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Read My Lips

July 11, 2019

Greetings,

 

Benjamin Franklin once famously quipped “In this world, nothing can be said to be certain, except death and taxes.” While we’ve been busy eating kale and doing Pilates to deal with the former, we are still stuck with the latter. And, in the world of cannabis, taxation goes to unprecedented levels, as state and local governments look to cash in on this new industry. Let us take a closer look to see how they are doing…

 

In California, the state charges an “excise tax” of 15% on cannabis sales to consumers, plus a “cultivation tax” of $148/lb on production (estimated to be 2% of retail or 6% of wholesale prices). Furthermore, local municipalities jumped on the gravy train, passing a separate “gross receipts tax”, ranging from 1-5% of consumer sales. Of course, these are additive to standard state/city sales taxes of ~8%. According to Fitch Ratings, this combination of taxes could result in 35-45% effective tax burden for California cannabis companies. Ouch! And of course, this excludes the costs of licenses, permits, and other regulatory compliance burdens.

 

OK, but hold on – this is not the government’s first rodeo with excise taxes. How are other industries faring? First, we’ll consider a mature industry, such as beer, wine and spirits. According to public financial data, the excise tax to sales ratio is ~6-8% for the most recent fiscal year. Next, let’s turn to a declining industry, such as tobacco. Here we see excise tax rates of ~20%, as the government works to disincentivize consumption over the long-term.

 

So why tax a fledging, growth industry like cannabis at such high rates? To us, this policy seems counterintuitive, as it chokes the industry’s growth and ends up depriving the government of much needed tax revenue. The high prices mean consumers will be less likely to buy, especially if there’s a widely-available and weakly-policed black market (like in California). Furthermore, the high taxes place significant working capital burdens on producers and retailers in an environment when capital is scarce. Simply put, this is not a recipe for success.

 

But don’t take our word for it…let’s check the tape. In 2018 (the first year of recreational legalization for California), the state took in $345 million in tax revenue from cannabis, $103M in the fourth quarter alone. This fourth quarter result breaks out into $51M of excise tax, $16M of cultivation tax, and $36M of sales tax (the gross receipts tax is at a municipal, not state level). These figures are about one-third of estimated levels and relatively weak compared to other states, especially Nevada.

 

Based on the above, we are strong advocates for government measures like CA Assembly Bill 826 (Temporary Cannabis Tax Reduction Bill), which proposes to cut the excise tax to 11% and postpone the cultivation tax for 2 years. Such measures will go a long way to boosting the industry during this critical phase in its development as well as provide a more sustainable engine for tax revenue creation. Broadly speaking, this is what Presidio View is all about – deploying capital in a disciplined, informed way to build a sustaining, responsible, and healthy cannabis industry and thus ending the long-running, unregulated illicit market.

 

While taxes may be a certainty, there is no reason to add craziness to the mix. To paraphrase another former well-known, statesman, “Read our lips: Fix these taxes!”  

 

Thanks for tuning in, and we look forward to providing you with more industry and business updates in the coming months. Until next time!

 

Cheers,

Mike and Kip

Co-Managers, Presidio View Capital

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