The 2020-21 Budget: The Governor’s Cannabis‑Related Proposals

The 2020‑21 Budget: The Governor’s Cannabis-Related Proposals GABRIEL PETEK LEGISLATIVE ANALYST FEBRUARY 14, 2020 analysis full gutter 2020-21 BUDGET LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET Executive Summary Proposition 64 Legalized Adult-Use Cannabis. In November 2016, California voters approved Proposition 64. Under Proposition 64, adults 21 years of age or older can legally grow, possess, and use cannabis for nonmedical purposes, with certain restrictions. Under the measure, various state agencies are responsible for regulating cannabis. For example, the Bureau of Cannabis Control (BCC), California Department of Food and Agriculture (CDFA), and Department of Public Health (DPH) have responsibility for licensing different types of cannabis businesses. Proposition 64 Imposes Two State Excise Taxes on Cannabis. Proposition 64 established two state excise taxes on cannabis, which are administered by the California Department of Tax and Fee Administration (CDTFA). The first is a 15 percent excise tax on retail gross receipts (known as the retail excise tax). The second is a cultivation tax on the weight of harvested plants. Currently, final distributors must remit these taxes to CDTFA, despite cultivators and retailers being legally responsible for initial payment of the taxes. These taxes are deposited into the Cannabis Tax Fund, which is continuously appropriated for various types of activities. Governor’s Budget Proposal Proposes Change to Point of Collection of Cannabis Taxes, and Interest in Additional Changes. The Governor proposes moving the responsibility for remitting (1) the cultivation tax to the first distributor and (2) the retail excise tax to the retailer. The Governor also expressed interest in other changes to cannabis taxes, but has not provided any additional details on these potential changes. Proposes Consolidation of Licensing Functions Into New Department. The Governor proposes consolidating the cannabis‑related licensing functions in BCC, CDFA, and DPH into a new Department of Cannabis Control. The administration has not provided any details on the proposal but indicates that further information will be available in the spring. Proposes Various Cannabis-Related Expenditures. The Governor’s budget proposes $70.2 million to support 291 positions across eight departments. Funding for these proposals would come from a variety of sources, such as the Cannabis Tax Fund and various fees. The administration has also provided its plan for expending the Cannabis Tax Fund revenues in 2020‑21 directed by Proposition 64 to certain types of activities. Issues for Legislative Consideration Proposed Changes to Point of Collection Would Improve Tax Administration, but Other Tax Changes Also Merited. We find that changing the point of collection for the retail excise and cultivation tax should improve tax administration and compliance by creating a closer nexus between the taxed activity and the responsibility for remitting taxes. We also find that additional changes to the structure and rates for cannabis taxes are warranted, consistent with our December 2019 report, How High? Adjusting California’s Cannabis Taxes. Accordingly, we recommend that, if the Legislature retains the retail excise and cultivation taxes, it approve the Governor’s proposal to change their point of collection. However, we also recommend that the Legislature consider other changes to the state’s cannabis tax structure and rates. www.lao.ca.gov 1 analysis full gutter 2020-21 BUDGET Concept of Consolidating Licensing Functions Makes Sense, but Details Are Important. We find that the concept of consolidating the cannabis licensing functions into a single entity focused on cannabis makes sense, and could improve the accountability and effectiveness of the state’s cannabis activities. However, we also find that the Legislature will want to closely evaluate the details of the proposal to ensure it is well planned and aligns with legislative priorities. Accordingly, we recommend that the Legislature request the administration to provide additional details on the plan—and the associated budget proposal and trailer bill legislation—as soon as possible. Take Holistic, Incremental Approach to Funding Proposals, Focusing on Oversight. We find that the Legislature’s decisions regarding changes to the cannabis regulatory structure and taxes could affect departments’ resource needs. As a result, we recommend that the Legislature withhold action on cannabis‑related proposals until all the budget proposals and budget trailer language are available this spring. We also find that there is significant uncertainty regarding some departments’ resource needs due to the immaturity of the cannabis industry and, therefore, recommend that the Legislature be cautious about ongoing funding commitments for such departments. Finally, we recommend that the Legislature use its oversight role to ensure that departments are implementing programs effectively and programs are achieving desired outcomes. