On May 11, 2018, the California Department of Tax and Fee Administration (CDTFA) released its cannabis tax revenue numbers for the first quarter of 2018. These numbers fall short of the high expectations of industry analysts and the state. The CDTFA reports that it has collected a total of $60.9 million from licensed cannabis operators in Q1. This amount includes the state’s cultivation, excise and sales taxes, but does not include local tax revenue collected by cities or counties. Breaking it down a bit further, the excise tax generated $32 million, the cultivation tax brought in a mere $1.6 million, and the sales tax generated $27.3 million. Medicinal cannabis sales are exempt from sales tax if the purchaser holds a valid Medical Marijuana Identification card.

In addition to regulation and the elimination of the black market, the promise of tax revenues  was a major force behind the passage of Prop 64 back in 2016. The governor’s budget proposal had predicted $175 million in revenue in the first six months of 2018, which has proven to be optimistic based on the first quarter results. Two prime culprits for the tax shortfall may be suppressed sales volumes due to competition from healthy gray and black markets and fewer tax paying operators due to widespread local government bans on commercial cannabis activity and major delays in those jurisdictions that are allowing commercial cannabis.

In addition to competing with leaner gray and black market competitors, compliant operators face strict zoning requirements, slow and reticent local permitting bodies, and moratoriums on commercial cannabis activity. These obstacles result in fewer regulated operators, fewer sales, and fewer tax dollars. The expected tax revenue will only come if the cannabis industry is able to launch at scale and thrive. Imposing high taxes on a fledgling industry, much of it still emerging from the gray and black markets, is not an ideal way to encourage transitioning and new operators to jump through the numerous hoops set up by state and local governments. Local prohibitions on commercial cannabis exist in 70-80% of local jurisdictions. This means that operators are flooding those few jurisdictions that are permitting commercial cannabis activity with applications, resulting in delays.

The CDTFA’s report may have already put a damper on AB 3157, a bill  currently in committee that, if passed, would reduce the excise tax to 11% and eliminate the cultivation tax until June 2021. A recent addition to the bill allows the Legislature to restore the excise tax rate to 15% if the revenues collected from the excise tax are “insufficient to adequately fund the reasonable regulatory costs” outlined in the Revenue and Taxation Code. This language seriously weakens AB 3157 and puts a significant amount of pressure on a brand new industry.

There may be a significant tax break on the horizon for California’s growing legal cannabis market. A bi-partisan group of Assemblymembers introduced a bill (AB 3157) that will temporarily cut the state excise tax from 15% to 11% and eliminate the cultivation tax, which is currently $9.25 per ounce ($2.75 per ounce of cannabis leaf and $1.29 per ounce of fresh cannabis plant) until June 1, 2021. The bill is intended give the legal cannabis industry a chance for a strong start, encourage black and gray market cannabis operators to make the transition to the legal marketplace and prevent the black market from successfully competing with legally compliant tax-paying businesses.

AB 3157 will be welcome news to California’s cannabis entrepreneurs, many of whom are concerned about the ability of their businesses to survive under the heavy tax burden imposed by state and local governments, while simultaneously having to compete with a sophisticated and experienced black market. Assemblymember Rob Bonta (D-Oakland), a supporter of the bill, noted “California cannabis businesses are making significant investments as they embrace the regulated marketplace while, at the same time, being undercut by unregulated competitors.” Currently, California imposes an excise tax, cultivation tax, and sales tax, not to mention the license application fees, the general cost of complying with various state and local rules and regulations, and the usual corporate taxes. Local governments are also joining in and imposing significant cannabis taxes on local cannabis businesses, including sales taxes, cultivation taxes and other operation-specific taxes. On top of these state and local taxes, cannabis businesses are unable to deduct business expenses other than cost of goods sold (COGS) from their federal taxes due to 280E.

The Adult Use of Marijuana Act (AUMA) called for the regulation of cannabis to “reduce barriers to entry into the legal, regulated market,” and “tax the growth and sale of marijuana in a way that drives out the illicit market for marijuana and discourages use by minors and abuse.” The disproportionately high tax rate imposed on cannabis companies presents an incredibly high barrier to entry for a new or transitioning cannabis business. Additionally, the high prices that compliant cannabis businesses need to charge consumers in order to afford California rents and California taxes only encourage diversion, abuse and the growth of the black market. By temporarily relieving a portion of the heavy tax burden on cannabis companies while the industry gets its bearings, AB 3157’s supporters hope to reduce the disparity in price between the black market and the legal market for consumers and other operators along the supply chain.