California Dreams of Taxing Pot

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SAN FRANCISCO — California cities and counties could conceivably issue clouds of bonds backed by more than $1 billion a year in marijuana-related tax revenue if Proposition 19 passes Tuesday, transforming a decades-old pipe dream into reality.

Prop. 19 would legalize marijuana under California law, but not federal law, permitting local governments to tax commercial production, distribution and sale of the drug in the Golden State and allowing anyone over 21 to grow, sell and smoke pot. The option comes at a time when California is beset by funding shortfalls.

Roger Davis, a partner and head of the public finance department at Orrick, Herrington & Sutcliffe LLP, indicated that marijuana bonds are hypothetically possible. Several cities in California already tax medical marijuana sales, which the state estimates generates tens of milllions of dollars..

“By one legal structure or another, it is likely that ways could be found to borrow directly or indirectly against a marijuana tax, assuming the measure passes,” Davis said in an interview.

According to a report by the state’s Legislative Analyst’s Office in the official voter guide, increases in state and local government tax and fee revenues could be in the hundreds of millions of dollars annually. The Board of Equalization — the state collector of sales and excise taxes — analyzed an earlier effort to tax marijuana and estimated such taxes would generate $1.4 billion in annual revenue.

However, the LAO also noted that uncertainty about the reaction from the federal government makes it hard to judge how much revenue would actually be collected. U.S. Attorney General Eric Holder has publicly railed against the California legalization measure.

Still, state and local governments around the country have a proven ability to find ways to issue bonds backed by creative revenue streams. And they’ve been turning financial somersaults in recent years to meet their pension funding and union labor obligations.

The U.S. Virgin Islands sold $400 million of tax-exempt bonds in June backed by a rum tax, and New Jersey has issued bonds based on cigarette ­taxes. Alaska has issued bonds based on fishing license fees.

Many bond industry veterans say that if steady taxes can be generated from marijuana sales, bonds could theoretically be issued against that revenue stream. During The Bond Buyer’s California Public Finance Conference earlier this month, hundreds of poll participants overwhelming agreed that marijuana tax-based bonds would be issued if Prop. 19 passed.

Numerous precedents already exist for bonding against tax revenue generated from activities some people view as sinful. Gambling and lottery revenue is routinely bonded. Some states sell revenue bonds based on liquor  sales taxes, and such “sin taxes” could serve as a ready model for pot bonds, while the 1998 Master Settlement Agreement with tobacco companies backs billions of dollars in bonds.

Of course, existing taxes and fees with proven revenue sources back those bonds. In contrast, there is little more than an educated guess about the revenue a legalized marijuana industry would produce.

“It is also unclear how the legalization of some marijuana-related activities would affect its overall level of usage and price, which in turn could affect the level of state or local revenues from these activities,” the LAO reported in its analysis of Proposition 19. “Consequently, the magnitude of additional revenues is difficult to estimate.”

Frank Benest, a consultant to city and county governments and former Palo Alto city manager, said bonds theoretically could be issued by localities based on a marijuana tax, but their success would depend on the stability of the revenue stream and many other unanswered questions.

“It is totally new ground,” Benest said. “[A marijuana tax] is just not any old ­revenue, it is not like increasing your tax on rental cars. There are all kinds of health and social issues and safety issues related to this.”

Local governments in California are strapped for revenue due to falling tax collections and rising employee pension costs. Benest noted that localities are looking for revenue wherever they can find it. But even if local governments want to tax pota, most new taxes need voter approval.

Several cities in California already tax medical marijuana sales, which is legal in the state, and 11 cities are proposing ballot measures tomorrow that address marijuana sales, according to the Sacramento Bee newspaper.

Oakland, which has been somewhat of a bellwether for pot dispensaries, has a question on Tuesday’s ballot that would increase the tax rate for medical cannabis businesses from the current 1.8% to 5% and creating a 10% business tax for recreational marijuana “industries.”

Berkeley has two marijuana-related measures on the ballot. One would authorize a 2.5% tax on medical marijuana businesses and a 10% tax on nonmedical pot outlets. The other would increase local dispensaries from three to four and allow the city to issue permits allowing up to 200 square feet of industrial marijuana cultivation.

If the measures pass, Berkeley anticipates a windfall from the gross receipts tax on medical cannabis businesses in excess of $165,000 in 2011 and $460,000 in 2012. The square-foot tax would raise $159,655, according to an analysis of the local measure by city attorney Zach Cowan.

“It is impossible to anticipate the amount of tax proceeds this would raise [from] non-medical cannabis businesses if they are legalized,” Cowan said in the report.

The California Board of Equalization estimated in a report last yearthat the state could collect $392 million annually from taxing pot. .

Despite the possible economic benefits, some cities do not welcome marijuana sales.

A measure in Morro Bay would ban medical marijuana dispensaries and another in Rancho Cordova would impose an annual “personal cultivation tax” of $600 to $900 per square foot for residents growing the plant for either medical or recreational use.

The legal maneuvering may all be for naught if the U.S. government takes a heavy hand enforcing federal law, which still classifies marijuana as illegal. Holder adopted a hands-off policy towards medical use of the drug in 2009, saying the Justice Department would end raids of legal medical marijuana clubs, but is no fan of wider legalization. He took a firm stand against California’s pot proposition in an October letter earlier this month to former administrators of the Drug Enforcement Administration.

“The Department of Justice strongly opposes Proposition 19,” Holder said. “If passed, this legislation will greatly complicate federal drug enforcement efforts to the detriment of our citizens. ... The department is considering all available legal and policy options in the event Proposition 19 is enacted.”

According to bond industry veterans, that is precisely the kind of federal ­opposition that clouds the outlook for marijuana bonds.

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