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET INTRODUCTION The Governor’s 2020‑21 budget includes various this report: (1) provides some background on cannabis‑related proposals, including both budget cannabis regulation and taxation in California, trailer legislation and budget change proposals from (2) describes the Governor’s proposals, and multiple departments. To help the Legislature in its (3) provides recommendations on these proposals consideration of the Governor’s various proposals, for legislative consideration. BACKGROUND Legislature Created the Regulatory Framework state agencies have roles related to regulating for Medical Cannabis. While voters legalized the the cannabis industry. For example, as shown use of medical cannabis in California in 1996, the in Figure 1 (see next page), it gives three state state did not create a regulatory framework for departments responsibility for licensing different medical cannabis until the Legislature approved types of cannabis businesses and various other three state laws (Chapter 688 [AB 243, Wood], departments roles, including hearing appeals of Chapter 689 [AB 266, Bonta], and Chapter 719 cannabis‑related disciplinary actions, tax collection, [SB 643, McGuire])—known collectively as the and cannabis‑related environmental functions. Medical Cannabis Regulation and Safety Act Proposition 64 Imposes Two State Excise (MCRSA)—in 2015. Prior to MCRSA, most regulation Taxes on Cannabis. Like other businesses, of medical cannabis was left to local governments. cannabis businesses generally must pay Proposition 64 Legalized Adult-Use Cannabis. broad‑based taxes such as income taxes, In November 2016, California voters approved payroll taxes, and sales taxes. Additionally, Proposition 64. Under Proposition 64, adults 21 Proposition 64 established two state excise taxes years of age or older can legally grow, possess, on cannabis. The first is a 15 percent excise tax on and use cannabis for nonmedical purposes (often retail gross receipts (known as the retail excise tax). referred to as recreational or adult‑use), with The second is a cultivation tax on harvested plants. certain restrictions. Proposition 64 authorizes the As of January 1, 2020, the cultivation tax rates Legislature to amend the measure’s provisions, are $9.65 per ounce of dried flowers, $2.87 per if the amendments are consistent with the ounce of dried leaves, and $1.35 per ounce of measure’s intent and further its purposes. (We fresh plants. The California Department of Tax and note that amendments to the measure’s regulatory Fee Administration (CDTFA), which administers structure require a majority vote; however, these cannabis taxes, adjusts the cultivation tax amendments to the measure’s taxation structure rates annually for inflation. Proposition 64 identifies require a two‑thirds vote.) Since the passage of three broad goals that should be considered when Proposition 64, the Legislature has passed laws adjusting cannabis tax rates: undercutting illicit amending the measure, including Chapter 27 of market prices, generating sufficient revenues, and 2017 (SB 94, Committee on Budget and Fiscal discouraging youth use. Review), which brought the state’s medical and Distributors Responsible for Remitting adult‑use regulatory structures into conformity State Taxes. Cultivators and retailers bear the and made changes to the point of collection for legal responsibility for the initial payment of the cannabis taxes, as described later. cultivation and retail excise taxes, respectively. Proposition 64 Tasked Various Departments However, pursuant to Chapter 27, final with Responsibilities. Under Proposition 64, distributors—rather than cultivators or retailers— as amended by Chapter 32 of 2016 (SB 837, must remit these taxes to CDTFA, resulting in Committee on Budget and Fiscal Review), various a multistep payment process. We explain this www.lao.ca.gov 3 analysis full gutter 2020-21 BUDGET those businesses must transfer Figure 1 the cultivation tax until the final Key Departments Involved in distributor remits it to CDTFA. Cannabis Regulation in California • Retail Excise Tax. Retailers Regulatory Agency Current Primary Responsibilities generally must pay the retail Licensing and Enforcement Activities excise tax to final distributors Bureau of Cannabis Control • Licenses distributors, retailers, and testing when they make wholesale laboratories. purchases. These distributors Food and Agriculture • Licenses cultivators. then remit the retail excise taxes Administers track and trace information to CDTFA. Retailers must make technology system. these payments before they sell Public Health • Licenses manufacturers. the products to consumers, so the tax is based directly on the Appeals wholesale price (the price that Office of Administrative • Provides administrative hearings related to Hearings (OAH) denied licenses, discipline actions against retailers pay to distributors) rather licensees, and citations for unlicensed than the retail price (the price activities. that consumers pay to retailers). Cannabis Control Appeals • Hears appeals of OAH decisions. Pursuant to Chapter 27, CDTFA Panel sets the tax based on its estimate Tax Collection and Other Administrative Activities of the average ratio of retail prices Tax and Fee Administration • Administers cannabis taxes. to wholesale prices—commonly Employment Development • Collects payroll taxes. known as a “markup.” CDTFA’s Department current markup estimate (as of Secretary of State • Processes cannabis business filings and January 1, 2020) is 80 percent. trademark registrations. Due to the 15 percent statutory tax rate and the 80 percent markup Environmental Activities estimate, the current effective