Tag Archives: tax

Excise Tax: What is it good for?

A recent Huffington Post headline read “Legal Marijuana Has Already Generated $15 Million For Schools”. The funds are appropriations from Colorado’s marijuana tax revenue. The appropriations weren’t the result of magic, but were instead the result of specific terms in Colorado’s Amendment 64 that levied an excise tax on recreational marijuana and specifically dedicated that revenue to schools. An excise tax is a tax on the sale or use of a particular good or service. It is more commonly known as a sin tax and is typically attached to goods or services deemed to be harmful or otherwise discouraged (e.g., alcohol, tobacco, and gambling).

An article from the Canna Law Blog outlines four government purposes for levying excise taxes: “1) generating revenue; 2) tailoring the tax burden to those that benefit from the services the excise tax funds; 3) controlling externalities; and 4) discouraging consumption of potentially harmful substances individuals might over-consume absent taxation.” The third and fourth purposes are the most relevant to an excise tax on marijuana, with the primary focus on controlling externalities such as youth use, prevalence of illicit markets, and marijuana abuse.

At first glance, levying an excise tax seems to be an obvious choice. But, as I argued in my last post, there are a lot of “unknowns” about how the marijuana market will respond to legalization. There is also an issue with whether the marijuana market is well-suited to an excise tax. While market research is limited, current research shows marijuana to be largely inelastic in demand. That means that market demand doesn’t change dramatically with price changes, so raising the price via taxation won’t decrease demand. Teens aged 12-17 are the only group showing any relative price sensitivity. If these numbers are true, an excise tax on marijuana won’t help control many externalities and won’t discourage consumption because people will be happy to pay more, not consume less. Even if consumption didn’t decrease, however, revenue generated from an excise tax would benefit California and could be earmarked for programs that aim to improve social welfare such as, education, youth substance use prevention, and more. This article explores some of the ways a marijuana excise tax revenues can improve social welfare and also explores some of the important drawbacks that an excise tax would have on California’s overall marijuana market.

California has experience levying excise taxes on alcohol, gasoline and tobacco products. An excise tax on marijuana is likely next in line given our familiarity and the precedents among states with recently legalized marijuana. Colorado, Oregon and Washington all implemented excise taxes on marijuana. As mentioned earlier, Colorado implemented a marijuana excise tax that specifically reserved the first $40 million raised each year for school infrastructure. Oregon and Washington, on the other hand, dedicated their excise tax revenue to a variety of different programs including, but not limited to, school funding, research on marijuana’s health impacts, youth education, enforcement of new regulations, and similar programs focused on reducing externalities. California should prioritize funding research with tax revenue given the lack of reliable data currently available. There is great need for scientific research that analyzes the health and intoxication effects of the 80 plus compounds in marijuana, the development of reliable testing modules for quality control, and also DUID. Sociological research is also important because marijuana’s current illegality severely limits our ability to gather reliable data on consumer usage patterns, the true size of the market, user quality of life, and long-term social outcomes (e.g., user productivity, mental health, and increases in overall usage).

An excise tax on recreational marijuana has both positive and negative implications for society. On the positive end, the funds collected from excise taxes can be dedicated to a particularized cause. For Colorado it is school infrastructure; for Oregon and Washington it is a host of various social programs. Either way, the excise tax revenues guarantee funds to specified causes that aim to improve social welfare.

The downside to sin taxes is that, by its nature, the tax is typically associated with the sale and/or use of a particular good or service, which presents a very costly issue for marijuana businesses. Ordinarily, businesses can deduct the costs of doing business—such as materials, rent, advertising, etc.—from revenues, meaning that they pay tax only on profit. Under federal law 280E, however, marijuana businesses cannot claim these deductions. Instead, they have to capitalize those costs and report them as cost of goods sold (COGS) once the product is actually off the shelves. However, COGS only includes direct costs of production and labor: it does not include all costs.

