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CC - (1) Discussion of Potential Excise Tax on Commercial Cannabis Businesses; (2) Direction to the City Manager Regarding a Commercial Cannabis Excise Tax Ballot Measure; and (3) Direction to the City Manager as Deemed Appropriate.
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Meeting Date: October 9, 2017
Contact Person/Dept: Jesse Mays/City Manager’s Office
Phone Number: (310) 253-6009
Fiscal Impact: Yes [] No [X] General Fund: Yes [] No [X]
Public Hearing: [] Action Item: [x] Attachments: [X]
Commission Action Required: Yes [X] No [] Date:
Public Notification: (E-Mail) Meetings and Agendas - City Council (10/04/17), GovDelivery E-mail Lists: Marijuana, Fiscal and Budget Issues, Chamber of Commerce, Press Organizations (10/3/17)
Department Approval: John Nachbar, City Manager (10/04/17)
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RECOMMENDATION
Staff recommends the City Council (1) discuss a potential excise tax on commercial cannabis businesses in the City; and (2) provide direction to the City Manager regarding an excise tax ballot measure; and (3) provide other direction to the City Manager as deemed appropriate.
BACKGROUND
The City Council’s Strategic Plan, Goal Five (“Identify New Revenue Sources to Maintain Financial Stability”), Objective One (“Potential Retail Marijuana Excise Tax”) states that if the City Council will “consider a cannabis tax for placement on the ballot during the April 2018 municipal election.” In addition, the Plan states that there will be “analysis by and recommendations from the Finance Advisory Committee (FAC) on a marijuana tax by the end of 2017.”
It is anticipated that City cannabis business permit and application fees charged to cannabis businesses should pay for all of the City’s costs for cannabis business regulation enforcement, and cannabis business application review and processing, by setting these fees as levels such that the City recovers 100% of its costs associated with enforcement and permitting activities. These fees would be subject to modification by City Council at any time if the City’s costs increase.
A cannabis business excise tax would be separate from and in addition to any fees charged to businesses. The tax revenue could be used for any General Fund purpose, such as police and fire services, or parks, recreation, and community service programming.
Tax Rates in Nearby Cities
Los Angeles
Los Angeles is currently the only Westside City with a special cannabis business tax. Los Angeles voters approved a special gross receipts tax on cannabis businesses as a part of Measure M, which was approved on March 7, 2017. The measure imposed a tax of 1% on testing and distribution; 2% on manufacturing and cultivation; 5% for medical storefront retail; and 10% for adult use storefront retail.
Santa Monica
Santa Monica does not have nor has it proposed a special cannabis tax. Currently, Santa Monica only plans to allow two medical storefront retail businesses.
West Hollywood
West Hollywood does not have a special cannabis tax, but it is studying the issue. It would not bring the issue to voters before its March 2019 election. It plans to contract with a public opinion/polling firm in 2018 to survey residents about the likelihood of them voting for a cannabis tax.
Beverly Hills
Beverly Hills does not have a special cannabis tax and has no plans to implement one. It is only allowing medical cannabis deliveries (cannabis deliverers based in other cities can deliver to Beverly Hills, but Beverly Hills will not allow any of the delivery businesses in the city itself.)
Tax Rates in Other California Cities
Cities throughout California tax cannabis businesses differently. The variety of rates and rate structures are shown in Attachment 1, Figure 1: “Cannabis Tax Rates in Select California Cities”.
State Taxes
The sum of taxes on cannabis, as well as other regulatory costs, should be taken into account when deciding on a local cannabis tax rate. The State imposes two cannabis specific taxes: an excise tax on retail sales and an excise tax on cultivation.
Adult-use retail cannabis sales will be also be subject to state and local sales and use tax and a state cannabis excise tax of 15%. The Culver City local sales tax is 9.75%. This will bring the total tax rate for retail sales in Culver City to approximately 25%, before any local tax has been added.
Medicinal retail cannabis sales to customers with a valid Medical Marijuana Identification Card are exempt from state and local sales tax (per California Health & Safety Code Section 11362.71). However, most medicinal cannabis users are not currently enrolled in the State ID program and instead use a physician recommendation. Medicinal purchases with a physician recommendation and not an ID card are subject to state and local sales tax. All medicinal cannabis retail sales would be subject to the 15% state excise tax.
Cannabis cultivation is subject to a state tax of $9.25 per dry weight ounce of cannabis flower, and $2.75 per dry weight ounce for cannabis leaves.
