Taxing Phantom Marijuana Transactions in Colorado

On Wednesday
I
suggested a few reasons why tax revenue from the first month of
sales by Colorado’s newly legal marijuana stores was not as robust
as anti-pot activists feared/hoped. Tax attorney Pat Oglesby

notes another reason: The stores, all of which began as
dispensaries, were allowed a onetime transfer of marijuana from
their medical inventories. In fact, all of the
marijuana initially available for sale to recreational
consumers came from medical stocks, since cultivation for general
use was not allowed until January 1. That marijuana was not subject
to the state’s 15 percent excise tax, which applies at the
wholesale level. Oglesby calculates that January’s revenue was
$800,000 lower than it would have been if those transfers had been
taxed.

Another kind of in-house transfer complicates collection of the
excise tax. Until October, marijuana stores are required
to grow 70 percent of their inventory, just as dispensaries were
required to do (for reasons that never made much sense). Amendment
64—Colorado’s legalization measure, which is now part of the
state constitution—authorizes “an excise tax to be levied upon
wholesale sales of marijuana.” But when the retailers are the
growers, Oglesby
observes, “There is no wholesale sale, so somebody has to make
up a ‘transfer’ price to tax. That’s crazy.” Since there is no real
transaction, marijuana suppliers have an obvious incentive to
lowball the “price” they charge themselves. The Colorado
Department of Revenue’s solution is to collect 15 percent of the
“average market rate,” which it
calculates based on figures reported by dispensaries for “both
arms‐length transactions and integrated sales.”

The initial
rate, based on survey data from late last year, is $1,876 per
pound (about $117 an ounce) for flowers. That comes out to less
than $15 per eighth. By comparison, dispensaries before
legalization typically were charging about $25 an eighth, which is
what Medicine Man in Denver still charges patients
for many strains. Recreational customers, facing a supply that will
be artificially constrained until marijuana from plants grown for
the recreational market is available, pay
nearly twice as much. Eventually those prices should converge,
although patients will still pay less because of tax exemptions.
Assuming the retail price settles around $25 per eighth before
taxes, the implied retail markup is about 40 percent, which seems a
bit high
compared to cigarettes and beer but is in the same neighborhood
as wine and liquor.

The difficulty of taxing transactions that are mostly fictitious
was one of the arguments for imposing a special sales tax on
marijuana, which was
approved by voters in November and is currently set at 10
percent. When the vertical integration mandate expires, there
should be more “arm’s length transactions,” which will make the
excise tax easier to assess.