Given the state of federal law, recreational marijuana businesses subjected to a state excise tax will most likely not be able to deduct those taxes from their federal bill—meaning that they will have to pay for it twice. Let’s say the wholesale cost of an ounce is $50 and a retailer has to pay $50 in excise tax when she buys it from the grower. The retailer then passes the cost on to the consumer and adds $50 in profit, making the total cost of the ounce $150 ($50 to he grower, $50 excise tax, $50 markup). But even though the profit is only $50 in this scenario, the retailer cannot deduct the cost of the excise tax and instead has to pay tax on $100 ($150 revenue minus only the cost of the goods from the grower, $50). The retailer pays the excise tax and then, when that cost is passed on to the consumer, the reimbursement for the excise tax has to be reported as income. This is not a problem with excise taxes, but more a problem of excise taxes combined with 280E.

One negative aspect of these federal costs is that they force businesses to impose much higher pre-tax prices. High prices post-legalization could prove to be costly for society by way of preserving the dominance of the black market. Marijuana businesses also suffer huge profit losses due to the combination of the federal tax costs and state imposed tax burdens, such as excise taxes. These combined costs may make it difficult for such businesses to survive tax season, never mind make any profit. There have been suggestions that a potential cure may be as simple as imposing the excise tax on marijuana production so it could be included in COGS, but it is unknown whether the federal government will accept such clever maneuvering. For now, federal deduction exclusions remain a very real detriment to marijuana businesses profit margins and their ability to thrive in this burgeoning market.

Why should we care about whether marijuana businesses profit? For starters, the livelihoods of Californians depend on the state’s economic success. In 2013, California was ranked the 8th largest economy in the world. That makes for a very large pool of employees and individuals dependent on California’s economic health. Moreover, according to the ArcView Group, California’s legal marijuana market is the largest in the U.S., worth an estimated $1.3 billion. Colorado has a smaller market but legalization still created upwards of 10,000 new jobs for Coloradans. Even if California market estimates are optimistically high, the numbers and experience in Colorado reveal that marijuana business failures post-legalization could have crushing results for Californians. Thousands of individuals who invested their lives and money to this burgeoning industry would be thrust into unemployment or, worse, driven to the black market. All things considered, it would be prudent for us to examine the consequences federal deduction exclusions have for California’s economy post-legalization.

The takeaway from today’s discussion is that there are social but also economic harms that a marijuana excise tax can offset or exacerbate if not thoroughly considered in tandem. Additionally, an excise tax is just one mechanism by which the positive outcomes discussed today can come to fruition. The state could also achieve these through other forms of taxation or by funneling a portion of the funds from licensing fees into research or other worthy causes. As my title suggests, the discussion of levying an excise tax on marijuana really boils down to the question, “What is it good for?” Recall the metaphor of the marijuana tax seesaw from my first post. The consideration of a marijuana excise tax has a similar seesaw; this seesaw has competing social interests on either end. On one end we can generate funds for projects that increase social welfare (sociological research, reducing/preventing youth access, elimination of marijuana criminality), and on the other, we can increase socio-economic health (encourage new businesses, move black market participants into legal market) by generating less tax revenue to allow new (local) marijuana businesses to thrive. To remix a Motown hit song, “sing it with me, Excise tax- huh- what is it good for?…” Unlike Edwin Starr, we cannot unequivocally claim “absolutely nothing,” but it is still a worthy question to ask.

Alexa Quinn for Drug Law and Policy

Follow Drug Law and Policy on Twitter @DrugLawPolicy or Alexa @aquinn_dlp.

You can also contact Alexa Quinn by email: aquinn.dlp@gmail.com.

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Marijuana and Tax: It’s Complicated

The other day I was walking my dog through a park and I saw two children gleefully playing on a seesaw. As I returned home and got back to work the image of the seesaw stuck with me. The seesaw is a great metaphor for the legalized marijuana tax conundrum because it demonstrates the challenge of balancing interests. If we imagine California’s marijuana tax scheme as the seesaw, we can see the Golden State’s two primary objectives sitting at each end: generating state revenue on one end and reducing externalities (social harms attributed to marijuana use) on the other. Although both objectives can play nice, if the interests are not balanced and cognizant of the other, one end of the seesaw will crash into the dirt while the other soars sky high. And the dirt in this case isn’t the playground kind that can be dusted off; it is muddied public policy that would incentivize the black market.