The State and the City would also both impose permit fees on cannabis businesses.
As an example, the total impact of state and local taxes on a hypothetical $100 retail sale is shown in Attachment 2. This example assumes that the retailers would pass along 100% of the cost of the excise tax to the end customer, even though the City only taxes the business on its gross revenues and not the end customer directly. In Culver City, the total bill for a $100 in adult-use product would come to $131, including $6 in Culver City excise tax. In Los Angeles, that same sale would come with a bill of $134, including $10 in excise tax. For a $100 medicinal sale in Culver City, the total bill including all taxes would come to $120, including $5 in excise tax. In Los Angeles, the $100 medicinal sale would come to the same $120, including $5 in excise tax.
Finance Advisory Committee
At the September 13, 2017 meeting of the Finance Advisory Committee, staff presented a draft commercial cannabis tax ordinance, including proposed tax rates for various categories of businesses, as proposed by the City’s cannabis consultant, Hinderliter, de Llamas & Associates (HdL). HdL’s proposal included the following recommendations:
• A special tax on cannabis businesses, with the tax rate varying by business type.
• Retail, manufacturing, and distribution businesses taxed initially at 4% of gross receipts, with the ability for City Council to modify the rate to between 4-6%.
• Testing businesses taxed at 1% of gross receipts, with the ability for City Council to modify the rate to between 1-1.5%.
• Initial tax rates for retail, manufacturing, distribution, and testing are to be set for 3 years, after which those rates can be adjusted by resolution of the City Council within the specified range.
• Cultivation businesses taxed at $10 per square foot of canopy grown, which based on the price of cannabis is approximately equal to 2.5% of gross receipts. The cultivation tax would also be adjusted annually for inflation, beginning at year three.
• Taxes would be required to be remitted quarterly.
The FAC recommended one change from the consultant’s initial recommendation: that the initial tax rate period be set for two years, instead of three, so that tax rates could be adjusted by City Council and by CPI after only two years if desired. Staff supports this recommended change. FAC supported a general strategy of the City starting with lower tax rates for a set period of time in order to attract businesses and provided certainty to business owners.
City Council Subcommittee
Subsequent to the meeting of the FAC, the City Council Subcommittee met to review and discuss the proposed tax rates. The Subcommittee agreed with the FAC recommendation on the initial tax rates for manufacturing, distribution, and testing. For retail sales, the Subcommittee noted the higher retail tax rates imposed in Los Angeles, and recommended increasing this tax rate. For cultivation, the Subcommittee noted the higher cultivation tax rate imposed by cities such as Long Beach, and recommended increasing this tax rate. Based on these two factors, the Subcommittee recommends the following rates:
• Retail (medicinal): range of 5 -8% with an initial rate of 5%
• Retail (adult-use): range of 6-10% with an initial rate of 6%
• Manufacturing: range of 4-6% with an initial rate of 4%
• Distribution: range of 4-6% with an initial rate of 4%
• Testing: 1-1.5% with an initial rate of 1%
• Cultivation: $12 per square foot of canopy (roughly equivalent to 3% of gross receipts).
See Attachment 1, Figure 2 “Subcommittee Proposed Tax Rates: Initial Rate and Suggested Voter Approved Range of Rates” for a table of the proposed rates, with Los Angeles rates shown for comparison.
As proposed, Culver City’s initial rates would be lower for adult use retail; would match Los Angeles’ rates for medicinal retail and testing; and would be higher than Los Angeles’ rates for manufacturing, distribution, and cultivation.
DISCUSSION
Staff recommends setting tax rates low enough to be competitive with surrounding cities, but high enough to not leave dollars “on the table”. It is possible that Culver City can achieve slightly higher tax rates than Los Angeles due to the numerous competitive advantages offered by the City. In addition, City Council’s direction thus far is to offer a relatively few number of permits compared to Los Angeles, so the businesses that end up siting in Culver City may be here for specific reasons and may be “price-elastic” to slightly higher tax rates. However, until tested in the market, there is no way to know for sure what the ideal tax rate is that will be attractive to business without setting the City’s tax rate unnecessarily low. Businesses make their siting decisions based on a variety of factors, of which tax rates are only one factor.
An additional reason to avoid tax rates that are too high is to reduce the factors leading to the expansion of the cannabis black market. Higher tax rates tend to increase the share of the cannabis market that is pushed underground.
