Editor's note: This is the second column in the series, "Taxing THC, Leveling the Playing Field." Read Part I of the Growing Pains series on cannabis taxation in the June 2023 issue of Cannabis Business Times.
In Part I of this series, published in the June 2023 issue of Cannabis Business Times, we explored the extensive confusion surrounding exorbitant state, county and city cannabis taxation. What changes must be made to salvage a positive outcome from this increasingly frustrating confusion?
There are several possible solutions for federal cannabis taxation that could fit existing taxation models, lower the total tax burden on the cannabis industry, promote product diversity, support the nascent cannabis market and set the stage for a long, sensible and profitable relationship between cannabis operations, commerce and government. Federal cannabis taxation strategies can only be successfully implemented if state and local jurisdictions consider how to best support the future of the American cannabis industry by tempering their focus on tax profits.
The Path From Plant to Product
Each link along the supply chain from grower to retailer invites an opportunity to levy taxes whenever a product changes hands. Without end-to-end vertical integration in the supply chain, these taxes can quickly add up.
Sales taxes on most non-cannabis products are passed down the supply chain from the manufacturer, through wholesale distributors, and on to retailers to collect from customers. However, cannabis taxes are typically non-transferable, so each business along the way pays taxes on its sales. Each business must recoup its tax expense overhead by charging the next level in the supply chain for its production expenses plus profit plus taxes.
Let’s look at sinsemilla flower production as an example. Three likely tax possibilities might target:
- the vertically-integrated grower who cultivates, processes and packages the cannabis in-house,
- the second-party distributor that places products in stores and
- the dispensary that makes the final retail sale. When an independent cannabis nursery sells plantlets to a grower, that adds a fourth possibility for taxation. A transportation company may add a fifth tax. And cannabis products must be checked for regulatory compliance by testing laboratories that may also incur yet another cannabis tax.
Processed products follow a similar path from wholesale flower sales, through making concentrates and infusing products, followed by wholesale distribution and retail sales involving several commercial transfers between differing companies, each of which may be taxable transactions. Add compliance testing and transport, and seven separate commercial entities may be involved. These taxes are paid by the manufacturers, distributors and transporters, but are passed on to consumers through higher wholesale prices paid by retail outlets.
In general, cannabis excise taxes are much higher than comparable products, as are commercial taxes. These discrepancies play a key role in the economic struggles of legal cannabis markets. High taxation on growers and distributors encourages illicit sales both in and out of state. Licensed growers either sell to legal distributors (some of whom may be selling illegally out of state, according to anecdotal accounts), or they revert to selling directly to the illicit market. It’s increasingly difficult to make a profit by following the rules, and illicit sales often support cannabis production in each state.
Calculating Alcohol Taxes
U.S. alcohol taxes are based on a “proof gallon,” which is a gallon of liquid that is 100 proof or 50% alcohol. This excise tax is adjusted, depending on the percentage of alcohol in the product. For example, distilled spirits are generally taxed at $13.50 per proof gallon, or $2.14 per 750-milliliter, 80-proof bottle, or 0.71 cents per milliliter of ethanol.
A “standard drink” contains 15 milliliters of ethanol, which is approximately the same for a can of beer with an alcohol by volume (ABV) of 5%, a glass of 12% ethanol wine or a shot of 40% ethanol spirits. In that case, we can figure that 15 milliliters of alcohol would be taxed approximately 71 cents per milliliter, for a tax rate of 11 cents per standard drink.
However, the difference is that most health authorities recommend that drinkers limit their alcohol intake to one “standard drink” per day for women or two per day for men—whereas cannabis consumers regularly inhale, eat or apply much more than one or two “standard doses” each day.
THC Taxation Today
Taxing cannabis based on the amount of active ingredient it contains would be more in line with U.S. federal alcohol taxation. People pay higher taxes per volume unit to drink stronger alcohol—liquor incurs the highest taxes, followed by wine and finally beer.
Illinois was the first state to tax cannabis products based on THC content—levying a 10% retail tax on cannabis products with 35% THC or less, such as sinsemilla, and a 25% tax on cannabis products with more than 35% THC, such as concentrates. Illinois is also the only state with a separate tax rate for edibles and other infused products, set at 20%. However, the fixed tax on flower (which typically falls under 35% THC) does not provide any tax advantage for lower potency cultivars.
Connecticut and New York commenced cannabis taxation in 2022 with more carefully considered systems. Connecticut proposes a variable tax rate as high as 20% on cannabis products—which includes excise taxes of 62.5 cents per milligram of THC in flower, 9 cents per milligram for other smokable cannabis products such as concentrates, or 2.75 cents per milligram for edibles; and a 6.35% retail sales tax and 3% municipal sales tax. Following this system, Connecticut’s THC tax per gram for 20% THC flower will be $1.25 per gram or $35 per ounce, and the retail price of a package of gummies containing 100 milligrams of THC will also include a $2.75 tax surcharge, according to analysis from The Motley Fool.