tax State Water Resources • Regulates water-related impacts of Control Board cultivation. rate on wholesale gross receipts is 27 percent (15 percent x Fish and Wildlife • Monitors and reduces environmental impacts of cultivation. [100 percent + 80 percent]). Pesticide Regulation • Develops and enforces pesticide use Revenues From Cannabis guidelines for cultivation. Taxes Go to Three Types of Activities. The state deposits process below and illustrate how it works for a the revenues from the two hypothetical manufactured product in Figure 2. cannabis taxes into the Cannabis Tax Fund. • Cultivation Tax. A cultivator determines Proposition 64 continuously appropriates Cannabis the amount of cultivation tax it owes by Tax Fund proceeds to fund three types of activities: weighing the plants it harvests. It then pays • Allocation 1—Regulatory and this amount to a distributor when it sells or Administrative Costs. First, revenues pay transfers the harvested plants. In a case in back certain state agencies for any cannabis which cannabis travels from the cultivator to regulatory and administrative costs not just one distributor prior to retail sale, that covered by license fees. distributor remits the tax to CDTFA. In many • Allocation 2—Specified Allocations. Second, cases, however (such as the case illustrated in after regulatory and administrative costs are Figure 2), the supply chain is more complex, covered, revenues go to certain research and with multiple manufacturers and distributors other programs, such as researching the effects handling harvested cannabis and the products of cannabis and the effects of the measure. derived from it. In these cases, each of 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET • Allocation 3—Percentage Allocations. Legislature Provided Funding to Implement Third, these revenues go to three broad Cannabis Regulations. Starting in 2015‑16, types of activities: 60 percent for youth the Legislature provided funding to a variety programs related to substance use education, of departments to implement the state’s prevention, and treatment; 20 percent for cannabis‑related regulatory efforts. Generally, this environmental programs; and 20 percent for funding was provided on a limited term basis— law enforcement. (Unlike the other allocations, through 2019‑20—because it was recognized that funding for Allocation 3 comes from tax there was substantial uncertainty regarding the level receipts from the prior year.) The measure of ongoing workload that the departments would generally authorizes the administration to experience related to this newly‑regulated industry. choose how to allocate funding among various eligible activities within each of the three Allocation 3 categories. Figure 2 Cannabis Tax Collection for a Simple Manufactured Product Cultivation Tax Retail Excise Tax Cultivator Manufacturer First Last Distributor Distributor Retailer CDTFA CDTFA = California Department of Tax and Fee Administration. www.lao.ca.gov 5 analysis full gutter 2020-21 BUDGET GOVERNOR’S JANUARY CANNABIS PROPOSALS Modifications to of Alcoholic Beverage Control, among other departments.) The administration has not provided Cannabis Tax Structure any details on this planned consolidation to date. Proposes Change to Point of Collection of However, the administration has indicated that it Cannabis Taxes. The Governor proposes budget anticipates providing further information this spring. trailer legislation changing the type of businesses responsible for remitting the state’s two cannabis Adjustments to excise taxes (known as the point of collection). Cannabis-Related Funding First, he proposes moving the responsibility for Proposes $70.2 Million in 2020-21 for remitting the cultivation tax from the final distributor Eight Departments. As shown in Figure 3, the to the first distributor. Second, he proposes moving Governor’s budget proposes $70.2 million to the responsibility for remitting the retail excise tax support 291 positions (including 15 temporary from the final distributor to the retailer. help positions) across eight departments. The Signals Interest in Considering Additional administration proposes funding these proposals Changes to Taxes. The Governor also indicates from a variety of sources, such as the Cannabis Tax that he will consider other changes to the existing Fund and various fees. In some cases—such as the cannabis tax structure, including the number of Cannabis Control Appeals Panel and the Office of taxes and tax rates, with the aim of simplifying Administrative Hearings (OAH)—these proposals the system and supporting the legal cannabis represent a continuation of funding levels similar market. However, to date, the administration has to those provided in the current year. However, in not provided any additional details on what specific other cases, they represent changes. For example, changes may be under consideration. CDTFA is proposed to receive additional funding Consolidation of Licensing Functions in 2020‑21 compared to 2019‑20. This increase in Into New Department of Cannabis Control Figure 3 The Governor proposes Governor’s January 2020‑21 Budget Proposals for consolidating the cannabis‑related Cannabis Implementation—Summary of Fundinga functions that are currently housed (In Thousands) in three licensing agencies—the Funding Proposed Bureau of Cannabis Control 2023‑24 and (BCC) within the Department