Earlier this year, the San Diego City Council voted to increase the city's cannabis business tax from 8% to 10% to fill a budget hole. Now city finance officials say they likely overestimated how much revenue the tax hike would generate.
Receipts from July through September suggest the cannabis business tax is on track to generate $19.7 million this fiscal year — $1.5 million short of the $21.3 million assumed in the budget. Last fiscal year, when the tax rate was still 8%, the cannabis businesses tax generated $16.7 million for the city. The tax rate was set at 5% when it was approved by voters in 2016.
San Diego's Office of the Independent Budget Analyst (IBA) wrote in a recent report that licensed retailers, manufacturers and distributors are still being undercut by their unlicensed competitors.
"This projected shortfall is largely due to a continued decline in reported taxable gross receipts driven by increased competition from the illegal market and decreased wholesale prices caused by an oversupply of cannabis products," the IBA report said.
Kimberly Simms, a San Diego-based attorney in the cannabis industry, said consumers are sensitive to price increases.
"As the cost of living continues to rise all around us, people have to make choices," Simms said. "And if there's readily available cannabis on the illicit market, and you continue to make it more and more expensive on the regulated market, people are going to be driven back to the illicit market."
In addition to the illicit market, San Diego is also competing with suburbs that have lower tax rates. Encinitas has a cannabis tax rate of 7% for retail outlets and 4% for manufacturers. La Mesa taxes retailers at 4% and manufacturers at 2.5%.
La Mesa also has less restrictive zoning rules around cannabis retail outlets, leading to a much higher concentration of dispensaries per capita than San Diego.
"Cities are realizing that it's better to have some piece of the pie than no piece of the pie," Simms said. "I think if we continue to see this trend of increasing taxes, then it just continues to bolster the illicit market."
San Diego also allowed cannabis retailers to stay open for an additional two hours this year. But the IBA report found not all retailers have opted to extend their hours — a fact that Simms attributed to high operating costs.
President Trump last week signed an executive order downgrading cannabis from a Schedule I drug — akin to heroin, with no medical value and a high risk of abuse — to a Schedule III drug, akin to ketamine or anabolic steroids, with a low to moderate risk of abuse.
Simms said if the rescheduling survives any potential legal challenges, it should offer some relief to cannabis businesses by allowing them to deduct ordinary expenses such as payroll and rent from their taxable income.
"I hope that some of those savings are passed on to the consumer, but we don't know when that's going to happen," Simms said.
