Problems with the MORE Act

The MORE Act legalizing marijuana is supposed to be voted on by the U.S. House in the lame duck session. It has lots of issues, political and substantive.

Three non-tax issues, first; then three tax issues.

Without nationwide testing and packaging standards, states will race to the bottom, as they have with hemp, and whichever states have the loosest standards will see their industry flourish.  Some states don’t want to be in that race to the bottom.

2. Interstate commerce will will wipe out growers in most states other than California and Oregon.  The once-prominent STATES Act would go the other way, and let states protect growers from imports.  Interstate commerce is a killer defect for some growers. Maybe all, if low-cost imports from South America come in.   

3. interstate commerce will bring a quick end to experimentation with regulatory models, experimentation we desperately need.  Even Canada is struggling with getting the details right.  Take taxation, for instance.  There is nowhere near a consensus on what to tax (the tax base:  weight? THC? ad valorem?), let alone where to collect and how much to tax. I.  280E repeal

Now some tax issues:

I.  280E repeal

The MORE Act devotes revenue dollars to casualties of the War on Drugs, but the tax side is not so friendly.  280E is basically a tax on retailers, and turns out to favor Mom & Pop – or the social equity licensee – over Big Retail Marijuana, like retail chains such as John Boehner’s Acreage Holdings.  

While small businesses may rely on reputation and word of mouth, Big Business advertises.  Recently, “$1 out of every $6 spent on restaurant advertising in America [was] done by McDonald’s.” 

For retailers, cost of goods sold includes only what they paid for inventory.  So salaries, rent, and electric bills are notdeductible.  So today, the costs of operating sleek, chic boutiques – in high-rent districts that Mom & Pop and social equity licensees can’t afford – are not tax-favored.  Both Mom & Pop and the chain boutique deduct what they pay the grower, but the chain boutique pays more federal income tax, because Mom & Pop’s non-deductible rent is lower.

Growers pay little 280E tax.  Growers can deduct just about all their expenses – their employees’ salaries, their rent, even their electric bill for artificial grow lights – all that goes into producing cannabis as “cost of goods sold,” so it’s fully deductible.  No problem.  

Glitzy showrooms and beckoning strorefronts are frills.  Social equity licensees can’t afford them. 280E is overbroad, hitting lawyers’ fees (!), but it’s better than nothing.

Now 280E was was designed as punishment.  So 280E irritates key players in the marijuana industry, who view it as a cruel vestige of the misguided War on Drugs – an insult.  Plus, they say it’s unfair, because it treats marijuana businesses more harshly than other businesses.  But we’re not going to tax marijuana like milk.  And sometimes a tool designed for one purpose is the best thing for another.

As part of the income tax, 280E is progressive — high-income taxpayers pay more. Excise taxes tend to be regressive.

II. Tax cut – temporary so far

And nothing is what we get from the MORE Act.  280E creates a tax holiday.  It’s a budget buster.

280E goes away right away, but the Act’s replacement doesn’t show up for over a year.

Here’s section 4(c) :

Effective Date.—(1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to articles manufactured or imported in calendar quarters beginning more than one year after the date of the enactment of this Act.

Will there be efforts to extend the holiday?  

280E’s tax could be kept in place as descheduling happens:  “The Internal Revenue Code of 1986 shall apply in all respects as it did the day before the date of enactment of this Act.”

III.  Weak new tax, eventually

A.  Tax collapse

The MORE Act imposes only a primitive ad valorem tax, five percent of price, which will quickly fade.  Post-legalization, prices always fall, as sellers get past start-up problems and benefit from economies of scale.  Taxes based on price collapse as prices do.  The per-unit revenue stream will turn into a trickle.

B.  Transfer pricing

Huge pricing issues are inevitable for a federal pre-retail ad valorem tax (and even at retail, but that’s not on the table).  Vertical integration is required in some states, and common in others, and the farm-to-store operation will have to assert a transfer price in every case.  (I used to work in international tax, whose bane is still transfer pricing.)  The bill recognizes that problem, and says the transfer pricing rules for large cigars will apply (new Code section 5702(r)(5)).  (The only federal ad valorem substance tax is on large cigars, also imposed pre-retail, like the MORE Act’s weed tax.  But that tax has a unit cap:  52.75% of the manufacturer’s price, with a cap at 40.26 cents per cigar.)   Good luck.  Those large rules probably haven’t had much of a work-out.  The MORE Act’s weed rules will need a lot of work, especially in vertically integrated situations.

Two states with pre-retail ad valorem weed taxes tax de facto by the ounce – CO and NV – with sophisticated categories, despite their statutes.  That’s how they avoid the transfer pricing problem.

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Lots of issues.  The MORE Act won’t just sail through.

 

 

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