Collection Point for Marijuana Tax — BOE

(For a more comprehensive discussion of this issue, go to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1741735.)

At the end is an excerpt from an email of November 3, 2010, from Anita Gore, spokesperson at the California State Board Of Equalization, to me.  But first, here is what I was asking her about:  some draft language I sent her:

“For alcohol, fermentation takes place in bonded locations.  Tax is imposed as beverage alcohol as or before leaves its final bonded location.

“For tobacco, the choke point is found after the time when and distant from the place where the curing process makes green tobacco smokable.  Cured tobacco from tens of thousands of domestic farms travels untaxed to manufacturing plants where tax will be assessed.[1]

“For marijuana, Staff of the California Board of Equalization, which “typically recommends that excise taxes or fees be imposed as high in the distribution chain as possible,” advises against collecting from “the highest point in the distribution chain[,] . . . the grower[,] . . . [because], growers normally sell in bulk volume, which would not be conducive to a unit-based tax.”[2]  The Staff instead recommends collecting at the level of the distributor/processor, where repackaging would allow for the use of tax stamps.

“A more aggressive scheme for taxing marijuana would involve a limited number of farms or grow areas placed under security.  The government could monitor the process from seed (or clone) to cigarette, and assess tax when the product is packaged for sale.”

[1] Tax on imported tobacco is assessed at customs.  Meanwhile, “monitoring of raw leaf tobacco [to] . . . control the supply of raw leaf tobacco from grower to manufacturer” is nonetheless a part of a comprehensive excise system.  Brandy Brinson, “Regulating Security,” Tobacco Reporter Magazine (June 2006), available at http://www.tobaccoreporter.com/home.php?id=119&cid=4&article_id=798.

[2] BOE Analysis, supra note 152, at 8.
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Here is my question:

“What would prevent growers (in the system the Staff recommends) from diverting unprocessed marijuana into the black market before it gets to the distributor/processor?  That is, might not the alcohol model be more bullet-proof than the tobacco model?  If so, would practical considerations nonetheless tip the scales toward the tobacco model?”

This is her reply to me, on November 3, 2010:

“As you mention, Prop. 19 failed, so we will not be implementing any taxation program at this time for the manufacture and sale of marijuana.  Regarding any future attempts at legalization, there are too many unknowns to make any decisions at this time.

“However, generally speaking, growers would be licensed and inspected regularly.  By knowing the size of a grower’s crop, we know the approximate amount of product produced.  Just like alcohol, some product may go out the back door that the taxing agency is not aware of.  This can never be completely controlled.  There is no fool proof system to stop all evasion schemes.  But by using indicia, licensing all the levels including retailers, and doing regular inspections, the State of California can reduce the evasion level.”

A parental excise tax illustrates some principles

Australian economics professor and author of Parentonomics Joshua Gans shows that excise rates can be too high to collect any revenue and that evasion can beat the system as he tried this plan for his daughter “B.”:

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Gans came up with a special incentive plan for candy. If B. wanted to buy candy, she would have to pay her parents a 100 percent tax, effectively doubling the cost.

The tax was based on how much B.’s candy consumption would add to the family’s health costs, because of increased dental visits and the like. As it turned out, Gans never earned any revenue from the tax — because B. never bought candy with her allowance.

“I realized that’s just a ripoff,” B. says. “Why would I want the candy then?”

Of course, just as people evade government regulation by crossing state lines for cigarettes or fireworks, B. can go to her grandmother’s for tax-free candy.

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http://www.npr.org/blogs/money/2010/09/02/129604336/?ft=1&f=93559255, via http://taxprof.typepad.com/

Bright and silly lines

Two recent examples in the news prove that drawing reasonable lines in taxation is not child’s play.  New York taxes sliced bagels at 9 percent, as it taxes bagels with cream cheese spread by the seller, and exempts unsliced bagels.  Federal tax on loose cigarette tobacco is about 10 times that on pipe tobacco.

