“Regulating Marijuana in California,” a Report by the Public Policy Institute of California, does a good job of explaining some of the tax issues involved with legalization.
But rather than dwell on what the PPIC got right, I’ll write about two problems. Unlike my friends who study drug policy broadly, I look just at the tax part. Mostly, I’ll quote from the RAND Report, Considering Marijuana Legalization: Insights for Vermont and Other Jurisdictions, http://www.rand.org/pubs/research_reports/RR864.html, which is in the public domain, and which I helped write. The quotes are in bold.
- Colorado’s weight-based tax
The PPIC Report overlooks the way Colorado actually taxes product at the producer level, which is by weight. The rate of the weight-based tax has changed to approximate 15 percent of the latest market value, but the RAND Report explains it this way:
Colorado side-stepped its constitutional authorization of a 15-percent “excise tax to be levied upon marijuana sold or otherwise transferred by a marijuana cultivation facility to a marijuana product manufacturing facility or to a retail marijuana store” (Constitution of the State of Colorado, Art. XVIII, section 16) and ended up taxing something it could measure, so it taxed bud at $0.62 per gram, trim at $0.10 per gram, and seedlings at $1.35 each.
The problem arises when the cultivation facility does not sell marijuana to anyone and transfers it only to itself. That is standard in Colorado, where, most of the time, marijuana is not “sold or transferred” before retail. That is because Colorado once required all marijuana businesses to be vertically integrated. Vertical integration means that only one company handles marijuana from farm to market—all the way from seedling to retail sale, with no sellers in between. Vertically integrated companies still dominate the market in Colorado—with no sale from a producer to a manufacturer or retailer. So there is no market-based or arm’s-length price to tax at 15 percent. There is no sale of any kind, not even a related-party sale, just an intracompany transfer.
So Colorado had to alter tactics and tax not a price, but “fifteen percent of the average market rate” (AMR) of a producer’s marijuana (Colorado Revised Statutes section 39-28.8- 302, 2014). That rate is supposed to reflect the value of marijuana as it leaves the producer’s hands (“Average Market Rate,” undated). The Colorado Department of Revenue (CDOR) is in charge of finding that AMR. For 2014, it found the AMR of bud, the potent flower of the plant, to be $1,876 per pound, so it imposed on bud a tax of $281.40 per pound, or approximately $0.62 per gram (CDOR, date unknown). Finding immature plants to have an AMR of $9, it imposed a tax of $1.35 on each. Finding the AMR of trim (i.e., everything else) to be $296 per pound, it imposed a tax of $44.40 per pound, or approximately $0.10 per gram, on trim.
These rates apply, surprisingly, to sales even to unrelated parties, for which there is an actual arm’s-length price. So Colorado essentially could not make its price-based tax on producers work and has de facto completely converted that price base to a weight base.
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Those tax rates have change a bit since the RAND report went final. Here are new rates: https://newrevenue.org/2015/12/31/no-drop-yet/
Here are details on how the weight base works: https://newrevenue.org/2015/05/06/how-colorados-weight-base-works/
UPDATE 11 April: Here’s a tweet:
Grower pot tax in one State:
Colorado taxes weight.
Price is what they tried to tax
‘Til they ran into the facts.
Yes, that’s pure doggerel, but I seem desperate, having made this point over and over, while even sophisticated analysts fail to mention the de facto weight tax.
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2. How a Price Base Goes in the Wrong Direction
The PPIC Report overlooks the critical problem with taxing by price, or “ad valorem” – by value. Again, from the RAND Report:
But an ad valorem tax has disadvantages. The most serious one is that an ad valorem tax base amplifies changes in pretax prices automatically. Here is why that is a problem: At first, as the legal industry struggles to gear up, supply cannot meet demand, so pretax prices could be abnormally high early on. (That is what happened in Colorado and Washington.) A price-based tax amplifies those high pretax prices and makes early after-tax prices much too high. So bootleggers benefit. That is, the black market and fake medical market retain market share.
But as time goes on, as legal operators learn and become efficient, and as they expand and achieve economies of scale, their costs can drop dramatically. If they pass cost savings on to consumers, pretax prices decline, and a price-based tax automatically declines with them. As after-tax prices drop, the dangers of youth use, abuse, and leakage to other states grow. So a price base then can lead to taxes that are too low, which could be a problem for a maturing marijuana industry.
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In summary, the PPIC Report overstates (1) the prevalence and (2) the advisability of taxing by price. Despite those criticisms, the PPIC Report explains some of the nuances of taxation well.
I am not against all price-based taxation of cannabis. Actually, a price-based tax is probably a good place to start. But a weight-based tax, like Colorado’s, and like the one in California’s AUMA ($9.25 per ounce for bud, indexed — less for trim) is a more solid and sustainable tax. Combining that kind of weight-based tax with a modest rate of price-based taxation – the Colorado and AUMA model – is a good start.
This is just about structure. Whether AUMA’s rates are too high at first or too low in the long run — I’ll venture no opinion.
The Center for New Revenue 