Marijuana Tax: An Unintended Consequence of 280E – Fragmenting the Industry?

Premise:  A fragmented industry is harder to supervise and regulate.

Here’s what may be a counterproductive incentive of 280E.  Say Mom and Pop operate a marijuana business:

Mom and Pop MJ
Gross receipts

100

COGS

-60

Other expenses

-20

Actual pretax income

20

Federal tax base

40

Federal tax at 35%

14

After tax profit

6

They find an opportunity to expand their business that costs 30 and yields net pre-tax income of 40 by doubling CGS to 120 and doubling gross receipts to 200.

Mom and Pop MJ doubles
Gross receipts

200

COGS

-120

Other expenses

-50

Actual pretax income

30

Federal tax base

80

Federal tax at 35%

28

After tax profit

2

After taxes, they are worse off.  So they won’t expand. [Is this a real case or just a theoretical sport case?  This example proves my point only if the second 40 of net pre-tax income costs more to earn than the first 40.]

The public policy problem is that section 280E tends to fragment the industry.  Instead of one supplier, 280E creates an incentive for there to be two suppliers – each more profitable after tax than one expanded supplier.

By contrast, this disincentive does not happen if Mom and Pop operate a legal business:

Mom and Pop Legal business
Gross receipts

100

COGS

-60

Other expenses

-20

Actual pretax income

20

Federal tax base

20

Federal tax at 35%

7

After tax profit

13

Let’s say they, too, find an opportunity to expand their business that costs 30 and yields net pre-tax income of 40 by doubling CGS to 120 and doubling gross receipts to 200.  Absent taxes, the marginal revenue exceeds the marginal cost, so they would do the deal.[1]  Taxes don’t change the result.

Mom and Pop Legal business doubles
Gross receipts

200

COGS

-120

Other expenses

-50

Actual pretax income

30

Federal tax base

30

Federal tax at 35%

10.5

After tax profit

19.5


[1] It’s axiomatic that a business will take a deal where the marginal revenue exceeds the marginal cost.

http://www.cliffsnotes.com/study_guide/Profit-Maximization.topicArticleId-9789,articleId-9769.html

eId-9769.html

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Author: patoglesby

From 1982 to 1990, I worked in tax policy for Committees of the United States Congress. In recent years, I was Adjunct Lecturer at UNC-Chapel Hill's Business School and then Adjunct Professor at its Law School.

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