The successful marijuana legalization initiative in California created to raise significant tax revenue for the state could turn into a catastrophe. The voter-approved Proposition 64 addresses taxes on medical and recreational marijuana, but due to a glitch in the technical language of the initiative, California could lose a huge amount of money.
When legal recreational marijuana sales commence on Jan. 1, 2018, Prop. 64 will apply a fifteen percent excise tax on medical and recreational cannabis, additionally to some taxes on marijuana producers according to the weight of each plant grown. The state's 7.5 percent sales tax is added to that for recreational marijuana, but the ballot proposition repeals that tax for medical marijuana. It was done in order to give medical cannabis users a tax break relative to the recreational consumers once the initiative's new taxes take force in 2018. The catch is that the target date of Jan. 1, 2018 was omitted in the relevant subsection of the 62-page document, which means that the medical cannabis sales tax elimination took effect this week, when the measure passed.
Such a collision means that while recreational sales will be set to begin in California only in 2018, tax-free medical cannabis sales are going to start from now through the end of 2017. In other words, it creates a 14-month tax holiday for medical marijuana customers. As a result, California may face a disappointing near-term cannabis tax revenue picture. And although California lawmakers said they had not intended to create a tax-free market, the Board of Equalization of California ruled otherwise.
If new recreational cannabis users become regular customers of the tax-free medical market, tax revenue will keep falling short of the projected numbers even after 2018. Many will not be willing to endure the so-called “switching costs”—looking for a new dispensary and favored types of marijuana for the questionable privilege of paying greater taxes in the recreational market come 2018. Both medical and recreational weed would be subject to the fifteen percent tax starting in 2018, but recreational users would also pay local recreational pot taxes, meaning that buyers could give to the coffers as much as 25 percent in total.
As we can see from the Washington example, the reluctance of recreational users to depart from the gently taxed and loosely regulated medical market so impeded the establishment of the open recreational marijuana market that the state's legislators simply shut the medical system down. But because the recreational and medical marijuana systems in California were both created by a ballot initiative, California's elected officials cannot do the same.
In order to obtain medical marijuana legally and tax-free, a user must get a state-issued patient ID card. Users presumably will not want to endure the administrative hassle, as well as to pay a $100 fee to obtain one. Therefore, the ID requirement could limit the bleeding from the state's coffers to millions rather than tens of millions of dollars. That could be one of the best scenarios, which, however, depends on cannabis dispensary employees consistently checking whether their customers have the required card to buy tax-free marijuana. At the moment, the picture seems not so optimistic: according to the Board of Equalization chair Fiona Ma, nearly two-thirds of all dispensaries have not been fully compliant with sales tax requirements up to now.
The motivation for dispensary owners would be to keep customers happy allowing the ID requirement slide, secure in the knowledge that getting caught evading sales taxes is unlikely. The marijuana industry lacks access to banks—it operates mostly on a cash-only basis. That makes taxes difficult to monitor by the government. Such control also costs state money from its medical marijuana tax revenues, which are going to have a tough year.
According to the Stanford Institute for Economic Policy Pension Tracker, pension debt in California reaches almost $300 billion, based on the state's expectation of 7.5 percent investment returns. Using more pragmatic investment estimates, the debt is close to $1 trillion.
Given the success of the marijuana initiative earlier this month, tax advocates may try to use ballot measures to solve two looming state problems: health care costs and massive unfunded public pension liabilities.
Given the nature of how medical cannabis is typically sold in California, it is not clear whether the initiative's language on sales tax will actually turn out to be a significant impact on the state revenue. For instance, in Los Angeles, only 135 put of 700 estimated medical marijuana dispensaries are operating legally. Others are not allowed by the city and, therefore, do not pay taxes. Statewide, only two-thirds of all dispensaries there have fully complied with the state sales tax requirements.
The executive director of the California Cannabis Industry Association, Nate Bradley, said that policy experts disagreed with the Board of Equalization's interpretation of the initiative, since the law was intended to generate tax revenue. He added that there were legal precedents of ignoring provisions that are obvious clerical errors, but the board declined to invoke them in the Proposition 64 ruling.