Focus Compliance NOT Enforcement
Focus Compliance NOT Enforcement – efficient reporting and collection practices will yield far greater compliance and monetary results for the State of California than “kicking in the door” raids ever could.
Author – aBIZInaBOX Inc – Jordan S. Zoot, CPA
Focus Compliance NOT Enforcement – we were prompted to write this Post by the article “California Cannabis Taxes Lag as Illegal Market Flourishes” . We were pleased to see this article. The January 11th article gives us a reason to write the type of post we enjoy writing – a post where we disagree with everyone on numerous points.
We agree with the premise of the January 11th article, it is likely that at least 80% of the cannabis sold in California in 2018 was sold in the underground market. We doubt the percentage of legal sales is as high as 20%. The classification of sales as legal sales or as underground depends in part on what sales are counted legal sales and what is counted as the dollar amount of a legal sale. If the sales that count as legal sales are all sales between licensed cannabis businesses, the legal sales may indeed be 20% and the underground sales 80%.
The sales amounts are easy to define for underground sales – the amount at which cannabis changes hands between the seller and the consumer. How does one measure the amount of a legal sale by a licensed dispensary that does not collect the full amount of taxes imposed at the time of the sale and that cannot prove it paid over to the full amount it actually collected in tax? Such a sale appears to be generally considered a legal sale at the amount actually collected even though the taxes collected and remitted may be substantially understated. Does a legal sale occur when a licensed manufacturer or distributor buys cannabis from a licensed grower pursuant to a contract that says the buyer will be responsible for the Cannabis Cultivation Tax (“CCT”), but neither the buyer not the cultivator pays CCT to CDTFA? Is the transaction an underground sale or a legal sale? If a California cannabis product must be fully and accurately tracked, reported and all cannabis-related taxes paid in order to constitute a legal sale, it is our opinion the underground market is greater 80% of the total market.
The solution for California, however, is not to spend $200M or any other substantial amount on enforcement. Enforcement of marijuana laws in California has been a money-wasting policy failure for over 30 years. This policy failure has accomplished little good and caused substantial injury to many at tremendous cost to the public. Judicious enforcement of the law is to be applauded. Judicious enforcement of the law is part of the solution, but it is only a small part of the solution.
Part of the solution may also be found in lowering taxes on cannabis. Localities have already discovered cannabis businesses like all other businesses are tax rate sensitive. At a state-wide level, jurisdiction shopping does not work. Lowering California cannabis taxes may help a little, but only a little. The efficient collection and remittance of the proper amount of cannabis taxes on the sales that are being reported will accomplish far more and will cost far less. The taxes that California imposes on cannabis contribute to the underground market for cannabis, but California will have a substantial underground cannabis market even if it wholly abolishes state-wide taxes on cannabis.
The evolution of California’s cannabis industry over the past forty years has guaranteed that for the foreseeable future California will have a substantial underground cannabis industry. As a consequence of Proposition 215 and Proposition 64, a substantial underground cannabis economy has been preserved in California for the foreseeable future. The right of Californians to enjoy cannabis is enshrined in the California Constitution. It is our opinion that at best California may be able to get 80% of the total cannabis production in California into the legal medical and recreational cannabis marketplace. California should consider it has created a model regime for regulated cannabis commerce if all significant cultivation sites by size are licensed, and all commercial cannabis is processed, packaged, transported, and delivered by licensed cannabis businesses.
Backyard grows that distribute to friends and family will exist in California for the foreseeable future. Also, as long as there remains a substantial differential between the cultivation cost of cannabis and the retail value of cannabis in the underground market, some will take the risk of breaking the law. Lower taxes and more enforcement are at best partial solutions to a much larger problem. Far more can be accomplished within the existing legal framework that has been accomplished to date.
We have complimented the California agencies that are struggling to regulate California’s cannabis industry for their efforts. We are now going to criticize these same agencies for falling into the trap that tends to make governmental agencies financially inefficient and frustrating for those who suffer under the administration of these agencies. Agencies tend to be process oriented rather than goal oriented. The goal is to bring as much of California’s cannabis industry as possible into a fully compliant and accurately taxed market.
Focus Compliance NOT Enforcement
California’s efforts should be directed at issuing cannabis licenses as quickly and as efficiently as possible. California had a substantial underground cannabis industry long before regulation began. CDTFA wrote regulations that described what California wanted in a regulated and taxed commercial cannabis market with substantial public input. The laborious process created barriers to the goal of getting as much of the underground industry into the licensed and regulated industry as possible. California should be trying to issue licenses as quickly and as efficiently as possible with whatever conditions are appropriate to maintain licensed status.
With respect to land use and public health and safety issues, California should almost wholly defer to local jurisdictions. State-wide regulation with respect to matters of land use and public health and safety should consist of no more than broad guidelines. If a local jurisdiction issues a license to a cultivator, distributor, manufacturer, transporter or dispensary, that should be sufficient for California. It is solely the testing laboratories that should be largely subject to regulations imposed on a state-wide basis.
The long-range key to California’s successful regulation of its cannabis industry will lie in minimizing the delta between cultivation costs and retail prices. There are two rules of thumb California’s regulators should not forget. First, Cultivators will not grow cannabis unless they believe they can make money growing cannabis. Secondly, the street price for cannabis will generally be between 40%-60% of the retail price for the same cannabis.
In the past, the cannabis pie was divided into three slices – cultivator, middle-market functions and retailer. The cannabis pie is now divided into four slices – cultivator, middle-market functions, retailer and California taxes and fees on cannabis. California must regulate its cannabis industry in a manner that makes it as easy as possible for the middle-market functions to efficiently conduct business. California must begin to look at issues relating to the regulation of its cannabis industry from the perspective of how to make it easy to do something effectively and efficiently.