by DeEtte L. Loeffler, JD, L.LM Taxation
Some people have posited that making recreational use of marijuana legal in California would help to solve a host of financial and practical problems. Current proposed legislation, discussed below, would make California the fifth state to legalize recreational use, after Alaska, Colorado, Oregon, and Washington. However, a review of the proposition makes clear that unless federal law changes, adopting it could cause more harm than good.
Fiscal Crisis. California continues to suffer from a fiscal crisis. Some key concerns for voters entering the 2016 election cycle are significant shortages in funds for schools, universities, courts, and roads and other infrastructure. One option for raising additional funds to meet these needs would be to legalize, regulate, and tax recreational use of marijuana. Reports from other states which have legalized the drug sound hopeful. Colorado and Washington State have both reported 2014-2015 revenue from such sales at $70 million (which for Colorado is almost twice as much as it received for sales of alcohol). Those numbers are gaining attention in states like California, which already generates significant tax revenue from the sale of marijuana for medical use (“medical marijuana”).
Current Revenue. California currently imposes a sales tax on medical marijuana. The state does not, however, track how much revenue it collects from this tax. Third party estimates of this revenue are widely varied, with some as low as $59 million annually and others as high as $1.3 billion annually. According to the State Board of Equalization, the proceeds of this tax are distributed in part to the cities, counties, and other local jurisdictions where the marijuana is sold, and the balance of the tax proceeds are deposited in the state General Fund. Money in the General Fund can be used for any purpose the legislature sees fit. Federal law permits states to impose a tax on the sale of this product.
Ballot Measure. On November 2, 2015, a ballot measure was introduced to regulate and tax personal, recreational use of marijuana by adults over the age of 21 years. The Control, Regulate, and Tax Adult Use of Marijuana Act would legalize possession and use of up to one ounce of marijuana and up to six plants per adult. Sales to those under the age of 21 years would be prohibited. The measure would impose sales tax on commercially distributed marijuana flowers (at $9.25 per dry ounce) and leaves (at $2.75 per dry ounce).
Some estimate the proposition, if adopted, would generate $500-$800 million annually, although this number apparently includes sales taxes from medical use marijuana as well as the new proposed product. However, unlike revenue from the current tax on medical marijuana, none of the revenue would be deposited in the General Fund. Instead, the funds would be deposited to a “California Marijuana Tax Fund” and used for matters related to the product. Funds would be used to regulate commercial growers and sellers, to fund Fish and Wildlife’s efforts to eradicate illegal growers, and $12 million per year would be given to state colleges and universities for marijuana related research. Other funds would be used to educate youth. It is unclear what uses could be made of the remaining revenue in the Fund. Practical Problems. The proposed legislation would not solve existing problems and would lead to some new ones.
State Fiscal Problems. As noted above, none of the revenue generated by this proposed legislation would be helpful in addressing the state’s current fiscal problems since the bill prohibits it being deposited in the General Fund. Also, it is not clear this new product would in fact cause the state to have increased revenues. The bill allows individuals to grow their own plants, which should reduce public demand a little. Moreover, given the wide range of revenue estimates for the current medical marijuana tax, it is possible the market need for this product may already be fully met.
State Tax Collection Problems. Collecting the new state tax would also be a problem so long as marijuana remains an illegal product under federal law. State officials think that the revenue collected under the current medical use tax are well below actual sales. This is because such businesses do not retain good records - generally for fear the records would be used against the business owner in a federal drug prosecution.
Federal Problems for Business. Marijuana businesses have a federal tax problem too. Under Olive vs the IRS, 749 F2d 32 (2015), the 9th Circuit Court of Appeals upheld the tax court decision finding that 26 U.S.C. § 280E precludes taxpayers operating a medical marijuana dispensary from deducting ordinary or necessary business expenses associated with operations because the business consists of illegal drug trafficking. Such businesses therefore owe federal income tax on 100% of their gross sales proceeds, not on the net. In addition, in the recent case of Beck v. Comm'r, No. 25842-10, T.C. Memo. 2015-149, (T.C. 2015), the tax court held that such businesses could also not take a tax deduction for products and related supplies seized by the federal government.
Marijuana businesses also have a federal banking problem. Federal law prohibits banks from opening accounts for businesses operating in violation of federal law, and in 2015, attempts to use credit unions for this purpose were blocked by the federal government. Lack of banking has led to such businesses engaging in “creative” and underground banking, and in maintaining large amounts of cash on the grounds. Most have hired private security for their premises. This combination of tempting cash and private security personnel puts the safety of local police officers in jeopardy.
Finally, there is a housing problem for marijuana businesses. Under federal law, landlords who knowingly rent to marijuana dispensaries run the risk of federal forfeiture of their real property, which makes it difficult for such businesses to open. Purchasing the property on which the business operates is not a solution since forfeitures would still be possible.
Increased State Costs. If the proposition were to become law, and we assume this leads to increased use of marijuana, there would likely be a number of increased costs as well. In states where marijuana is now legal, police administer blood tests to drivers suspected of driving under the influence. Police must be trained to administer such tests, and the tests are expensive. Laboratory tests (which could be used as evidence in court), can cost $100 or more. The proposition did not appear to include funds to pay for police training and increased drug testing.
Conclusion. Since the revenues from the proposed law would not be available for use in the General Fund, the proposition would not help to solve the state’s fiscal problems. The proposition would also not solve the current tax collection issue since growers and distributors would likely remain unwilling to keep accurate records of their sales and inventory. In addition, unless federal law changes, practical problems with federal tax, banking and forfeiture law will remain. Finally, making marijuana more readily available may compound all of these problems while at the same time adding additional ones. As currently proposed, legalizing recreation marijuana in California will not bring forth the desired tax benefits, and therefore is currently does not appear beneficial to the state.