At the September 12, 2017 Board meeting, the Board appointed an ad hoc subcommittee of Supervisors Provenza and Villegas to provide policy feedback to staff on the promulgation of a cannabis tax ballot measure. Staff and the subcommittee have met regularly to discuss cannabis tax policy matters. Additionally, HDL was retained to conduct a fiscal analysis of various taxation mechanisms and rates, which analysis is attached as Attachment A.
In developing a tax measure, there are several key questions which the Board must address: (a) whether the tax will be a general or special tax, (b) the area of taxation, (c) the mechanism of taxation, and (d) the rate of taxation.
General or Special Tax
A general tax is one in which the tax proceeds go into the County’s general fund and are available for general governmental purposes. The Board of Supervisors may levy a tax for general purposes, provided the ordinance proposing the tax is approved by a two-thirds vote of all members of the Board (4/5 vote) and the tax approved by majority vote of voters.
In contrast, any tax levied to fund a specific governmental project or program, or any tax in which the proceeds are not placed in the general fund, and are not made available for general government purposes, is a special tax. With limited exceptions not relevant here, a special tax of this nature requires a majority vote of the Board to place it on the ballot and approval by a two-thirds vote of voters.
Staff and subcommittee recommend a general tax. Should the Board wish to provide voters guidance as to how the tax revenues would be appropriated, the Board can always include an advisory measure.
Area of Taxation
A cannabis tax measure could levy the tax on a countywide or unincorporated area basis. Given the cities within Yolo County are all pursuing their own cannabis regulatory structures and out of deference to local control, staff and subcommittee recommend that a cannabis tax only apply to commercial activity in the unincorporated area. It is important to note that even though it is recommended the measure only apply to the unincorporated area, the vote on the tax measure would be countywide.
Mechanism of Taxation
There are three identified mechanisms for the taxation of cannabis cultivation each of which is discussed in some detail in the HDL analysis. A brief summary of the comparative advantages and disadvantages of each is as follows:
Square Footage of Canopy: A tax on the square footage of permitted canopy. This method is the most predictable for tax revenue forecasting, as the tax is levied irrespective of production or revenue. It is generally simple to calculate and administer. Given that the tax does not differentiate between quality/cost of product, the effective rate of taxation can vary as lower cost product is taxed at a higher rate than that of a higher cost product. Consequently, this effect could be used to move County cultivation up market, as there is an inverse correlation between cost of product and effective rate of taxation (the higher the product cost, the lower the effective rate of taxation). Conversely, square footage-based taxes can be viewed as regressive for growers. Additionally, it is important to note, that while square footage-based taxes can be multiplied to attempt to capture multiple grow cycles, there is the potential for sophisticated cultivators to produce grow cycles in excess of the multiplier (i.e. indoor cultivators are typically charged three times the per square foot rate of outdoor cultivators; however indoor cultivators may be able to produce more than three cycles. Similarly, some outdoor cultivators can produce more than one harvest a year as well).
Gross Receipts: A tax on the gross revenue of a cultivator. It is subject to variability. Tax revenues are based on production which can fluctuate or be seasonal (i.e. outdoor growers only harvest once per year). It is harder to collect, especially if there are segmented rates for different product. It is typically applied to commercial activities other than cultivation. Generally considered progressive to growers who pay tax only on what they sell. It is important to note that this is a tax on revenue, not profit.
Weight: A tax on the total weight of cannabis produced. It is subject to variability. Tax revenues are based on production which can fluctuate or be seasonal (i.e. outdoor growers only harvest once per year). It is generally easier to calculate and administer provided the tax is a fixed rate (other than a potential differentiation between flower and trim/leaf). However, similar to square footage-based taxes, a fixed rate inherently does not differentiate between quality/cost of product, so the effective rate of taxation can vary as lower cost product is taxed at a higher rate than that of a higher cost product. Again similar to square footage-based taxes, this effect could be used to move County cultivation up market, as there is an inverse correlation between cost of product and effective rate of taxation (the higher the product cost, the lower the effective rate of taxation). This dynamic aside, weight-based taxes are generally progressive to growers as they pay tax only on what they produce. The County already collects weight data through its track and trace program, making it feasible to bring a weight based tax online with existing resources.
Recommendation: Staff and the subcommittee recommend a weight-based cultivation tax as it is progressive, transparent, captures the totality of production, and can be coupled with the County’s existing track and trace system. Staff and the subcommittee also recommend a gross receipts tax on all other commercial cannabis activity.