New York is following a similar path, levying excise taxes on all cannabis products, ranging from 5 cents per milligram of THC in flower to 8 cents per milligram in concentrates and 3 cents per milligram in edibles, plus a 9% retail tax and 4% local tax. Total New York THC tax per gram for 20% THC flower will be $1 per gram or $28 per ounce, and the retail price of a package of gummies containing 100 milligrams of THC will also include a 30-cent tax surcharge, according to The Motley Fool.
In the states where THC content is taxed, the estimated taxes per ounce of 20% THC flower in Illinois and New York ($28) and Connecticut ($35) average about $30 per ounce. This is roughly comparable to the fixed taxes by dried flower weight levied in Maine ($21/ounce) and Alaska ($50/ounce). In 2022, California ended its dried flower tax on cultivators, which had increased to $10.08 per ounce before being eliminated. New Jersey’s is much lower at $1.52 per ounce.
Proposed Taxation of THC Content
We can also make a calculation like the “standard drink” average used for alcohol to deduce a standard dose of smoked cannabis. If we estimate that there are about 20 doses (one dose equaling a strong toke on a joint or bong rip) in a gram of flower, then one dose weighs approximately .05 gram. Returning to our standard of 20% THC content, there are 200 milligrams of THC in a gram of flower, or 10 milligrams in a dose.
Using the range of THC taxation rates proposed by Connecticut and New York, this equates to $1 to $1.25 per gram of 20% THC in flower or between 5 to 62.5 cents per dose, according to analysis from The Motley Fool.
Once again, cannabis tax rates are all over the map!
Comparing EtOH and THC
We can extrapolate examples from the existing federal taxation system for ethyl alcohol (EtOH) to envision a cannabis taxation system based on THC content. Common alcoholic drinks range in EtOH content from 3% to 8% in beers, 10% to 15% in wines, and 35% to 45% in spirits. The THC percentage of sinsemilla flower as stated on labels can range from less than 10% to more than 30%, and the highest purity concentrates can exceed 70%. The potency ranges of cannabis products are analogous to the varying strengths of alcoholic beverages.
Taxation by milligrams of THC is equivalent to taxation by milliliters of ethanol—71 cents per milliliter of ethanol, compared to a range of 5 to 62.5 cents per milligram of THC.
But how would the taxation of THC affect retail prices?
Taxing THC content
High THC content presently drives sales. Unfortunately, chasing potency just to increase sales could result in some growers spiking their flower samples with concentrates to raise the percentage, or seeking biased analyses from laboratories that “test higher” than others, rather than encouraging accurate results that would correctly inform consumers. Solving this situation by taxing THC potency could restore honesty to the system and greatly assist as well as protect consumers.
Echoing ethanol’s villainous role during alcohol prohibition, THC is stealing the show now as post-prohibition cannabis markets open. Were it not for the controversy surrounding this single compound, there would be no need for this article. Since THC is the molecule of contention cast as the culprit of the cannabis market, should governments follow alcohol taxation’s lead and tax the active ingredient, THC?
If THC is taxed, higher THC content on product labels will cost distributors, retailers and consumers more in taxes than lower potency products. THC taxation would reduce the price for products with lower THC content, which should favor smaller growers, who could grow smaller amounts of more diverse varieties allowing more chances for success. It could also improve consumer education and increase marketplace diversity by providing lower potency cultivars with other enhanced properties to compete with more potent cultivars and products.
The cannabis industry is emerging from its prohibition period, and in these nascent times, it would greatly benefit from government tax policies encouraging its growth. Amid growing support for decriminalization, now is the time to establish solid industry standards that will support our society through efficient taxation.
Short-sighted approaches aimed at immediate maximization of tax revenue will continue to strangle the industry. Excessive taxation is the stumbling block to progress and, until removed, there will be little, if any, advancement.
Continued excessive taxation will have the ultimate effect of suppressing small businesses while encouraging larger businesses that can leverage their economies of scale.
Cannabis industry evolution is stalled while governments hesitate on making the decisions that will allot agribusinesses larger slices of the pie. No other industry tolerates such obstructive taxation. For commercial cannabis to flex its muscles, the tax system must be overhauled—and while this will certainly happen, it may not happen until smaller companies have been taxed to death.
Federal tax regulators have established systems for tobacco and alcohol taxation, as well as a wide variety of state cannabis taxation systems available for their scrutiny. Some make more logical sense than others, and tough decisions must be made. Taxing THC follows extant precedents and presents a familiar approach for federal cannabis taxation.
More reasonable and equitable federal taxation of THC following alcohol taxation’s model could accomplish several societal goals including encouraging legal cannabis sales, diminishing illicit sales, lowering the potency range, increasing product diversity, favoring local farmers and ancillary businesses, and creating a long-term profitable tax base.
