Post COVID-19 World: Cannabis Taxes Part III

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Post COVID-19 World: Cannabis Taxes Part III

By DataTrek Co-founder Jessica Rabe

California is the single most important economy in the US; that makes it a key case study in how the US will address the economic aftermath of the COVID-19 Crisis. Heading into 2020, California had a projected budget surplus of $21 billion, but the coronavirus has now put that cash surplus in jeopardy. In just San Francisco alone, a new report from the Mayor’s Budget Office and other city leaders projected the city’s deficit for the upcoming 2-year budget could rise to well over $1 billion due to the virus. That does not even include expenses tied to the city’s response to the public health crisis.

California is not alone; many other state governments will face major revenue shortfalls from the economic fallout of COVID-19. Especially with three of the state’s largest sources of tax revenue – personal income taxes, corporate taxes and sales taxes – at risk. And it is not just the state’s finances that the virus threatens, but local governments as well.

This predicament makes nontraditional sources of tax revenue – such as from legal retail marijuana sales – essential to the budgets of state and local governments. Taxing sales of legal recreational marijuana provides a revenue stream that does not potentially drive people out of state or further dampen demand like increasing income, sales, corporate or real estate taxes.

Although dispensaries in California already started selling recreational marijuana as of January 2018, “as much as 80% of the cannabis market in California remains illicit” according to the 2019 annual report from the state’s Cannabis Advisory Committee. A few important issues from the report:

  • Presence of the highly competitive black market: “While California [was] expected to generate $3.1 billion in licensed cannabis sales [in 2019]” – which makes it the biggest market for legal cannabis globally – “nearly triple that amount — $8.7 billion – [was] expected to be spent in the illicit cannabis market.”
  • About three-fourths of California cities ban recreational sales: The Bureau of Cannabis Control has only issued a fifth of the retailer licenses that it originally estimated due to local control. Consequently, California has the lowest market density ratio of retail licenses to consumers out of the US states that have legalized adult-use sales. This has created a lack of access to legal cannabis: “residents in 40% of the state have to drive 60 miles or more to find a licensed dispensary to buy safe, legal, tested cannabis.”
  • Missed tax budget projections: California has received $1.03 billion in marijuana tax revenues since January 2018, or what the state initially thought it would reap in just one year.

Bottom line, the biggest issues plaguing the California legal marijuana market are high tax rates, burdensome regulations and no access to retail cannabis sales in most cities. Two points here:

  • High tax rates: Fitch Ratings reported that California taxes on legal marijuana could reach as high as a 45% effective tax rate. That was before marijuana retailers had to pay 12.5% more in taxes starting this past January, and cultivator taxes went up by over 4% as well.
  • Slowing tax revenues: Sales have started to stagnate as the 1.5% increase in cannabis tax revenues in Q4 2019 was the smallest quarterly rise thus far. Prior quarters saw an average increase of 15.5%.

As for how COVID-19 will impact the legal marijuana market in California, three points:

#1: Many consumers will become more price sensitive. Either they will have to forgo this discretionary purchase altogether in favor of paying more pressing bills like their mortgage, rent, car payments, etc. Or they will turn to the still-vibrant black market to avoid paying steep taxes.

#2: Prior to COVID-19, marijuana-related businesses were already struggling to compete, having to lay off workers or even close amid slowing marijuana sales. The current crisis will likely accelerate this trend. Since marijuana is still federally illegal, cannabis businesses have long struggled to initiate or maintain banking relationships. They also do not qualify for Federal aid like the PPP as cannabis is classified as a Schedule I drug.

#3: Although legal recreational marijuana sales initially increased in states like California, Colorado and Washington as consumers tried to stock up amid stay-at-home orders, it was a short-lived bounce. For example, according to Headset: “while sales in California’s market have largely been outpacing 2019 sales throughout the coronavirus crisis, the amount by which they’re exceeding 2019 sales has narrowed significantly from earlier in the year.”

Consumers could restock in the weeks ahead, but we’d note the current dearth of tourism across California and other states where recreational marijuana is legal. A return of tourists once the economy reopens could help, but that will depend on the pace of the economic recovery and Americans’ willingness to vacation this summer.

Bottom line: state-level financial stress due to COVID-19 may well force jurisdictions like California to adjust their legal marijuana policies and regulations to encourage consumers to abandon the illicit market. While we recognize legal marijuana is a controversial topic for many people, the budget shortfalls that COVID-19 will create on the state and local levels may help sway opinions about the issue. In truth, they don’t really have a choice. Legal marijuana tax revenues may well be the largest untapped source of government income available in the US.

Sources:

https://bcc.ca.gov/about_us/documents/cac_annual_report_2019.pdf

https://www.cdtfa.ca.gov/news/20-03.htm

https://www.latimes.com/california/story/2020-03-25/california-20-billion-budget-reserve-may-get-wiped-out-by-coronavirus-crisis

https://www.ktvu.com/news/covid-19-to-cause-san-francisco-budget-shortfall-of-over-1b-city-report-estimates