In the New York case, the answer seems to me to be to exempt bagels that are simply sliced.   They are more like a loaf of bread than they are like a sandwich.  More transformation than just slicing, like combining (as with cream cheese) or heating should be required for a change in tax categories.  The answer should definitely not be to create a new category and tax it at 4.5 percent.  Fairness is the enemy of simplicity.

In the tobacco case, I don’t know about the differences in the kinds of tobacco, but roll-your-own smokers are now happy to put pipe tobacco in their cigarettes.  The 10-fold difference is way out of whack, it seems.

This line-drawing comes up all the time.  It produces weird and embarrassing results for those of us who support some kind of taxation, but it’s manageable.

What’s not manageable is different excise tax rates based on hidden characteristics of the purchaser.   No one I know suggests having the rich and poor pay different sales taxes when they buy the same item, like shampoo (we may get some progressivity anyway if the rich buy costlier stuff).  But some proponents of medical marijuana contend that when marijuana is legalized for all, medical users should pay no or less tax.  That would be weird.

When smokers draft the marijuana laws

(For a more comprehensive discussion of this issue, go to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1741735.)

The process of initiative and referendum that California and other, mostly Western, States use is a weak instrument for creating a new system of taxation and regulation .

California’s Proposition 19 reflects the wishes of the powerful forces in the marijuana community.  For instance, it doesn’t even tax marijuana:  it allows localities to tax or not tax.

This one-sided drafting is a recipe for backlash.  In a deliberative process, by contrast, if marijuana becomes legal, opponents of marijuana won’t necessarily be convinced it’s OK, but some of them may cut a deal if they see enough benefit from the revenue gain.

The American way of the Founders is not the victory of one faction over another, but accommodation.  Meaningful taxation of marijuana is the middle ground we may get to one day.

Proposition 19’s  revenue is so speculative and ephemeral that even if it passes, all the tax thinking remains to be done.

Why we can’t raise taxes

Mr. Rangel, lauded here in a previous post, is an example of the reason people don’t want to pay taxes.  He treated himself better than most people could treat themselves, thanks to the power of his office.  His success came thanks also to his friendliness and love for people, to be sure, but he broke the rules.

So people distrust their representatives who write Federal tax laws and want to keep their power down.

Our work is cut out for us.  The Democrats could gain a lot of credibility by trying Mr. Rangel and voting against him not on friendship but on the merits.

Reaping what we sow

As the public resists taxation,  end games for our democracy are foreseeable, though the timing is beyond me.  The military leads the list of institutions that Americans have confidence in (76 percent) followed by small business (66 percent) and the police (59 percent).  The Presidency and the Supreme Court tie at 36 percent, while Congress brings up the rear with 11 percent.  http://www.gallup.com/poll/141512/congress-ranks-last-confidence-institutions.aspx

So here’s the result: eventually unable to borrow and still unable to tax, States and the Feds cut spending to the point where passable roadways, crime-free neighborhoods, and then clean water go missing.  The military steps in for the benefit of the public.  The Constitution is suspended.  The military takes what assets it needs to fund a government.  Police units help out.

Another end game is conflict with China as we renege on our debts, maybe by fast or slow devaluation.  The military will need all the confidence it can get in that scenario, too.

I’m for balancing the budget, like many Republicans from the middle of the 20th century were.

Some arguments against medical marijuana

[An updated version appears as part of http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1741735.]

While marijuana helps some people with illness, I am very wary of exemptions, lower rates, or special rules for marijuana when it’s said to be medicinal.  No proscription, no prescription.

First, any special rule puts the government in charge of making decisions about individual people.  The government can distinguish, however awkwardly, among substances, so as to tax wine with an alcohol content of 13.9 percent at a lower rate than wine with an alcohol content of 14.0 percent.  But putting human beings into categories can be more difficult.  To be sure, there are easy cases, like the extra Federal tax exemption for individuals 65 and over (you just produce that birth certificate or otherwise prove your birth date as Mr. Obama has done to the satisfaction of most).  But even the extra tax exemption for blindness on the Form 1040 creates a regulatory tangle and even a few disputes.  Deciding whether someone has some ailment as subjective as chronic pain is a task that I hate to see government taking on.  Folks who are distrustful of government ought to be especially careful about this kind of official categorization of individuals.

