Despite being among the largest and most mature legal marijuana markets in the country, the cannabis industry in California is struggling. Regulatory hurdles, high taxes, and a still-thriving illicit market have left legal cannabis companies in California fighting to stay afloat.
The recent news that the Drug Enforcement Administration plans to reclassify cannabis into a less restrictive category under federal law could provide some much-needed financial relief to licensed California cannabis businesses. However, more action is needed from state and local lawmakers if the industry is to serve Californians better and reach its full potential.
If cannabis is rescheduled under the federal Controlled Substances Act, legal marijuana businesses in California will see a reduction of federal tax burdens and improved access to investments. Currently, cannabis is federally prohibited as a Schedule I drug, the most restrictive category, locking state-licensed cannabis businesses out of many traditional banking services and limiting investor interest. Moving marijuana to the less-restrictive Schedule III could grant cannabis businesses greater access to financial services.
Perhaps more importantly, the move would finally allow state-sanctioned cannabis businesses to deduct ordinary business expenses–such as payroll and rent–from their federal corporate income taxes. Such deductions are afforded to other legal businesses but barred for those trafficking in federally controlled drugs categorized as Schedule I or Schedule II substances. As a result, state-licensed cannabis companies have been paying an effective tax rate upwards of 70%.
While California’s marijuana businesses may gain critical relief from lower federal tax burdens, rescheduling cannabis won’t address the myriad other taxes, fees, and compliance costs imposed by state law. California’s cannabis dispensaries must also pay a statewide marijuana retail tax of 15%, a general sales tax of 7.25%, and local taxes in most jurisdictions.
A Reason Foundation analysis compared local tax assessments across California counties and showed the cumulative local taxes per pound of marijuana range from $51 in Santa Cruz County to $814 in Solano County. Cannabis companies also pay licensing and application fees. State and local laws also impose elaborate rules on cultivation, retailing, transportation, manufacture, testing, facilities, security, environmental compliance, and other aspects of cannabis operations, all of which add to high start-up and operation costs that make it harder for new businesses to enter the market and nearly impossible to earn a profit.
Those tax and compliance costs get passed onto consumers. According to some estimates, taxes alone account for upwards of upwards of 40% of the final price of legal marijuana in California. Legal producers compete directly with illicit ones that have established market share over decades. Illicit cannabis operations are not subject to the taxes and compliance costs faced by their licensed counterparts and often offer lower prices to consumers. As a result, years after legalization, illegal sales continue to account for around two-thirds of marijuana sales in California.
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Fortunately, Gov. Gavin Newsom and the legislature began addressing these problems with significant reforms in 2022. The state followed the Reason Foundation’s recommendations by eliminating the wholesale cultivation tax and restructuring the state’s retail excise tax. However, reducing the statewide excise tax and local taxes is necessary for cannabis legalization to succeed.
Lawmakers should also refrain from creating costly new regulatory hurdles they’ve recently considered, such as prohibiting modular buildings on the premises of marijuana businesses or creating an ever-expanding list of banned words that cannot be used in cannabis product branding.
The DEA’s rescheduling of marijuana would be a welcome step in helping the state’s legal cannabis market compete and succeed. Still, California lawmakers need to do their part by reducing taxes and unnecessary regulations on legal cannabis products.
Michelle Minton is a senior policy fellow at Reason Foundation, and Geoffrey Lawrence is the research director at Reason Foundation.