Rate of Taxation
A critical element of promulgating a potential cannabis tax measure is setting an appropriate tax rate that both generates sufficient revenue to the County and allows for a sustainable cultivation market. To that end, staff generated the chart included in Attachment B, that compares the tax rates set by other counties according to the relative percentage of value of the tax. This allows for comparison across all mechanism type (assuming a current wholesale price of $1000/lb and three harvest cycles per year of indoor/mixed light cultivation). Current cannabis taxes as represented as a percentage of value range from 1-15% in counties with a cluster around the 3-10% of value range. Many of these taxes have minimums and maximums and allow the Board of Supervisors to set the tax within that range as well as different tax rates and mechanisms for different commercial activities. It is important to note that not all counties that have a tax in place currently allow for commercial cannabis activities.
Given the distribution of tax rates, as shown in the attached chart (Att. B), staff and subcommittee recommend that the Board consider a tax rate as a percentage of value with a minimum of 5% up to a maximum of 10% with annual CPI adjustments, with the Board having the discretion to set within that range. Staff and subcommittee agree that flexibility is important as market conditions may change drastically as state taxes go into effect, vertical integration is permitted, etc.
The HDL analysis also cautions that California currently produces over five times of what it consumes domestically:
A Standardized Regulatory Impact Assessment (SRIA) prepared for CDFA estimates statewide cannabis production at 13.5 million pounds, though its estimate of the amount of cannabis consumed by California residents is just 2.5 million pounds, suggesting a significant amount of overproduction that is presumably exported to other states through the black market. A separate study performed for the California Cannabis Industry Association put statewide consumption even lower, at 1.6 million pounds.
Additionally, the HDL report notes that the legalization of recreational cannabis is only anticipated to result in a 9.4% increase in consumer demand, putting further downward pressure on legal production.
Furthermore, given that cultivation is the first step of production, and that there is the potential for an overabundance of cultivation capacity in California, if quality is assumed equal, the tax rate is likely to be a significant factor in price differential. As such, to ensure market stability and by proxy tax revenue and tax funded service stability, it is important that the tax be competitive with other jurisdictions.
A 5-10% of value tax would correspond to the following tax rates (assuming $1000/lb wholesale price and 3 harvest cycles for greenhouse/indoor):
| Tax Mechanism |
Percent of Value |
Tax Rate |
| SQFT (Proposed Min 1lb/20 SQFT) |
5% |
$2.50/SQFT Outdoor
$7.50/SQFT Indoor |
| SQFT (Proposed Max 1lb/20 SQFT) |
10% |
$5/SQFT Outdoor
$15/SQFT Indoor |
| SQFT (Proposed Min 1lb/10 SQFT) |
5% |
$5/SQFT Outdoor
$15/SQFT Indoor |
| SQFT (Proposed Max 1lb/10 SQFT) |
10% |
$10/SQFT Outdoor
$30/SQFT Indoor |
| Gross Receipts (Proposed Min) |
5% |
5% Gross Receipts |
| Gross Receipts (Proposed Max) |
10% |
10% Gross Receipts |
| Weight (Proposed Min) |
5% |
$3.25/oz flower |
| Weight (Proposed Max) |
10% |
$6.50/oz flower |
Current yields in Yolo County are lower than the industry expected yield of 1lb/10 square feet of canopy and currently appear to be closer to 1lb/20 square feet of canopy. This deviation from the expected yield can potentially be attributed to unanticipated contamination and pests, boron in the water, and cultivator ability. Given that this is the first year of production and that many cultivators are still in the process of developing their cultivation area, etc. future production could trend closer to the expected yield. As such the chart also includes to what rate a 5-10% of value square foot-based tax would correspond (gross receipt and weight based rates would not change, as those methods account for productivity) at 1lb/20 square feet of canopy.
The chart below shows the estimated tax revenue for the corresponding percentage of value at both the current productivity of 1lb/20 square feet of canopy and the expected standard of 1lb/10 square feet of canopy. The number of cultivation sites are based upon current number (68), active applications (75), and total potential applications (100). The breakdown between outdoor and greenhouse or indoor is based upon the current breakdown (80% outdoor and 20% indoor), as well as an estimated prospective breakdown (30% outdoor and 70% indoor) which favors a trend toward greenhouses as the industry matures. Additionally, Board policy discussion on the matter has signaled an increased interest in the industry transitioning to greenhouses rather than outdoor cultivation which also informed the prospective breakdown.
It is important to reiterate that legal cannabis cultivation is a new market and as such it is impossible to have complete confidence in any of the assumptions or estimates. These revenue estimates are best used an illustrative guide to relative tax revenues, rather than a discrete revenue estimate.