Second, any special rule rewards hypocrisy with a special right. Folks who pretend to be sick get something that honest folks won’t allow themselves to get.

Third, providing even any perceived benefit, even a placebo, to folks who say they are sick encourages people to think of themselves as victims.  (The argument back is that we all may have chronic pain in our souls: it’s the human condition.)  Having people think of themselves as victims has a positive aspect:  it encourages them to seek help (and it encourages others to try to get them help).  But such thinking tends to weaken the thinker.

Fourth, any special rule adds complexity.

Finally, any special rule diminishes the tax base.

Rand estimates of marijuana legalization

A new Rand corporation study, “Altered State?  Assessing How Marijuana Legalization in California Could Influence Marijuana Consumption and Public Budgets,” estimates revenue from the California proposals.  http://www.rand.org/pubs/occasional_papers/2010/RAND_OP315.pdf

It’s quite elaborate.  I’m working through it, but it seems to do a good job of spotting the issues.

A couple of quick reactions:

The uncertainty in Rand’s conclusions makes the case for having the State be the sole retailer (and maybe having the State own the whole supply chain).  Rand finds it hard to estimate elasticities and can’t pin down bootleggers’ reactions or even current price.  Setting a tax rate too firmly fixes a probably incorrect rate in place.  So following the lottery model, where the State can adjust prices quickly, looks appealing.

Their analysis makes the case for measuring potency and taxing on the basis of it.  First, they note the incentive, long noted on this blog, that a per-ounce tax gives to produce more intoxicating cannabis.  But second, there’s more to it.  Measuring potency officially by the State will give consumers certainty about what they are getting.  Bootleggers can’t supply that certainty.  Folks will pay a premium for it.

The imprecise statement that potency testing will cost $100 per test needs elaboration.  The cost must include fixed and variable costs, and they need to be stated.

Still, this is the most thorough and serious look at revenue I’ve seen.  And I’ve just started to study it.

Drain America first?

The NYT of July 4 points out that we are subsidizing big oil, and undertaxing it.  “As Oil Industry Fights a Tax, It Reaps Billions From Subsidies,”  http://www.nytimes.com/2010/07/04/business/04bptax.html?ref=global-home.  Transocean, the owner of the Deepwater Horizon that caused all the trouble, is one of what John Kerry called those Benedict Arnold corporations that escaped the USA to avoid tax.

That brings to mind a controversy in the 1980s about whether a pamphlet describing some tax break for the oil industry that was to be issued by the staff of the Joint Committee on Taxation would use the phrase “Drain America first.”  Friends of the oil industry at the Member level didn’t like the phrase:  I don’t think it got printed in the pamphlet.

Toward a Strong Death Tax

A friend reminded me yesterday that “[t]he estate tax is seen as the most ‘unfair’ federal tax,” as shown in a 2009 Tax Foundation survey, http://www.taxfoundation.org/files/sr166.pdf.  That happens even though only a tiny fraction of people will ever pay it.

As a vehement supporter of death taxes (even with the right wing’s label), I quickly blamed propaganda and said education is the answer.  Let people know not just “you won’t pay it,” but also that it’s not a meaningful disincentive to economic activity.

But an article makes me wonder.  It says that many people deny scientific consensuses despite exposure to scientists’ views:  people base their views of reality on ideology, not science.  If scientists want to educate the public, they should start by listening, Chris Mooney, Washington Post of June 27, 2010, http://www.washingtonpost.com/wp-dyn/content/article/2010/06/25/AR2010062502158.html?hpid=opinionsbox1.

That propensity to disregard what so-called experts say makes it hard to think education will do the trick.  And taxes aren’t science.  When I got into the tax policy business, one of the first things I learned was, “It’s all theology.”  You can’t convince people that a particular tax policy is right or wrong:  individual values determine everyone’s views.

The article’s thinking might lead tax policy folks to ask citizens where they think revenues should come from.  (Let folks think about the effects of payroll taxes over against those of death taxes.)   Maybe that would work.

