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Killing the golden goose — don’t strangle the new cannabis industry with a big tax grab

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One major attraction of Proposition 64, which legalized recreational marijuana, for many California policymakers was a potential $1 billion in tax revenues from a market estimated to grow to $7.6 billion by 2020. The tax revenue could be a big boon for youth, health, research, law-enforcement and environmental programs set to get the money.

These tax benefits are, of course, in addition to tens of millions of dollars in annual savings from reduced criminal justice costs and redeployed law-enforcement resources, according to the state’s Legislative Analyst’s official review of Prop. 64.

The Legislative Analyst warned that the $1 billion in such revenues likely isn’t coming “right away.” New companies need to set up efficient production pipelines, and regulators need to scale up operations. Also, medical marijuana products won’t incur sales taxes anymore.

Realizing those tax revenues over time, paradoxically, may depend on whether policymakers overreach, and try to grab a big tax payday fast. If state and local fees and taxes are piled too high, they will obstruct the development of a legitimate and sustainable legal cannabis industry.

Just as problematic, excessive taxes will create massive incentives for what’s called “cross-border arbitrage” (i.e., people running across state, local or tribal boundaries to get a better price) and will sustain a black market for illegal marijuana sales that benefits no one but lawbreakers.

Prop. 64 imposes cultivation taxes of $9.25 per ounce of bud and $2.75 per ounce of leaves, plus a 15 percent state excise tax, and allows local jurisdictions to charge their own sales taxes. Those additional local fees could hamstring this new and delicate industry with overtaxing. Already, several major cities are proposing hefty additional fees, such as San Diego, whose proposal calls for a tax of 8 percent to 15 percent.

These pricey proposals are coming out despite other states’ legalization experiences. They quickly found too much can be a very bad thing when trying to create a safe, regulated and sustainable legal cannabis industry.

A May study by the nonpartisan Tax Foundation found that Colorado, Washington and Oregon all had to reduce or modify effective initial tax rates of at least 30 percent, because the resulting high prices fueled a substantial black market.

In Colorado, where state and local taxes put the overall effective rate at 29 percent, the state will cut its retail sales tax from 10 to 8 percent.

Washington’s burden is effectively 37 percent, thanks to sales, excise and gross-receipts taxes set at a level between the rates for cigarettes (104 percent) and beer (11 percent). There, the Tax Foundation says, the state had to sign a compact with a Native American tribe to ensure state fees weren’t wildly undercut by tribal alternatives. The state also had to modify strict zoning regulations to give businesses an adequate array of site options.

Oregon, meanwhile, shifted from an impractical tax on harvests to a retail sales tax of 17 percent (with local jurisdictions allowed to take 3 percent more).

A Priceonomics study found that prices in California dispensaries (especially in San Francisco) are already 35 percent higher than those three states.

As well, the Tax Foundation found that cannabis-related taxes were slow to come in initially, but ramped up after the states adjusted their approaches, and soon far exceeded projections.

California jurisdictions casting about for new revenue sources will be tempted to load up on high taxes in exchange for allowing recreational-use dispensaries in their jurisdictions. But they should tread lightly.

The smarter approach keeps cannabis taxes moderate, nurtures emerging cannabis companies into a sustainable industry and watches revenues take off over time. In addition, cities can try to profit indirectly from the new industry, through increased employment and real-estate utilization, creating a broader tax base. They can also charge one-time license or annual fees for regulatory compliance. This assures continued growth and long-term rewards.

A quick cash grab, by contrast, would defeat Prop. 64’s intent, perpetuate the black market and increase law-enforcement burdens.   

Michael Chernis is a Los Angeles-based attorney and expert specializing in the cannabis industry. With decades of experience as an attorney handling high-profile big business cases and civil rights issues, he has lobbied on behalf of dispensaries to have more open laws surrounding medical marijuana.

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