The good news is that balancing these objectives is attainable and reasonable. First, generating state revenue is attainable once a system to tax marijuana is in place. Colorado is a great example of this: it gained a new source of revenue by implementing a multi-faceted tax approach that generated $52,570,081 in 2014. The recreational marijuana market generated $40,968,203 alone. Second, tax can serve as a mechanism to offset some of the most salient social harms attributed to marijuana use such as youth access and use, drug crime, and the health risks of ingesting unregulated products.

The difficulty of deciding how to tax marijuana is not only in trying to balance interests. The idiosyncrasies of the marijuana market add to the difficulty of creating a balanced tax structure. We have very limited data on the marijuana market due to its status as an illegal drug. As such, it is difficult to gather reliable information about marijuana users and how they respond to market changes. This creates a lot of guesswork and “best estimations” which may be wrong and could create problems once in play within a burgeoning market. In addition, the marijuana plant itself is unlike anything else we have taxed before. Alcohol and tobacco are the nearest in kind to marijuana but both substances are easier to tax by nature. We are able to tax distilled spirits by alcohol content because alcohol is a homogeneous material that lends itself easily to testing. Marijuana, on the other hand, is not homogenous and technology still needs to be developed for reliable potency testing processes. The heterogeneity of marijuana plants also distinguishes it from tobacco because taxing marijuana by unit or weight is not as effective as it is to tax cigarettes (details of this are discussed below).

In order to meet our objectives we need to establish the type of tax, basis for the tax, the rate, the collection point, and the market structure that will best achieve our objective(s). None of these variables is mutually exclusive and there are various ways to stack them. For example, marijuana can be taxed by weight, potency, price, or even by product type (e.g., raw material, edibles, concentrates). The tax can be imposed on growers, processors, retailers, consumers, or some combination of these. Each of these combined, however, has different degrees of efficacy. If we really want to meet both objectives (revenue and reducing negative externalities), we’ll need to consider the different benefits and drawbacks to each approach. Each approach will require different tradeoffs and will have real-life effects on consumer usage, safety, and even business sustainability. The discussion on how to tax marijuana is lengthy and complicated. Today, the goal is to start the conversation by looking at the various tax bases and how each can help California meet its tax objectives.

Let’s move now to discussing how the various tax bases fare on the seesaw of generating revenue and offsetting externalities. First, a tax based on price is easy to administer but does not necessarily help control prices. This will not bring in much revenue if post-legalization prices plummet as predicted by many in the industry. Revenue aside, there are numerous other reasons price control is desirable. The most salient is thwarting youth access. It is well established that youth substance use rates are particularly price sensitive. Youth access and use decrease as prices increase. One important caveat to a price-based tax is that it only remains easily administrable if it functions in a horizontally integrated system. Rather than have “jacks of all trades,” horizontally integrated systems feature distinct entities with limited roles within the market (e.g., growers, processors, and retailers). The RAND study “Considering Marijuana Legalization” explains that a horizontally integrated system is preferable when imposing price-based taxes because they depend on the existence of a real price—normally, on an arm’s-length sale between unrelated parties. On the other hand, if prices do start and remain high, a price-based tax can be too high and push consumers into illegal black markets. Going back to the seesaw image, it is apparent that a price-based tax alone cannot achieve both objectives of legalizing marijuana. The seesaw of marijuana tax objectives can only come close to being balanced if we compromise the amount of revenue generated for more positive impacts on social harms. Further, the outcome of a balanced seesaw depends on multiple variables aside from price alone.

Marijuana can also be taxed by weight. Similar to a price-based tax, a weight-based tax is also easy to administer. It also has the distinct feature of bringing in a steady amount of revenue since it isn’t determined by market price. The difficulty of a weight-based tax is in the details. For instance, the weight of each marijuana plant changes over time due to drying and trimming and weight changes aren’t exact among each plant. We have to establish timelines for when marijuana plants should be weighed and our timelines may not coincide with the initial objectives of taxing the product. The main concern, however, is the risk that it will incentivize production of higher potency products. This is a disadvantage for three reasons. One, consumers may unwittingly ingest more potent products, which may lead to health and safety issues. Two, the tax base wouldn’t encourage consumers to purchase less potent products. Third, potential revenue for higher potency products would never be captured within the market.