American Public Media has a budget simulation exercise online at http://marketplace.publicradio.org/features/budget_hero/.  Its treatment of taxes is primitive; its come-on ignores taxes altogether:  “If you ever wanted to control where your tax dollars go, here’s your chance to decide.”

Free choice to use tobacco and alcohol — Tax free!

Some go so far as to call for abolition of “differential excise taxes on tobacco, alcohol and entertainment. These kinds of taxes, often called sin taxes, are disrespectful of people’s freely made choices and represent an unwarranted interference with private decision making.”  Roy Cordato, Sales taxes and free choices, (May 25, 2010), http://www.newsobserver.com/2010/05/25/v-print/498695/sales-taxes-and-free-choices.html.  That’s wild.  The full letter is pasted below.

A more mainstream conservative view that is skeptical of excise taxes on specific goods says a tax should be “[n]eutral in its impact on resource allocation decisions” but allows for non-neutrality where there are negative externalities or “spillover effect.”  Joint Economic Committee Study by Richard K. Vedder and Lowell E. Gallaway, Some Underlying Principles of Tax Policy (September 1998), http://www.house.gov/jec/fiscal/tx-grwth/taxpol/taxpol.htm.

Point of View

Sales taxes and free choices

BY ROY CORDATO

Continue reading “Free choice to use tobacco and alcohol — Tax free!”

Why I'm studying a marijuana tax

1. Simplistically, either we adopt a marijuana tax (low hanging fruit) or we go broke because can’t muster the will to make hard choices.  This is a test.

2. For years, I worked for Congress on trying to tax income from intangibles, which is not only hard to measure, it’s hard even to locate (companies like to say it’s in tax havens).   Locating marijuana will be simple unless the tax is so high as to encourage bootlegging.  But once you find it, you can measure it.  Or tax it based on potency.

Fine-tuning gone wild

Some conservative in the 21st century sense finds an easy target for mockery in the UK VAT on the op-ed page of today’s WSJ:

Food for animals creates other problems. If it is “suitable for all breeds” it is taxed, but if “it is held out for sale exclusively for working dogs” it is not, unless, of course, “it is biscuit or meal,” in which case it is taxed.

So dog food for “sheepdog breeds” is taxed, but dog food for “working sheep dogs of any breed” is not; food for greyhounds is taxed, food for “racing greyhounds” is not. This may be the only tax in Britain that favors work over leisure.

I don’t believe much of what the WSJ puts on its op-ed page, but we have to fight a tendency to complicate things too much.

Related parties and the Xilinx case

The recent Xilinx case says:

“Purpose is paramount. The purpose of the regulations is parity between taxpayers in uncontrolled transactions and taxpayers in controlled transactions. The regulations are not to be construed to stultify that purpose. If the standard of arm’s length is trumped by 7(d)(1), the purpose of the statute is frustrated. If Xilinx cannot deduct all its stock option costs, Xilinx does not have tax parity with an independent taxpayer.”  http://www.ca9.uscourts.gov/datastore/opinions/2010/03/22/06-74246.pdf

On the surface, parity between deals involving related parties and deals involving unrelated parties can be achieved by ignoring the relationship.  That line of thinking would lead to the repeal the related party sales rules, because “If Dad cannot deduct his loss on the sale of closely held stock to Son, Dad does not have parity with an independent taxpayer.” But that repeal would not make sense.  Neither does that Xilinx result.

Whatever the Government’s regulations or litigating position may say, a low-taxed subsidiary is not in the position of a contract manufacturer in a world full of contract manufacturers.

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Lists of ways to fix the Federal income tax

People know already how to fix the income tax.  For instance, an unofficial list of loopholes and fixes appears at http://www.taxshelf.org/wiki/Main_Page.  A broader list, a compilation of tax expenditures (not all of which need fixing) by the Joint Committee on Taxation of the U.S. Congress, appears at http://www.jct.gov/publications.html?func=select&id=5.  There is plenty of tax learning to choose from if citizens want a better income tax.