only promote California's fledging industry but also combat the illicit market with its unlicensed, untested, and unsafe products," Bonta said. 

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