280E is constitutional

280E allows marijuana sellers to deduct only cost of goods sold, so they can’t deduct advertising and marketing expenses.  Taxpayers say the application of 280E to marijuana businesses is unconstitutional.  Off the cuff, I disagree.  (Here’s the Tax Court decision (finding 280E constitutional) and dissent in this case.)

First, the taxpayers say 280E changes a constitutional income tax into an unconstitutional tax, because for an income tax,  “there . . . has to be gain,” and 280E can impose tax when the taxpayer is actually in a loss position.  That goes too far, I think.  If a non-deductibility rule puts some taxpayer in a loss position and thereby presto-changeo converts an income tax into something else that’s not constitutional, then the same unconstitutionality would happen when the deduction is not for marijuana selling expenses but for disallowed lobbying expenses, golden parachutes, bribes, meals and entertainment, and so on.  That’s a big pile of nondeductibility rules to wipe off the books.  A single dollar of disallowed expense could well flip a tax return from gain to loss.  So all those rules would be unconstitutional, too.  And what about excess comp paid to a shareholder, actually paid, but designed to defeat the corporate tax and so disallowed?  Interest paid on what’s supposed to be debt and is actually equity?  And so on.  A matter of degree, but not of principle.

Second, even if the application of 280E turns the tax into something that’s not an income tax, doesn’t their argument prove that a VAT in the USA would be unconstitutional?  VAT allows deduction only for cost of goods sold, I think.

https://www.investopedia.com/ask/answers/042315/what-are-some-examples-value-added-tax.asp has this:

Example of Value-Added Taxation

To calculate the amount of VAT a consumer or business must pay, take the cost of the goods or service, and subtract any material costs previously taxed. An example of a 10% VAT in sequence through a chain of production can occur as follows:

A manufacturer of electronic components purchases raw materials made out of various metals from a dealer. The metals dealer—the seller at this point in the production chain—charges the manufacturer $1 plus a 10-cent VAT, and then pays the 10% VAT to the government.

The manufacturer adds value through its manufacturing process of creating the electronic components, which it then sells to a cellphone manufacturing company for $2 plus a 20-cent VAT. The manufacturer remits 10 cents of the 20-cent VAT it collected to the government, the other 10 cents reimbursing it for the VAT it previously paid to the metals dealer.

The cellphone manufacturer adds value by making its mobiles, which it then sells to a cellphone retailer for $3 plus a 30-cent VAT. It pays 10 cents of this VAT is paid to the government; the other 20 cents reimburse the cellphone manufacturer for the previous VAT it has paid to electronic component company.

Finally, the retailer sells a phone to a consumer for $5 plus a 50-cent VAT, 20 cents of which is paid to the government.

The VAT paid at each sale point along the way represents 10% of the value addedby the seller.

+++

Now the litigants in this case have spent a lot more time on it than I plan to.  I haven’t even read the government’s briefs.  But saying disallowance of a deduction is unconstitutional strikes me as implausible.

Tax marijuana by potency? $50 reward for finding a jurisdiction that does for cigarettes.

“I’ve challenged people over and over, including at conferences and on twitter, to name a jurisdiction that taxes tobacco by nicotine content, and no one has.” On 4 September 2018, I wrote that, and it’s still true.

Make that “unconcentrated tobacco” or “cigarettes.” Now that vaping has caught on, I wouldn’t rule out taxing vaping material by nicotine content.  It’s concentrated, so it’s homogeneous.  And it’s workable to tax marijuana concentrates by THC, like Canada.

But taxing unconcentrated plant material is SUCH a bad idea that no jurisdiction does it for analagous cigarettes.  Sampling allows cheating and manipulation.  These products are not homogeneous.  If that’s a deal killer for tobacco, why isn’t it for cannabis?

So maybe this is a publicity stunt.  The first message RECEIVED naming a jurisdiction that taxes cigarettes by nicotine content gets a $50 reward.  Write contest@newrevenue.org.