Department 2020‑21 2021‑22 2022‑23 ongoing of Consumer Affairs (DCA), the State Water Resources Control Board $22,556 $22,556 $22,556 $4,510 California Department of Food Fish and Wildlife 12,717 12,717 12,717 4,743 and Agriculture (CDFA), and the Tax and Fee Administration 12,864 8,184 7,983 7,983 Department of Public Health Office of Administrative Hearings 11,452 11,452 11,452 — (DPH)—into a new department Employment Development Department 3,633 3,630 3,630 1,637 with dedicated enforcement Pesticide Regulation 3,487 2,667 2,667 2,667 resources by July 2021. This new Cannabis Control Appeals Panel 3,033 3,032 3,036 — department, the Department of Secretary of State 448 448 448 448 Cannabis Control (DCC), would Totals $70,190 $64,686 $64,489 $21,988 be housed within the Business, a Does not include funding for a new Department of Cannabis Control, which is anticipted to be requested in spring 2020. Consumer Services, and Housing Agency (BCSH). (BCSH currently oversees DCA and the Department 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET 2020‑21 is primarily due to (1) one‑time resources • OAH ($11.5 Million). OAH requests proposed for cannabis‑related changes to the $11.5 million in Service Revolving Fund department’s information technology system and authority on a three‑year limited‑term basis (2) greater resources for enforcement activities. to provide administrative hearings related to We discuss the proposals for each of these eight denied licenses, discipline actions against departments in more detail below. licensees, and citations for unlicensed activities. • State Water Resources Control Board • Employment Development Department ($22.6 Million). The State Water Resources ($3.6 Million). The Employment Development Control Board (SWRCB) requests $22.6 million Department (EDD) requests $3.6 million in in 2020‑21 through 2022‑23 from the Waste 2020‑21—declining to $1.6 million annually Discharge Permit Fund, Cannabis Tax beginning in 2023‑24—from the Cannabis Fund, and Water Rights Fund to support Tax Fund to support cash collection of payroll 116 positions and the acquisition of aerial taxes from cannabis businesses, payroll tax imagery. Beginning in 2023‑24, annual funding enforcement, and outreach activities. would decline to $4.5 million (Cannabis Tax • DPR ($3.5 Million). DPR requests $3.5 million Fund) to support 24 of the 116 positions. The in 2020‑21 and $2.7 million annually thereafter proposed resources would support SWRCB’s from the Cannabis Tax Fund to support efforts to address water quality and instream nine positions focused on enforcement of flow related impacts of cannabis cultivation cannabis‑related pesticide use activities. and associated water diversions through This includes $1 million annually to County activities such as permitting and enforcement. Agricultural Commissioners for compliance • Department of Fish and Wildlife assistance and enforcement activities at ($12.7 Million). The Department of Fish and the local level. This request also includes a Wildlife (DFW) requests $12.7 million from contract with CDFA for laboratory testing of the Cannabis Tax Fund and the Lake and pesticide residue on legal cannabis grows. Streambed Alteration Dedicated Account • Cannabis Control Appeals Panel in 2020‑21 through 2022‑23 to support ($3 Million). The Cannabis Control 63 positions. Beginning in 2023‑24, annual Appeals Panel requests $3 million from the funding would decline to $4.7 million Cannabis Control Fund on a three‑year (Cannabis Tax Fund) to support 14 of the limited‑term basis to hear appeals of OAH’s 63 positions. The proposed resources would cannabis‑related decisions. support DFW’s environmental permitting and • Secretary of State ($448,000). The Secretary enforcement. of State requests $448,000 annually • CDTFA ($12.9 Million). CDTFA requests beginning in 2020‑21 from the Business $12.9 million from the Cannabis Tax Fund to Fees Fund to support three positions that continue its implementation and enforcement process cannabis‑related business filings and of the retail excise and cultivation taxes. This trademark registration workload. includes two proposals: (1) $8.4 million in 2020‑21—declining to $8 million annually in Notably, the Governor has not yet provided a 2022‑23—to support 39.8 positions (including proposal to fund the new DCC. That proposal is 1.3 temporary positions) and (2) $4.5 million anticipated to be available in spring 2020, along on a one‑time basis related to adding with the details of the proposed consolidation. cannabis taxes to the department’s new Proposes Expenditure of Cannabis Tax Fund information technology system. (Our office Revenues. As previously discussed, the language will provide additional comments on CDTFA’s in Proposition 64 is broad enough to allow proposal in a forthcoming analysis.) cannabis tax revenues—particularly those provided www.lao.ca.gov 7 analysis full gutter 2020-21 BUDGET pursuant to Allocation 3—to be used to support in 2020‑21 based on its estimates of Cannabis a variety of different possible eligible activities. Tax Fund revenues. If actual tax receipts differ Figure 4 presents the administration’s decisions from expectations, these funding amounts would on which specific programs and activities to fund change. Figure 4 Cannabis Tax Fund—Expected Revenues and Planned Allocations (Dollars in Millions) 2019‑20 2020‑21 Revenues Beginning Balance $210.8 $332.8 Cannabis tax revenues 479.1 550.4 General Fund loan repayment -59.3 — Total Revenues $630.5 $883.1 Allocations—Department/Program Allocation 1: Regulatory and Administrative Bureau of Cannabis Control for Equity Program administered by Go-Biz $15.6 $15.5 State Water Resources Control Board 14.4 10.9 Fish and Wildlife 9.6 8.5 Tax and Fee Administration 7.4 12.9 Employment Development Department 2.5 3.6 Pesticide Regulation 2.3 3.5 Statewide General Administration 0.2 2.9 Total Allocation 1 $52.0 $57.8 Allocation 2: Specified Allocations for Research and Other Programs Go-Biz—community reinvestment $20.0 $30.0 Public universities—evaluation of effects of measure 10.0 10.0 Highway Patrol—methods for determining impaired driving 3.0 3.0 University of San Diego—cannabis research 2.0 2.0 Total Allocation 2 $35.0 $45.0 Allocation 3: Percentage Allocations Youth Education Prevention, Early Intervention & Treatment Account Education—child care slots $85.8 $140.8 Health Care Services—local prevention programs 22.9 37.5 Public Health—cannabis surveillance and education 12.0 12.0 Resources Agency—youth community access grant 5.7 9.4 Subtotal, Youth Account ($126.4) ($199.7) Environmental Restoration and Protection Account Fish and Wildlife—environmental cleanup and enforcement 25.3 39.9 Parks—program development, ingress and egress, and restoration 16.9 26.6 Subtotal, Environmental Restoration and Protection Account ($42.2) ($66.5) State and Local Government Law Enforcement Account State and Community Corrections—local grants for public health and safety 27.7 44.8 Highway Patrol—impaired driving and traffic safety 14.5 21.8 Subtotal, State and Local Government Law Enforcement Account ($42.2) ($66.6) Total Allocation 3 $210.8 $332.8 Total Expenditures $297.8 $435.6 Balance of Tax Receiptsa $332.8 $447.5 a Balance available for Allocation 3 in the following fiscal year. Go-Biz = Governor’s Office of Business and Economic Development. 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET ASSESSMENT Modifications to Cannabis Tax • Basic ad valorem, set as a percentage of price, such as the current retail excise tax. Structure Are Needed • Weight-based, such as the current cultivation Proposed Changes to Point of Collection tax. Would Improve Tax Administration. We find that • Potency-based, for example, based on the the proposed changes to the point of collection amount of the main psychotropic component for the retail excise and cultivation tax should of cannabis known as tetrahydrocannabinol improve tax administration and compliance. As (THC) that is in the product. we described earlier, the state’s current approach • Tiered ad valorem, set as a percentage of to cannabis taxes splits the responsibilities for price with different rates based on potency collecting the original tax payment and remitting and/or product type. the tax to the state between multiple businesses. This separation of taxpaying responsibilities—which Our analysis focused primarily on three main is not typical for other state taxes—weakens each criteria: (1) effectiveness at reducing harmful use, business’s incentive to ensure that the correct (2) revenue stability, and (3) ease of administration amount of tax is paid. An additional concern and compliance. As shown in Figure 5 (see next arises because many cannabis businesses page), we found that no individual type of tax have limited access to financial services due performed best on all criteria. For example, tiered to federal criminalization. As a result, cannabis ad valorem and potency‑based likely are best businesses often have to conduct transactions in for reducing harmful use, but basic ad valorem cash. Accordingly, the current split of taxpaying is easiest to administer. Given these trade‑offs, responsibilities often involves cash changing hands we found that the Legislature’s choice depends multiple times, leading to problems with security, heavily on the relative importance it places on each compliance, and enforcement. Furthermore, criterion. That said, we found that the weight‑based distributor remittance of the retail excise tax tax is generally weakest, performing similarly to, requires a markup calculation that makes the or worse than, the potency‑based tax on the three tax more difficult to administer. The Governor’s main criteria. proposal to change the point of collection for the In our December 2019 report, we also discussed retail excise and cultivation taxes addresses these how various tax rates are likely to affect the three problems by creating a much closer nexus between goals for cannabis taxes outlined in statute: the activity that is taxed and the responsibility for undercutting illicit market prices, generating remitting taxes. For example, moving the point of sufficient revenues, and discouraging youth use. collection for the retail excise tax from the final We found that there are trade‑offs among the three distributor to the retailer would eliminate the need outcomes. For example, we expect a lower tax for the administrative complexity of having CDTFA rate would facilitate undercutting the illicit market, perform the markup calculation, thus further but make it less likely the state would generate simplifying the tax collection process. sufficient revenues under the measure. Additional Changes to Cannabis Tax Structure and Rates Are Warranted. As we discussed in Consolidation of Licensing