For these reasons, staff recommends that City Council ask voters to approve a range of tax rates, with and initial tax rate that may be changed by City Council after a set period of time.
Revenue Projections
Attachment 3, “Tax Scenario Analysis,” shows estimates of the City’s cannabis gross receipts tax revenue for three different possible scenarios and three different tax schemes. The gross revenue estimates are based on a hypothetical stabilized, California state market (2-3 years from January 1, 2018), when cannabis is estimated to be trading at $800 per pound. This is a conservative estimate, assuming price will drop from current price of around $1,600 per pound.
Conservatively estimated annual gross receipts are shown for each types of business: delivery ($546,624), manufacturing ($2,500,000), retail ($3,200,000), distribution ($2,000,000), and testing ($1,500,000). As is common in the State, the tax on cultivation is by square foot of cannabis canopy grown, not by gross receipts.
The analysis assumes that the market demand is enough to allow for three storefront retailers without a drop in gross receipts for any retailer. As a point of comparison, according to the website Weedmaps.com, there are currently 10 cannabis retailers operating in close proximity to Culver City.
The analysis assumes that storefront retail businesses that also have delivery permits will experience no drop in overall revenue, because the cannibalization of storefront sales by delivery sales will be made up for by sales to new customers who live outside the area. The analysis also assumes each cultivation permittee has a canopy size of 5,000 square feet.
The analysis shows how revenues change under three hypothetical scenarios.
• Scenario 1: A minimal number of permits are issued (11 total). Only one cultivation permit is issued. One retailer is adult-use, and two are medicinal.
• Scenario 2: A moderate number of permits are issued (19 total). Two cultivation permits are issued. Two retailers are adult-use, and one is medicinal.
• Scenario 3: The maximum number of permits are issued (27 total). Three cultivation permits are issued. All three retailers are adult-use.
The analysis also shows the effect of various tax rates imposed on each type of business: for adult-use retail between 6% and 10%; for medicinal retail between 5% and 8%; for delivery between 5% and 10%; for manufacturing between 2% and 6%; for distribution between 1% and 6%; for testing between 1% and 1.5%; and for cultivation between $8 and $12 per square foot of canopy. Testing labs do not have the same profitability as other types of businesses, so it is proposed to tax them at a lesser rate.
Each of the three scenarios can be combined with each of the different tax rates to generate an estimated total tax amount for various hypothetical situations.
In Attachment 3, the analysis summarizes Culver City’s estimated total annual tax receipts for each of the three scenarios, under three different tax schemes:
• Tax rates that match those in Los Angeles (“Match L.A.”)
• Tax rates proposed by the Subcommittee (“Proposed Culver City”)
• Maximum tax rates in the range of rates proposed by the Subcommittee (“Aggressive”).
Culver City’s tax receipt totals are shown, and the range of estimated annual tax receipts is from $904,661 (assuming a minimal number of businesses and matching L.A.’s tax rates) to $3,123,312 (assuming the maximum number of businesses and aggressive tax rates).
The estimated total annual tax revenue using the Subcommittee proposed rates and assuming the middle number of permits are issued (Scenario 2) is $1,527,392.
Schedule
If directed by City Council, staff would return with a proposed resolution to place a commercial cannabis excise tax measure on the ballot of the General Municipal Election on April 10, 2018. The last day to call an election for ballot measures is January 10, 2018. However, staff would aim to present the resolution for City Council’s consideration at the November 13, 2018 City Council meeting, which is the last date recommended by the City’s election consultant, Martin & Chapman. At the same meeting, a resolution providing for the preparation of the arguments in support of/in opposition to the proposed tax measure would also be considered.
If approved by voters, the tax would go into effect immediately upon certification of the election results by City Council, which could happen as soon as the first City Council meeting after the election. A general tax requires a simple majority vote of 50% + 1.
FISCAL ANALYSIS
There is no fiscal impact associated with this discussion item.
ATTACHMENTS
1. 2017-10-09 ATT Cannabis Tax Rates
2. 2017-10-09 ATT Total Tax Examples
3. 2017-10-09 ATT Tax Scenario Revenue Analysis
MOTION
That the City Council:
1. Discuss a potential excise tax on commercial cannabis businesses; and
2. Provide direction to the City Manager regarding a potential commercial cannabis business excise tax ballot measure, including direction as to the election date at which City Council would like to see it on the ballot (i.e. April 10, 2018 general municipal election); and
3. Provide other direction to the City Manager, as deemed appropriate.