How notches or discontinuities in Illinois’s weed tax are an unnecessary vestige of the primitive Scales of Justice “range” method of liquor taxation

The notion that marijuana flower is best taxed by measuring its THC content refuses to die.  Illinois backed into a THC tax on flower with a rule that smokeable marijuana with THC over a certain percentage (35% or so) is taxed at a higher rate ad valorem – 25% versus 10% for less potent stuff.

Why didn’t Illinois tax by THC directly?  To answer a different question, no jurisdiction in the world taxes tobacco by tar nicotine content.  ($50 prize for first person to identify such a current tax.)  THC in flower is impractical to measure, so a wide “range” of up to 35% should cover it all.  Flower rarely exceeds 35% THC; most smokeable concentrates do.

Leaving aside the weakness of ad valorem taxes, why didn’t they just tax raw plant material at one rate and smokeable concentrates at another?  The rush of getting legislation to move, according to one report, without getting into the fine points.

So there’s a notch.  34.999% hits you with one tax bill; 35.001% hits you with a tax bill 150% higher.  (Gaming possibilities, are listed in the BOTEC report for the Washington State Liquor and Cannabis Board, like spraying flower with concentrates to land comfortably below 35%.)

Notches, or discontinuities in tax rates producing marginal rates over 100%, are  usually suboptimal.  Some may be unavoidable, like the UK VAT threshold.  With 499,999 pounds sterling in turnover, there’s no VAT.  With 500,001, you owe VAT on each transaction.  Now that’s awkward, and calls for prediction (if it’s not based on the previous year’s numbers,) but how else could you work it?  To have identical transactions taxed differently would be weird.  One customer sneaks tax free in before the 500k threshold, but the next customer in line that day pays the tax.

But discontinuities for excise taxes may not be necessary.  They used to be.  They  began, I think, with the liquor tax.  Higher proof spirits weigh less than weak ones, so weighing the batch reveals the alcohol content.  But digital scales weren’t invented when the United States (for instance) started taxing liquor, so they HAD to tax by ranges with discontinuities.  The old Scales of Justice scales, which operated by adding weights “only one at a time,” were all they had – with an alcohol adaptation called “Dicas’s hydrometer.”  So they had six ranges – unavoidable then, for differentiation, but at least internally accurate, and unbeatable by sampling.

 

Ads and 280E

I’m giving a marijuana tax design talk to a Law School class at a major university on April 9.  One point I plan to make is that Tax Code section 280E, which makes marijuana advertising and marketing expenses nondeductible, is a good idea.  Ads enjoy protection under the commercial free speech doctrine, so states can’t ban them, but states, like the federal government, can make them nondeductible.  The professor saw some slides I put together, and didn’t think these were a useful part of an academic discussion.

 

CNR Vermont memo on 280E conformity

To:                   S.54 Conference Committee

From:             Pat Oglesby, Center for New Revenue

Re:                   Effectively Restricting Cannabis Advertisements via Tax Policy

Date:                March 11, 2020

Current Law

Current Vermont tax law follows Federal Internal Revenue Code §280E, allowing sellers of cannabis (whether or not licensed by the state) to deduct only their “cost of goods sold” – that is, the cost of producing or buying the cannabis they sell.

Under 280E, growers can deduct almost everything.  Nearly all their costs, such as salaries, rent, and electricity are treated as “cost of goods sold,” because they are inputs to producing cannabis.

Retailers, however, can typically only deduct only what they pay for the product itself.  They cannot deduct salaries, for instance, because that is an expense of selling cannabis, not of producing or buying it.  Similarly, 280E prohibits the deduction of advertisement costs.

As it looks at legalization, Vermont can consider carefully, ahead of the federal government, what to do about marijuana advertising.

 

Possible Options:

The House’s version of S.54 seeks to repeal 280E “conformity” for Vermont, and allow all selling expenses to be deducted for state income tax purposes.  This treats cannabis like every other business, which certainly seems an equitable approach – but it also would make advertising expenses tax deductible.  This would effectively create a state subsidy of cannabis advertising.

