Humboldt’s Principled Cannabis Tax

A new cannabis canopy tax is on the table in Humboldt County, California.  It follows two key principles of tax policy: Tax things you can measure, and collect early.

I.  Tax things you can measure

The square footage of area under cannabis cultivation is something you can actually measure. (I’ll use “canopy” here is a shorthand approximation of cultivation area.)  Some canopy, you can measure from the air. And some you can even find on Google maps.

Four of the first marijuana taxes in history, the 2010 wave of taxes in Albany, Berkeley, Long Beach, and Rancho Cordova, California, were based square feet of operations. Having the government measure the area being farmed is nothing new. For years, starting in the 1930s, U.S. tobacco farmers were allowed to grow on only a specified land area.

Sure, canopy is a crude way to tax cannabis. Taxing THC might be just right, in theory, as the RAND Vermont report points out. But we can’t measure THC reliably even for concentrates yet. And trying to tax bud (flowers) by THC is futile – like taxing tobacco by tar and nicotine content, which no one does. Yes, canopy doesn’t correlate well with THC, but you can measure it. And a canopy tax, in the long run, will probably be just one of several taxes on cannabis.

OK, indoor grows can’t be easily detected from the air, so the most environmentally unfriendly operations may have the easiest time evading tax. But we can figure out who is using electricity, and there are other ways to detect indoor growing.

Taxing only things you can measure leads to respect for the law. To be sure, taxing things you have to argue about (like prices in free-pot with pipe or arcane related party deals) has a job-creation advantage: It makes work for litigators and bureaucrats, who need to be paid to resolve all the disputes.

But, on balance, if you’re starting to figure out how to tax an industry, it makes sense to tax something you can find and measure.

II.  Collect early

Collecting tax at the beginning of the supply chain prevents cheating, and other problems. If cannabis is removed from the grow area, whether by a farmer or a thief, a canopy tax has already been collected. There’s no leakage. If the truck loaded with product is allegedly high-jacked, the tax has been paid.

III. Now to quibble

OK, this kind of canopy tax won’t be the final word in government revenue from cannabis, but it’s a start. A principled start. But it has some rough edges so far.

The Humboldt canopy tax doesn’t index dollar amounts for inflation. Federal alcohol taxes have been cut in half, in real economic terms, by failure to index. The Humboldt proposal’s rates may be low as the market matures, but as a lawyer and tax drafter, I’ll leave the number-picking to politicians and economists. Indexing, though, is structural, and doesn’t involve choosing a number. But there’s late-breaking news on the policy front: A Humboldt source predicts that indexing will be in the next draft.

Meanwhile, the canopy tax in Humboldt doesn’t factor in the ability of some growing areas to produce crop after crop in one taxable year. That favors indoor growing (and electricity use). Now counting crops is more intrusive than an annual tax. Still, counting the number of crops a parcel produces in a year is imaginable. An analogy is described by DISCUS, the liquor lobby: “In the 1790s federal excise tax was collected from distilleries based upon the capacity of the still and the number of months it distilled. In 1798, [George] Washington paid a tax of $332 on stills totaling 616 gallons operating for 12 months.”

Sure, like any tax, a tax on cannabis canopy will distort the market. A canopy tax will incentivize growers toward tall plants, which have lots of cubic feet of productive plant mass per square foot of grow area. But a canopy tax distorts less than a per-plant tax, which would push growers toward plants that are both wide and tall.

Now for some picky technicalities. Here’s the draft language:

The tax imposed by this section shall be at the following rate:
* less than 600 square feet of canopy: $0;
* 601 square feet to 6000 square feet of canopy at fifty cents ($.50) per square foot;
* 6001 square feet or more of canopy at one dollar ($1.00) per square foot. . . . By way of example, a canopy of 7060 feet at any time during the year will have a tax of $7060, not a tax calculated at 600 square feet + 6000 square feet + 1000 square feet.

To start with, that language doesn’t cover the case of exactly 600 square feet.  Or 6,000.5 square feet.  Literally.  And taxpayers love little errors like that to mess with. But that’s a nit, easily corrected.

A bigger technical problem is that the draft’s tax is not smooth. It’s spiky.  Inadvertently, it contains absurdly high marginal rates.  These examples show the problem:

If you grow on 598 square feet, your tax is zero.
If you grow on 602 square feet, your tax is $301.
If you grow on 5,998 square feet, your tax is $2,999.
If you grow on 6,002 square feet, your tax is $6,002.

In those examples, growing on four more square feet creates a spike, a cliff, a huge extra tax – a marginal tax rate well over 100 percent. In math, that’s a discontinuity.

That painful spike could be removed — and the word from Humboldt is that a fix is in the works. A smooth tax could work this way:

The tax imposed by this section shall be at the following rate:
* the first 600 square feet of canopy: $0;
* over 600 square feet to 6000 square feet of canopy:  fifty cents ($.50) per square foot;
* over 6000 square feet or more of canopy at one dollar ($1.00) per square foot. … By way of example, a canopy of 7060 feet at any time during the year will have a tax of $3,760, the first 600 square feet bearing zero tax, the next 5,400 square feet bearing $2,700 tax (at a rate of 50 cents per foot), and the last 1,060 square feet bearing tax of $1,060.

Under the smoothed-out fix:

If you grow on 598 square feet, your tax is zero.
If you grow on 602 square feet, your tax is $1.
If you grow on 5,998 square feet, your tax is $2,699.
If you grow on 6,002 square feet, your tax is $2,702.

That brings in less revenue, so if you wanted to hit the same dollar revenue target, you would have to increase the rates.

People dislike taxes naturally enough. When taxes are absurd, as with those crazy marginal rates, people get really worked up.

Enough quibbling. These rough edges are to be expected with new proposals. Taxing canopy, as proposed by some Humboldt County farmers themselves, is a good faith start.

[This is a draft I had almost finished and then forgotten about as a new project came up.  Comments welcomed.]

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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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