Agencies more detail in our December 2019 report, How Reasonable, but Details Lacking High? Adjusting California’s Cannabis Taxes, we Concept of Consolidating Licensing Functions also find that additional changes—beyond the in One Entity Makes Sense… We find that the point of collection—are merited. Specifically, in that concept of consolidating the cannabis licensing report, we analyzed four types of taxes: and associated enforcement functions that are currently spread across three departments into a www.lao.ca.gov 9 analysis full gutter 2020-21 BUDGET Figure 5 Comparing Different Types of Cannabis Taxes Scale From (Worst) to (Best) Basic Tiered Ad Valorem Tax Weight-Based Tax Potency-Based Tax Ad Valorem Tax Reducing Harmful Use Raising Stable Revenue Administration and Compliance single entity focused on cannabis makes sense. concept of consolidating the functions of the This is because the current structure of having three licensing agencies within a single entity three separate licensing entities—and no clear is very promising, the Legislature will want to lead agency for cannabis—creates challenges closely evaluate the specifics of the choices for the Legislature, as well as the cannabis made by the administration. Specifically, as industry. Specifically, the lack of a clear lead we describe in our recent report, The 2020-21 agency makes it more difficult for the Legislature Budget: Assessing the Governor’s Reorganization to know who to hold accountable when issues Proposals, and summarize in the nearby text box, related to cannabis arise or to easily access it will be important for the Legislature to keep in consistent information on cannabis licensing and mind several key considerations when evaluating enforcement activities. Similarly, the lack of a the specifics of the proposal, such as whether clear lead agency means that there is no central the reorganization would improve efficiency and point of contact for cannabis businesses. Instead, whether it is well planned. In addition to these businesses that hold multiple types of cannabis general considerations, the Legislature will licenses may have to go to multiple departments also want to consider whether the changes to to seek guidance. We note that the challenges Proposition 64 that are necessary to implement the with the current structure are exacerbated due reorganization might require voter approval. to the structure of DCA. Specifically, the sworn Issues to Consider When Evaluating officers that work on BCC‑related issues are housed under DCA’s Division of Investigation Cannabis-Related Funding Proposals rather than BCC itself, which further bifurcates Choices About Tax Structure and responsibility and accountability for cannabis Consolidation Will Affect Some Resource enforcement. Given the challenges identified Needs. We find that the Legislature’s ultimate above, we think that the Governor’s concept of decisions regarding possible changes to the consolidating the cannabis‑related licensing and cannabis regulatory structure—including the enforcement functions that are currently housed creation of DCC—as well as its decisions regarding in three departments into a new stand‑alone cannabis taxes could affect the level of resources department has significant potential to improve state agencies need to implement their programs. the accountability and effectiveness of the state’s For example, the Legislature’s policy choices cannabis activities. regarding the structure of cannabis taxes and the …But Legislature Will Want to Closely point of collection of those taxes would affect Evaluate Specifics. While we think the Governor’s the number of taxpayers and the complexity of 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET tax collecting activities undertaken by CDTFA. cannabis. For example, we find that there is However, the Governor’s proposed budget for uncertainty regarding the level of ongoing workload CDTFA does not reflect the proposed change in for OAH and the Cannabis Control Appeals the point of collection for cannabis taxes. This is Panel because neither entity has begun hearing potentially problematic if the Legislature approves cases. As such, there is no data on the number the proposal to change the point of collection of cases that will likely be heard or the number of given that it could result in higher or lower resource appeals that will result. Additionally, we find that needs for CDTFA. there is uncertainty regarding the level of ongoing Significant Uncertainty Regarding Resource workload for the Secretary of State because the Needs Given Early Stages of Implementation. In number of businesses seeking to register and some cases, due to the immaturity of the regulated receive trademarks is likely to vary over time as the cannabis industry, we find that there continues industry matures. Departments have taken different to be a high level of uncertainty regarding some approaches to this uncertainty. For example, some departments’ future resource needs related to proposals—such as those related to OAH and the Key Considerations When Reviewing Reorganization Proposals In our recent publication, The 2020-21 Budget: Assessing the Governor’s Reorganization Proposals, we recommend that the Legislature consider the following key questions when evaluating proposals to reorganize state departments through consolidation or transferring government functions: • Would the