By adopting an amendment sponsored by Rep. Donahue, the House chose to completely ban cannabis advertising.  Such a blanket ban may be an unconstitutional infringement on “commercial free speech” – the case law is unsettled on the question. It may be that such a ban is permissible under Vermont’s Constitution, and that Federal courts would not take up such a case while Federal prohibition remains in place – but query how long Federal prohibition will last.  If Vermont’s blanket ban on advertisements is ultimately struck down, there will be no restriction on cannabis advertisements.

Alternative 1: Say what’s NOT deductible.

Denying deductions for advertising is a place to start.  Listing other non-deductible selling expenses like excessive salaries stifles potential constitutional challenges.

Alternative 2:  Say what IS deductible.

A more nuanced approach would be to only re-allow certain 280E-disallowed expenses, keeping all others (including advertising expenses) non-deductible.  The Legislature could be guided by broadly acceptable social goals – allowing, for example, deductions for W-2 employee pay and benefits, maybe up to a cap (say, $100,000 per person per year).  A limited list of deductions could favor labor over capital, and small businesses over large ones (“mom and pop” shops use word of mouth and the personal touch to attract customers, not capital).

Possible additional allowable deductions include 1099 “gig” workers, and service providers like lawyers.  Charitable contributions sound nice, but are often disguised promotions. Real estate interests would push hard for rent to be deductible, but parents like to keep retail spaces non-glitzy and unappealing.

Conclusion:

A blanket ban on advertisement is likely to encounter Federal and State Constitutional challenges.  If such a ban is enacted, and then overturned, the State would not have any effective retractions on cannabis advertisements on the books, and the Legislature would have to scramble to enact them, over the objections of an industry that is likely to have more lobbying clout in the future than it has now.

By reverting to the restrictions on advertisements in the pre-Donahue House version of S.54 (i.e., audience restrictions, requiring pre-approval of all marketing materials, along with payment of a material review fee, etc.), and ensuring that cannabis advertisements are not inadvertently subsidized by allowing their costs to be deducted for state income tax purposes, S.54 would better protect Vermonters from the dangers of widespread advertisements intended to increase potentially problematic use.

 

 

My proudest accomplishment — threatened by the corona virus

The 2017 Tax Act stopped carrybacks of losses generally, primarily as a revenue raising ploy.  Now in a mad dash to Do Something about the corona virus, Congress is going to allow carrybacks so corporations can get cash.

That brings to mind filling out a form last year, in connection with my 50thcollege reunion, that describes my proudest accomplishment.  That was dreaming up Sec. 172(b)(1)(D), the so-called corporate equity reduction transaction rule, preventing the “carryback of excess interest losses attributable to corporate equity reduction transactions.”

Here’s the story.  At the height of the Leveraged Buy Out (LBO) craze in the late 1980s, Senator Bentsen asked staff (me) to Do Something about LBOs, which were making headlines and out of favor.  But I had to be sure not to Spook the Markets.  I was reading Forbes or Fortune in my office one day when a transaction caught my eye.  An LBO artist bought a profitable company in a merger transaction that incurred huge debt.  The debt created huge interest expenses.  Those deductible interest expenses were sot big that the new operation had losses.  Those losses were carried back to the profitable years of the profitable company, creating a TAX REFUND.  That looked like the Code was subsidizing LBOs.  That didn’t sound right, so we drafted up something that Senator Bentsen introduced; Mr. Rostenkowski put it in the House bill and it sailed into the law without any opposition rearing its head. The rule was estimated as picking up $2.2 billion in revenue over five years.

A side note:  To make sure we didn’t Spook the Markets, Senator Bentsen had me hold a Staff Briefing to float the notion.  Famous journalist Jeff Birnbaum, with the WSJ then, left the briefing in the middle once he understood the plan.  The Markets were Not Spooked, and the provision stayed in the Code until it got subsumed into a broader rule in the 2017 Tax Act.  I hope it comes back.