A Major Tax Policy Failure for California


by DeEtte L. Loeffler, J.D., LL.M., Taxation

States usually use tax legislation as a way to either raise revenue or to encourage (or discourage) certain behaviors in taxpayers. Legislation adopted by California voters in 2016 fails on both counts by encouraging the smoking of marijuana over cigarettes and decreasing tax revenues from the sale of the marijuana. How did this happen? You can blame the use of propositions to make tax policy, as these bits of legislation are not required to be coordinated.

In May, the California legislature adopted a bill prohibiting the sale and use of tobacco products by persons under the age of 21 years. The premise of the legislation was that most smokers begin smoking before age 19, so delaying their access to tobacco would make it less likely they would start smoking and become addicted. (Yes, this overlooks the fact that many individuals started smoking while still minors and were obtaining their cigarettes illegally anyway).

In the November election, voters adopted a punitive $2 per pack tax increase on cigarettes. This tax increase was primarily promoted, not as a legitimate way to raise tax revenue, but as another way to discourage smoking. The tax increase (if any) is to be used in part for programs to help people stop smoking and to discourage others from starting. So far, so good. Use of tobacco is being discouraged.

However, at the same time, voters adopted Prop 64 which makes the use of “recreational marijuana” legal with sales to begin starting in January of 2018. Prop 64 restricts the sale of recreational marijuana to persons under the age of 21 years (which is consistent with the smoking age for cigarettes). However, the law does not limit the sale of “medical marijuana.” Medical marijuana became legal in 1996 though Prop 215 which permit sales to those 18 years or older (and to minors with appropriate paperwork). Under Prop 64, individuals under the age of 18 can continue to access medical marijuana, just not recreational marijuana.

Finally, Prop 64 was strongly promoted as a way to raise large amounts of tax revenue for the state (as was the reported experience of other states that have legalized it). It imposes a 15% excise tax on all sales of marijuana (both recreational and medical), but exempts medical marijuana sales from the 7.5% sales tax. Unfortunately, the bill was worded imperfectly, and on November 9, 2016 the State Board of Equalization interpreted the law as immediately prohibiting the state from collecting sales taxes on the sale of some medical marijuana. The cost of this blunder? California estimates it receives $50 - $100 million in sales tax revenue from medical marijuana sales each year, with 2015 collections estimated at $58 million.

It seems unlikely the state will forgo all that revenue willingly for 2017, but it has lost the revenue for at least three months. Why? Because of another proposition which was adopted in November. Under Prop 54, legislators must post new bills on line for public review for 3 days before they can be voted on. The lame duck session for 2016 did not have sufficient time to post and vote on a bill before the close of the legislative session. We anticipate that the new legislature will be able to obtain the necessary two-thirds (2/3) majority to re-impose the sales tax on medical marijuana in 2017, but likely it will only be able to apply going forward.

Please read our Legal Disclaimer