California Looks at the Revenue Potential of Cannabis

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LOS ANGELES — The cash-driven nature of California's marijuana business will make it hard to tax cannabis sales, let alone securitize them, if voters agree to legalize recreational use in the state.

Californians made medical marijuana legal in 2000 and the state's voters on Nov. 8 will weigh in on Proposition 64, a ballot measure to legalize marijuana for adults aged 21 and older and impose state taxes.

Some 60% of voters said they favored passage of the marijuana legalization measure compared to 36% who opposed it, according to a survey released by the Public Policy Institute of California on Sept. 21.

The Yes on 64 campaign says legalization will generate up to $1 billion in new tax revenues annually for California.

But how much of that will materialize, and how it will materialize, remains unclear.

More than 15 years into the legalization of medical marijuana, it remains difficult to track the sales tax it generates, said Fiona Ma, chairwoman of the California Board of Equalization, the state's elected tax administration panel.

It is still largely a cash business, said Ma, speaking at the recent California Public Finance Conference.

Ma spoke of medical marijuana dispensary owners showing up at banks with duffel bags of cash.

Marijuana is still considered an illegal substance by the federal government and federal regulations make banks reluctant to work with medical marijuana cultivators or dispensary owners.

"In February 2015, I found out that the Board of Equalization collects sales taxes on dispensaries," Ma said. "I asked how much we collect each year. Everyone looked at us and said, 'I don't know.'"

She learned that the industry does not have legal access to banking. That means there are no bank statements, credit card statements, and nothing to do checks and balances if the BOE wants to audit these companies, Ma said.

"We estimated that we collected $44 million in 2014 in sales taxes from dispensaries, which probably only represents 25% of companies," Ma said.

When the companies register as a business with the state, there is no check box for cannabis, so the companies check agricultural or healthcare, making it hard to cross-reference, she said.

"How do you tax this industry in the right way and in a way that produces the most public benefit, so it is leverage-able and borrowable?" asked the cannabis panel's moderator, Justin Cooper, an Orrick partner.

State officials might want to pay attention to whether they are creating a tax that is good for borrowing, Cooper said. That could involve considering whether they could "peel it off and borrow against it as a discrete revenue."

Those considerations might include whether the revenue goes straight into the general fund and what kind of bonds work best, said panelist David McPherson, a principal with HDL Companies, which provides tax administration support and services to California cities.

Federal hurdles could also hamper expected economic benefits should Californians approve the marijuana legalization measure in November.

"The federal government is not enforcing it in areas where it is legal, but unfortunately it has not been done by statute," said panelist John Gust, a senior vice president at Jefferies LLC.

There are federal guidelines that allow banks to nominally serve medical marijuana businesses, but they are just guidelines, not laws, Gust said.

And banks don't want to take the risk of getting entangled in something that is still against federal law.

"I think the banking industry is concerned about violating the various money laundering acts," Gust said. "There is a lot of uncertainty. That is why many banks are staying out."

There are only 130 banks across the country that have approval to bank the cannabis industry, Ma said.

"There needs to be some easing of monetary policy just to get more banks into the mix," Ma said.

Though larger banks are staying out, Gust said that some small local banks are getting in, because the margins are quite large in the absence of much competition.

The state is working on creating a taxing system and business structure for medical marijuana dispensaries.

Panelist Jan Lynn Owen, commissioner for the California Department of Business Oversight, said the structure around medical marijuana dispensaries would be used if recreational marijuana is legalized in November.

The Bureau of Medical Cannabis Regulation licenses and regulates growers and producers of edible marijuana.

"We have a tracking system to regulate cannabis," Owen said. "We require licensees to provide approvals and permits from local government."

The state is even cracking down on the environmental impacts of the production of marijuana cultivation.

"Though it is in the process, you will see a strong regulatory scheme," Owen said. "We do expect Proposition 64 to pass in November."

Owens said that California is the sixth-largest economy in the world, so while it can take lessons from some other states, "we look at it as size matters."

UCLA Anderson Forecast Senior Economist Jerry Nickelsburg said during his organization's September forecast that legalizing marijuana will not be a salve for the state's revenue volatility.

He used a multiplier of what Colorado collects in marijuana tax revenue to estimate how the Golden State might do.

He disputed what he called predictions of a boom in production, distribution and sales and even marijuana tourism along the lines of California's popular wine tourism industry.

The pre-existing structure for medical marijuana will "dampen any gains from the legalization of the purchase of weed for recreational uses," Nickelsburg said.

Though there are other taxes and licenses required by businesses engaged in marijuana production and sales, the 2.9% sales tax in Colorado provides the best data on the dollar volume on sales, Nickelsburg said.

"Using population to gross-up the Colorado numbers and assuming a California 10% sales tax, the revenue calculation from marijuana sales would be $501 million or 0.4% of the state's general fund," Nickelsburg said. "The retail marijuana sales in Colorado are growing, so this number might be a bit on the low side, but it has a long way to go to make a significant impact on the budget."

The estimate for the size of the cannabis industry in Colorado is $5 billion, and the job gain is 28,000.

Translating those numbers to California results in an industry representing 0.2% of California's $2.5 trillion dollar economy and 0.13% of California's employment, Nickelsburg said.

Though there are risk factors to the California economy, "we think that the most likely outcome is that economic policy, taxes and grass will not be significant players over the next two-and-a-half years," Nickelsburg said.


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