Estimated Revenue @ 1lb/20 SQFT |
|
|
|
| Number of Cultivation Sites |
Tax as Percentage of Value |
Estimated Revenue |
Estimated Revenue w/ Attrition |
| 68 (80% outdoor, 20% indoor) |
5% |
$7m |
$5m |
| 68 (80% outdoor, 20% indoor) |
10% |
$15m |
$7.5m |
| 75 (30% outdoor, 70% indoor) |
5% |
$10m |
$7.5m |
| 75 (30% outdoor, 70% indoor) |
10% |
$19m |
$10m |
| 100 (30% outdoor, 70% indoor) |
5% |
$13m |
$10m |
| 100 (30% outdoor, 70% indoor) |
10% |
$26m |
$13m |
| Estimated Revenue @ 1lb/10 SQFT |
|
|
|
| Number of Cultivation Sites |
Tax as Percentage of Value |
Estimated Revenue |
Estimated Revenue w/ Attrition |
| 75 (30% outdoor, 70% indoor) |
5% |
$22m |
$16.5m |
| 75 (30% outdoor, 70% indoor) |
10% |
$44m |
$22m |
| 100 (30% outdoor, 70% indoor) |
5% |
$29m |
$22m |
| 100 (30% outdoor, 70% indoor) |
10% |
$59m |
$30m |
An estimate that includes an attrition factor of 5% revenue decline per 1% of taxation is also included in the above charts to provide the Board a sense of potential revenue decline as cultivators leave the local market for lower tax markets. Staff conferred with HDL on the use of an attrition factor; however, there is no current model that includes an attrition factor as there is insufficient data to accurately model or validate the assumption. However, HDL uses the previously mentioned attrition factor of 5% revenue decline per 1% of taxation as a stand-in. Again, while it is impossible to validate the attrition factor, staff felt it prudent to include an attrition calculation for the Board to consider in its deliberations.
Potential revenue estimates range from a low of $5m to $59m depending on rate of taxation, productivity, indoor or outdoor cultivation, and the use of the previously discussed attrition factor. However, it is important to keep in mind that even if productivity improves, there may not be a sufficient market to accommodate the new production. For example, the estimated production of 75 cultivators at 1lb/10 square feet of canopy would be 445k pounds, almost 20% of the state’s estimated consumption 2.5m pounds.
Staff reached out to County departments and other public service agencies to discuss their prospective needs related to mitigating cannabis impacts across a broad spectrum of programs including law and justice, health and human services, and K-12 education. Pursuant to the guiding principles on cannabis that the Board adopted at the October 11 Board meeting “requiring impacts of cannabis shall be fully compensated by the cannabis industry,” staff has concerns that the most conservative revenue estimates ($5m) may not provide sufficient revenue to address these impacts. In order to address these impacts and provide a net public benefit staff estimates that tax revenues would need to track closer to $10m, which appears feasible with a tax of 5% of value should net production increase. However, it is important to note that cannabis related impacts will still occur irrespective of a tax measure or the closure of County’s cultivation program. Given the potential for significant revenue variation given numerous external factors, the Board may want to consider an endowment strategy concept similar to the current Pomona fund. The potential for revenue fluctuation or decline could be mitigated by building an endowment which produces a consistent revenue stream thus providing service stability.
While the County currently does not permit commercial activities other than cultivation (other than drying and trimming facilities and nurseries, which may be permitted through a pilot program), staff and the subcommittee recommend the Board consider a gross receipts tax rate with a minimum of 5% up to a maximum of 10%, with the Board having the discretion to set within that range for all commercial activities. This language would be included to ensure that if the Board or a future Board permits additional commercial activities in the future, there would be a mechanism in place to collect revenue. The prospective inclusion of this mechanism is especially important as the future vertical integration of the market could alter economies of scale and effect the viability of single activity operations. HDL was unable to conduct a fiscal analysis of what tax revenue other commercial activities could generate as there are no established parameters for those activities, or the activities that may be allowed via the RFP process.
Also attached is a proposal staff received from representatives of the Yolo County Cannabis Coalition (Att. C). The document proposes a square footage of canopy based tax ranging from $1-3 per square foot, depending on cultivation type or a gross receipts tax of an initial rate of $2.5% with the potential to increase to 4% with an estimated tax revenue of approximately $4m annually.
Additionally, any tax measure would not preclude the use of development agreements as a means of generating revenue to mitigate impacts and provide net public benefit. Development agreements could be structured to overlay or be complementary to a tax measure and the two mechanisms need not be mutually exclusive. The subcommittee also discussed an interest in including cultivation activities in the pilot program RFP process to fast track the review and consideration of more complex cultivation operations through the use of development agreements. The Board may want to discuss and consider whether asking staff to bring back analysis for this option as part of the upcoming RFP discussion.
Staff plans on returning to the Board on December 12, 2017 pending Board direction to provide the Board another opportunity for feedback and guidance prior to a returning to the Board on January 9 for a first reading of the tax measure ordinance. A second reading of the ordinance would then occur on January 23, 2018. A 4/5 vote is required to place the ordinance on the ballot, assuming a general tax is proposed. The deadline to have the measure approved by the Board and a copy given to the Elections office is February 6, 2018. |