Reorganization Make Programs More Effective? A reorganization should result in programs becoming more effective and the public receiving improved government services. • Would the Reorganization Improve Efficiency? A reorganization should result in programs using fewer resources or improving the quality of services provided within existing resources. • Would the New Structure Improve Accountability? A reorganization should result in a government structure where the Legislature and the public can easily identify the person or entity responsible for managing a program. • Is the Reorganization Based Upon a Policy Rationale? A reorganization should be consistent with an underlying policy rationale to address a problem that has been clearly identified. • Does the Reorganization Reflect Legislative Priorities? A reorganization should be consistent with the priorities that the Legislature has set for a program or government function. • Do the Benefits Outweigh the Costs? The benefits of a reorganization should outweigh the costs to implement the reorganization, which can sometimes be significant. • Is the Reorganization Well Planned? A reorganization should be well planned given that it can result in significant complexities—such as the need to reclassify positions and responsibilities. • How Should the Reorganization Be Implemented? Government reorganizations can be implemented in a few different ways, though typically they have been pursued either through the formal executive branch reorganization process laid out in statute or budget trailer legislation. www.lao.ca.gov 11 analysis full gutter 2020-21 BUDGET Cannabis Control Appeals Panel—have recognized Legislature Plays Key Oversight Role Over this uncertainty by proposing limited‑term funding. Expenditure Plan for Cannabis Tax Fund. Since However, the Secretary of State has proposed Proposition 64 continuously appropriates Cannabis ongoing resources despite the uncertainty Tax Fund revenues to specific departments, regarding its ongoing workload. no legislative action is needed to appropriate Opportunity for Resource Sharing Possible the funds. We also note that the ability for the in Cash Collection. EDD’s proposal includes Legislature to direct the use of the Cannabis Tax resources to enable it to collect payroll tax Fund revenues is uncertain, given the language of payments from cannabis businesses in cash. Proposition 64. Despite this, the Legislature retains However, we find that it is unclear why EDD needs an important oversight role over the expenditures to perform its own cash collection activities rather from the Cannabis Tax Fund. The Legislature than leveraging those that are already in place at can use its oversight authority to ensure that CDTFA. Notably, the Franchise Tax Board (FTB) departments are implementing programs effectively already leverages CDTFA’s capacity to collect cash and programs are achieving desired outcomes. from cannabis businesses. RECOMMENDATIONS Modify Cannabis Tax Structure the three goals identified in Proposition 64: undercutting illicit market prices, generating Approve Changes to Point of Collection. sufficient revenues, and discouraging youth use. We recommend that, if the Legislature retains The trade‑offs among the three outcomes mean the retail excise and cultivation taxes (we discuss that the right tax rate ultimately is a question of potential changes below), it approve the Governor’s policy priorities. That said, we recommend the proposal to change their point of collection. These that Legislature consider tax rate changes ranging changes to the point of collection would simplify from a significant tax cut to changes that would tax remittance and collection responsibilities, be revenue neutral. For example, if the Legislature thus significantly improving tax administration and were to eliminate the cultivation tax but retain the compliance. retail excise tax, we would recommend setting Consider Broader Changes to Cannabis Tax the retail excise tax between 15 percent and Structure and Rates. We recommend that the 20 percent. (We estimate that a 20 percent retail Legislature consider other additional changes excise would be roughly revenue neutral in the to the state’s cannabis tax structure and rates, short term if the cultivation tax were eliminated.) We consistent with our December 2019 report, How find that such an approach would most effectively High? Adjusting California’s Cannabis Taxes. balance the goals identified in Proposition 64. To Specifically, we recommend that the Legislature the extent the Legislature makes these additional replace the state’s existing cannabis taxes with changes, it will also want to make conforming a tax designed to reduce harmful cannabis use changes to the Governor’s proposal for the point of more effectively—namely, a potency‑based tax or collection. tiered ad valorem tax. That said, if the Legislature prioritizes administration and compliance more Consider Consolidating Licensing highly, a basic ad valorem tax is worth considering Functions as an alternative. We do not recommend keeping Request Administration Provide Details the cultivation tax. on Consolidation Plan in a Timely Manner. We further recommend that the Legislature We recommend that the Legislature request the consider changes to cannabis tax rates to achieve administration to provide additional details on its 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2020-21 