Tax Policy – San Francisco Joins California Cities Levying a Gross Receipts Tax on Cannabis

Unlike the attention being drawn to San Francisco’s legal troubles with Proposition C, there is less fanfare surrounding Proposition D, which creates a new municipal gross receipts tax on cannabis. The measure will distort the cannabis market and raise costs for consumers in an especially opaque manner, as other gross receipts taxes often do.

Proposition D levies a tax on marijuana firms’ gross receipts over $500,000 (exempting retail sales of medical cannabis) beginning on January 1, 2021. The tax was approved narrowly by voters, 50.8 percent to 49.1 percent, and is less likely than Proposition C to face a legal challenge as the measure’s revenue would go to general purposes. The tax will also apply to internet retailers with San Francisco customers, including out-of-state retailers.

San Francisco is following the steps taken by other major cities and counties in California of often assessing gross receipts taxes on cannabis producers and retailers. This tax adds to San Francisco’s broader gross receipts tax, which applies rates ranging from 0.16 percent to 0.65 percent for firms with more than $1 million in gross receipts. On top of that, cannabis is also subject to a statewide 15 percent excise tax on the average market price of cannabis.

Of note is the tax’s proposed rates, which vary between 1 percent and 5 percent depending on the kind of business activity and a firm’s level of gross receipts:

Cannabis Business Tax Rates (Proposition D)

*The first $500,000 of a cannabis firm’s gross receipts is exempt from the Cannabis Business Tax.

Sub-Sector Gross Receipts* Tax Rate under Proposition D

Retail Sale of Cannabis & Cannabis Products

$500,001 to $1,000,000

 

$1,000,000 and greater

 

2.5%

 

5%

All Cannabis Business Activities Other than Retail Sale of Cannabis & Cannabis Products

 

$500,0001 to $1,000,000

 

$1,000,000 and greater

1%

 

1.5%

Localities in California often apply high rates. For example, the city of Alturas, in the northeast corner of the state, levies a 10 percent gross receipts tax on cannabis, and there is a 15 percent maximum rate on gross receipts in Campbell, a municipality just outside of San Francisco. 

The gross receipts tax will apply to every transaction in the cannabis production process. A cannabis grower will collect the tax on their gross receipts when they sell to a cannabis processor. The processor will then collect a tax on their transaction with a cannabis retailer. The tax is levied on the value of the inputs–the previously taxed cannabis purchased from the grower–in addition to the value added by the processor. This phenomenon is known as tax pyramiding, which is distortionary and inefficient.

A gross receipts tax applied to the cannabis industry alone will have only minor effects on the broader economy and may be viewed by some as a form of excise tax on cannabis consumption. However, the effects of the tax on cannabis firms are anything but minor.

Dispensaries with lower profit margins will bear a heavier burden of the tax due to how it pyramids. The effective tax rate is higher than the statutory rates of 1 percent to 5 percent, as the tax pyramiding compounds the amount of tax paid over the production sequence.

For vertically-integrated businesses engaging in retail sale of cannabis and other aspects of cannabis production, the $500,000 exemption will apply first to gross receipts attributed to the non-retail activity. Firms may prefer to exempt their gross receipts from retail sales first, as those are subject to a higher tax rate. Instead, vertically-integrated firms with more than $500,000 in gross receipts from non-retail business will have to pay the higher rate on their retail activities.

As my colleague Amir El-Sibaie points out, gross receipts taxes tend to encourage vertical integration to avoid the tax, even if the integrations are not economically efficient in the tax’s absence. Evidence from Washington State’s gross receipts tax on marijuana suggests that up to 44 percent of the tax burden will fall on consumers, raising the cost of cannabis. The increased costs will not necessarily be evident to consumers, as part of the tax is hidden in the final purchase price. The State of Washington has since repealed its gross receipts tax on cannabis, switching to a more transparent and less distortive excise tax on final consumption instead.

While it is still not clear what the ideal tax rate should be on cannabis, San Francisco should consider a better tax structure than the anachronistic and economically costly gross receipts tax.


Source: Tax Policy – San Francisco Joins California Cities Levying a Gross Receipts Tax on Cannabis