Another option is a tax based on potency or product type which has the benefit of addressing more externalities but would be difficult to administer given our current lack of knowledge regarding marijuana compounds. It’s important to clarify that for purposes of brevity in this post, I am conflating potency and product type (some edibles might be less potent, others might be more). A tax based on potency and/or product type can be used to shape usage patterns and implicitly impose limits or restrictions on how marijuana can be consumed. Therefore, it is advantageous in the sense that it addresses more social harms related to marijuana use. For example, California could impose a higher tax on products that typically yield higher potency and are more difficult to dose appropriately (e.g., edibles and concentrates). This could encourage users to purchase products, such as raw marijuana, which is typically smoked. This could be a desirable outcome because our familiarity with this form of marijuana enables us to better predict behavioral outcomes and leads to shorter durations of intoxication. In contrast, California could promote lung health and discourage smoking marijuana by taxing the raw material higher than other ingestible forms. Potency could be measured by the amount of THC, CBD, or THC:CBD ratio. However, the difficulties and inaccuracies in current technology for testing potency pose an immediate obstacle to the feasibility of such a tax. Plus, even a single marijuana plant can have inconsistent potency throughout. Finally, our experiences with the tobacco and alcohol industries have taught us that higher taxes do not always have positive impacts on public health.

At its inception, any potency-based tax should have at least three features. First, a potency-based tax would have to be set in ranges. These potency ranges would need to be set high enough to discourage divergence to black markets. Second, any potency tax would need to include a provision for revision based on timely reviews of any developments in new information regarding potency ranges and/or limits. Third, the previous feature necessarily requires at least some of the revenue be dedicated to research that can advance the system. Research could explore various topics such as testing modules, scientific improvements in measuring potency, and studies on the effects different products and potency had on users’ intoxication levels.

This discussion of the various ways to tax is only the tip of the iceberg and will be covered in more detail in future posts. Of particular interest is the history of alcohol and tobacco taxes. Both can serve as a great resource for what works and what doesn’t in terms of taxing to affect use and offset social harms. After we cover the lessons learned from above, you can join me in the related discussion of which market structure (vertical or horizontal integration) better facilitates particular tax methods. Join me next time for a discussion on sin taxes and the impact they can have on the burgeoning marijuana market.

Alexa Quinn for Drug Law and Policy

Follow Drug Law and Policy on Twitter @DrugLawPolicy or Alexa @aquinn_dlp. You can also contact Alexa Quinn by email: aquinn.dlp@gmail.com.

Marijuana Taxation: Can Taxes Help Shape a “Healthy” Marijuana Market?


Alexa Quinn
J.D. Candidate 2016

Can marijuana legalization raise revenue and eliminate the black market? And can marijuana taxes help offset other social harms attributed to marijuana use? My research will try to answer these questions through comparing the different approaches taken by Colorado and Washington in structuring their recreational marijuana markets. I’ll also look at the lessons we learned from taxing and regulating the alcohol and tobacco industries. Legalization forces us to consider a number of issues. My focus is on the benefits and drawbacks of taxation schemes and market structures as they relate to eliminating the black market, normalizing use, and sustaining the recreational market (e.g., price control, revenue, etc.). My goal is to weigh the social tradeoffs inherent to the various ways to tax marijuana and establish what the best options are for California. In the end, I think we’ll find that California can better serve its goals by establishing recreational marijuana taxes and regulatory schemes that simply pay the costs to oversee the legalized system and do not function as a “get rich quick” plan for the state.

About the Author:

Alexa Quinn is a lifelong resident of the Golden State. Ms. Quinn grew up in sunny southern California and completed her undergraduate degree in the very diverse city of San Francisco. She is a second year law student at Santa Clara University School of Law. She recognizes the immense change marijuana legalization can bring to her home state. California has an opportunity to give its voters a marijuana initiative that is, among other things, sound, fiscally responsible, feasible, and represents the entrepreneurial and innovative style of its residents. It is important to Ms. Quinn that the 2016 California ballot initiative seizes the opportunity to create balanced and informed policy. To see future posts by this author please follow this blog. You can also follow Alexa Quinn on twitter @aquinn_dlp.