BUDGET consolidation plan—and the associated budget proposal on a limited‑term basis given that there proposal and trailer bill legislation—as soon as is likely to be uncertainty regarding the level of possible. This is because, while the concept of this ongoing licensing workload. Taking an incremental plan is promising, the specific details will be critical approach to budgeting will better enable the to ensuring the Legislature is comfortable moving Legislature to use the annual budget process to forward. Having these details in a timely manner oversee the implementation of cannabis regulation will provide the Legislature with time to adequately and ensure that departments are appropriately assess the Governor’s proposal. As it performs resourced for this implementation. this review, we recommend that it consider the key Direct CDTFA and EDD to Report at Budget questions for reorganizations that we identified Hearings on Proposals Using Cannabis Tax previously, such as whether the proposal improves Fund. The CDTFA and EDD proposals are the efficiency and effectiveness of government and proposed to be funded from the Cannabis Tax is well planned. Fund. While legislative action is not required to appropriate these funds, the Legislature still has an Take Holistic, Incremental Approach interest in ensuring that they are spent efficiently to Cannabis-Related Funding and effectively. This is because, when more Proposals, Focusing on Oversight funds than necessary are spent on administrative activities in Allocation 1, such as those performed Make Resource Decisions After Making by EDD and CDTFA, fewer funds are available Proposed Changes. We recommend that the to fund the legislative priorities supported in Legislature withhold action on cannabis‑related Allocation 3, such as childcare slots. Accordingly, proposals until all the budget proposals and we recommend the Legislature use its oversight budget trailer language are available this spring. functions to seek information from the following This approach will enable the Legislature to see departments on their budget proposals using the the proposals in the context of the resources Cannabis Tax Fund: provided to DCC. Additionally, this will allow the Legislature to assess if any changes to resources • CDTFA. We recommend asking CDTFA levels provided to departments are merited based to explain how, if at all, it plans to adjust on specifics of the changes that are proposed. For its proposal to reflect the administration’s example, the Legislature’s decisions about the point proposed change to the point of collection for of collection for taxes—as well as the structure cannabis taxes, as well as any other changes of taxes—could impact the level of workload for to the tax structure and point of collection CDTFA to administer these taxes. under consideration. Limit Funding for Out-Years When There is • EDD. We recommend asking EDD to explain Uncertain Level of Ongoing Workload. Once the why it proposes collecting cash payments Legislature has all the administration’s proposals in from the cannabis industry rather than the spring, it will be faced with individual decisions collaborating with CDTFA as FTB does. This on budget proposals. As it evaluates these is particularly important given that CDTFA proposals, we recommend that the Legislature be has already invested significant resources to cautious about ongoing commitments when there is enable it to collect cash payments. uncertainty regarding the level of ongoing workload. Conduct Oversight Over Other Expenditures For example, we recommend approving funding for of Cannabis Tax Funds. We recommend that the Secretary of State proposal on a limited‑term the Legislature continue to use its oversight basis given the uncertainty in the amount of role to ensure that it is comfortable with the business filings and trademark registration administration’s plans for Cannabis Tax Fund workload the department will have for cannabis revenues more broadly. For example, the businesses on an ongoing basis. Additionally, Legislature could ask the administration to the Legislature will want to consider whether to identify the outcomes that it seeks to achieve approve a portion of the forthcoming DCC‑related www.lao.ca.gov 13 analysis full gutter 2020-21 BUDGET with the use of these funds—such as restoring In cases where the administration has not habitat or reducing rates of youth substance adequately identified expected outcomes, the use—and whether it has measurable targets for Legislature could adopt reporting language each outcome, such as the number of acres of requiring the administration to identify these habitat restored or the change in rates of youth outcomes. Alternatively, the Legislature could adopt substance abuse. A clear articulation of the desired legislative intent language articulating its desired outcomes from the funds provided would assist outcomes and require the administration to report the Legislature in evaluating the administration’s on measures assessing whether those outcomes approach to the use of the funds and in holding the are achieved. administration accountable on an ongoing basis. LAO PUBLICATIONS This report was prepared by Helen Kerstein with contributions from others, and reviewed by Drew Soderborg and Anthony Simbol. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 14 LEGISLATIVE ANALYST’S OFFICE