Marijuana is weighed for sale at the Outliers Collective in San Diego County, California in October 2016. (Vince Chandler, The Cannabist)

This blunder on new California marijuana law could cost state millions

The voter-approved Proposition 64 had addressed taxes for recreational and medical marijuana, but the omission of a date in proposed law has eliminated the tax on medical marijuana from now through the end of 2017

Benjamin Franklin said that taxes, like death, are one of life’s few certainties. But due to a glitch in the technical language of California’s successful marijuana legalization initiative, the state’s pot smokers may prove him wrong.

California’s marijuana legalization initiative is designed to raise significant tax revenue for the state. When legal recreational marijuana sales commence on Jan. 1, 2018, the initiative applies a 15 percent excise tax on recreational and medical marijuana, as well as some taxes on marijuana producers based on the weight of each plant grown. The state’s 7.5 percent sales tax is tacked on top of that for recreational marijuana, but the ballot proposition repeals that tax for medical marijuana. The idea was to give medical marijuana users a tax break relative to recreational users once the initiative’s new taxes begin in 2018. But because the Jan. 1, 2018, target date was omitted in the relevant subsection of the 62-page initiative, the medical marijuana sales tax elimination instead became effective this week when the measure passed.

As a result, tax-free medical marijuana sales will occur in California from now through the end of 2017. With recreational sales not set to begin until 2018, tax-free medical sales leave California facing a disappointing near-term marijuana tax revenue picture. The creators of the initiative have stated publicly that providing a 14-month tax holiday for marijuana was not their intention, but the state’s Board of Equalization ruled otherwise.

Tax revenue could continue to fall short of projections even after 2018 if new recreational users become regular customers in the tax-free medical market, where they would have every incentive to stay. Why endure what economists call “switching costs” – finding a new dispensary and favored types of weed for example – for the privilege of paying higher taxes in the recreational market come 2018? We have seen what could happen, in Washington state. The unwillingness of many recreational users to leave the lightly taxed, loosely regulated medical market so hampered the establishment of an explicitly recreational market that Washington state legislators shut the medical system down. But because the medical and recreational systems in California were both created by ballot initiative, the state’s elected officials do not have the same option.

Medical marijuana users must have a state-issued patient ID card to legally buy tax-free, and many users presumably will not endure the administrative hassle and $100 fee to obtain one. The ID requirement could therefore limit the bleeding from the state’s coffers to millions rather than tens of millions of dollars. Such an optimistic scenario depends on marijuana dispensary staff consistently checking whether customers have such a card and are therefore entitled to tax-free sales. The relevant historical record is not encouraging: Board of Equalization chair Fiona Ma recently noted that about two-thirds of dispensaries have not been fully compliant with sales tax requirements up to now.

The incentive for dispensaries would be to keep customers happy by letting the ID requirement slide, secure in the knowledge that getting caught evading sales taxes is unlikely. Because the marijuana industry lacks access to banks, it generally works on a cash-only basis, making tax auditing by the state difficult. Close monitoring of tax compliance also costs the state money from its medical marijuana tax revenues, which are about to endure a lean year.

There are precedents for ignoring legal provisions that were clearly clerical errors, but California’s Board of Equalization did not invoke them in interpreting the initiative’s implications for taxation. The drafting snafu thus becomes legally binding, meaning that the first year after the initiative’s approval could easily be a net financial loser for California. Marijuana tax policy expert Pat Oglesby of the Center for New Revenue is sympathetic to the initiative’s drafters, acknowledging “I made a more expensive mistake as a staffer on the Joint Congressional Committee on Taxation. It’s very easy to get a detail wrong in a long, complex document.”

Whether voters are as forgiving as Oglesby will likely depend on whether marijuana tax revenue declines steeply in 2017 and how rapidly it rises thereafter.

– – –

Keith Humphreys is a professor of psychiatry at Stanford University.