California will increase commercial tax rates on legal marijuana from 1 January 2020, in a measure that has surprised consumers and entrepreneurs, many of them in economic difficulties due to the low profitability of their businesses, and who have been begging the state to do the opposite.
High state and local cannabis taxes are a big problem for the marijuana industry in California, which has led to legal firms being less competitive than the illicit market: the unlicensed vendors can attract customers with lower prices, since illegal shops do not pay taxes. Industry analysts estimate that in this way consumers spend 3 dollars on the illegal market for every dollar they invest in the legal market.
But against all logic, the California Department of Tax and Fee Administration (CDTFA) announced at the end of last November that it plans to raise taxes on the legal cannabis industry once again. The increase in the tax on cannabis is considered another blow to an industry that is currently facing economic recession in a depressed market.
While the CDTFA describes its mission as "improving the lives of Californians through the fair and efficient collection of revenues that support our essential public services", it is hampering the ability of the legal cannabis industry to operate profitably. This latest tax increase is leading some California cannabis executives to believe that they are deliberately trying to destroy the livelihoods of legal operators.
Taxes will increase in two ways
The first of the increases concerns the state's 15% excise duty, which is calculated based on the prices that marijuana sellers set for retail sales, to cover their costs and make a profit. The California Department of Tax and Fee Administration investigated the average retail prices of marijuana throughout the state and determined that they had increased by 80% of wholesale costs. This is an increase on previous calculations of surcharge rates, which were at 60%. Therefore, the state intends to demand a greater amount of money from each marijuana retail sale.
The second increase is an adjustment for inflation for taxes for cultivation, which will be implemented as follows:
- From $9.25 to $9.65 for an ounce (about 30 g) of flowers, or an increase of 4.3%.
- From $2.75 to $2.87 for an ounce of leaves, or an increase of 4.3%.
- From $1.29 to $1.35 for an ounce of fresh plant material, or an increase of 4.6 %.
None of these increases are subject to a vote by legislators. The inflation adjustment was incorporated into Proposition 64 approved in 2017. In fact, all these relatively inflexible guidelines were incorporated into a law that aimed to ensure that state and local governments would raise a lot of revenue from this new legal industry.
Meanwhile, experts estimate that marijuana sellers in the black market will generate $8.7 billion in revenue in 2019, compared to 3 billion in legal sales. The absurdly high costs of trying to grow marijuana in a legal way have encouraged this black market and ensured that many legal sellers cannot make a profit.
The response of the state – of Governor Gavin Newsom and Attorney General Xavier Becerra (both Democrats) – has been to launch a new war on drugs in an attempt to take strong measures against the black market, instead of making marijuana more accessible to all consumers and encouraging more companies to enter the regulated market. So, the new taxes will be another blow for anyone who tries to sell or buy marijuana legally in California.
The cost of buying marijuana in the Golden State
These are the taxes that currently affect California marijuana buyers, as legal cannabis goes from seed to sale:
- State taxation.
- Local taxes, which could add some additional percentage points, depending on the city.
- The 15% consumption tax mentioned above.
- The tax for cultivation, which depends entirely on the stage of the plant being taxed.
- The costs of quality control tests in order to comply with the law.
Again, although estimates vary, this suggests that the typical Californian cannabis consumer could be facing a tax rate of between 45% and 80%, once these new increases take effect on 1 January 2020. That is practically inviting illegal producers to seize the market, and 2018 sales figures prove this.
In 2017, when California only sold medical marijuana, sales reached approximately $3 billion. Then, in 2018, with recreational and medicinal cannabis available, state sales fell $500 million to $2.5 billion. A major reason for this decrease is that California has been charging too much tax to its consumers.
But, in addition, about 80% of state municipalities have banned retailers from selling grass for adult use. This allows black market producers to fill the gap in cities where consumers have no other purchasing options.
California's exorbitant tax rate on legal marijuana has clearly discouraged large companies, which have been at the centre of a 2018 full of million-dollar mergers. When this is combined with the fact that most municipalities have banned recreational retail sales, this creates a scenario where companies are not guaranteed the success that investors imagined just seven months ago.
In fact, some local businesses are already closing or leaving California due to high operating costs, because it simply makes no financial sense to operate there. And if California does not take note soon, it will run the risk of causing irreparable damage to its legal marijuana industry.