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Harrington: Governor’s Tax and Regulate Subcommittee Preliminary Recommendations

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Eli Harrington 14 Nov 2018

It’s been too long since I’ve had the time to write for my own media outlet, but I’m dusting off the old keyboard to break down the first significant component to Vermont’s future tax-and-regulate system, the preliminary report to the Governor’s Marijuana Advisory Committee from the Tax and Regulate subcommittee. Alternative title for this column: I read all 85 pages so you don’t have to.

As an important reminder: this is a preliminary report that will not be completed and finalized until mid-December. Once it is finalized, this report will outline the Governor’s commission recommendations, but it’s the legislature that makes the laws and who will ultimately decide how much of these recommendations to incorporate.

Bullet point are highlighted below. The full text is available for download at the bottom of the article.

  • The stated emphasis is to defeat the black market and to prevent diversion — this is a report from the perspective of regulating a dangerous substance much more than it’s intended to support creating a new Vermont industry.
  • The proposed tax rate is HIGH — 26% at the retail level plus a 1% local option tax proposed for municipalities that have it.
  • State agencies have calculated very high costs of regulation and are looking for a lot of revenue — at least $15-19 million not including the Dept. of Liquor Control costs, which are not included in this report.
  • The report proposes five types of licenses: cultivation, processing, transportation, retail, and testing. The committee recommends that smaller cultivation licenses (500-1000ft^2) be available to small producers (500-1000ft^2) before larger producers in order to advantage smaller producers. Spoiler alert: no dollar amounts.

The Market:

Keep in mind that the Department of Taxes has been very conservative throughout this process in estimating possible legal cannabis tax revenues. While it’s smart for all politicians — and the public — to keep in mind that cannabis revenues aren’t going to be a magic bullet and fix the state’s economic woes, there is also political value for the Governor in keeping expectations low. By underestimating and downplaying the economic impact of legal cannabis sales, the Governor has a stated reason to continue his ‘no new tax increases’ fiscally-conservative policies to the revenue-hungry legislature.

It’s important to note that the Department of Taxes is working closely with the non-partisan Legislative Joint Fiscal Office and Legislative Economists to produce a more detailed market analysis.

Revenue estimates will be updated, but current ones have Vermonters outspending tourists five to one

The biggest problem with the not-yet-updated estimates used in this report is that the revenue estimates are based on a scenario in which Vermont residents spend five times more on legal cannabis than tourists. Again, these will be updated, but we’re the ones producing and selling the value-added products to the tourists, not the ones buying … I’ll give the technocrats and economists in the Department of Taxes a break until they update their statistics, but capturing the full potential of the out-of-state tourist market is the single most important macroeconomic factor in the economic success of Vermont’s future legal cannabis industry.

Tax Structure:

The proposed tax structure would be an ‘ad valorem tax,’ meaning that the tax is based on the determined value of the good, not the actual cost of producing the actual good or a quantitative measure (like unit weight or quantity of production). The committee is recommending an ad valorem retail sales tax of 20% PLUS the existing 6% sales tax for an effective 26% tax rate paid by consumers at the point of sale. There would be no tax for wholesale transactions between growers and wholesalers.

This is the easiest structure for the state to roll-out immediately and  basically allows the state to make up a retail tax percentage without tying it to any actual metrics. Other options were considered (taxing by weight, by unit, by THC%), but this was the most streamlined and simplest option for the state. The report acknowledges the need to have tax flexibility as prices change, but is (for now) unclear how frequently that percentage will be reviewed and how it would be changed. The report includes comparisons to other legal states tax structures; by comparison, Massachusetts has 17% excise retail tax with a 3% local option for a maximum tax rate of 20%.

The 20% tax would apply to all THC seeds, clones, plants and products; however, it would NOT apply to any industrial hemp seeds, clones, plants, or products with less than .3% THC. The report makes clear that while cannabis — including edibles —  could theoretically be considered exempt as ‘drugs intended for human use and food and food ingredients,’ they recommend a statutory change so that ALL marijuana products would be subject to the taxes.

While cannabis businesses will still not be able to deduct standard business expenses under Federal Law (read more about 280E on Forbes here), the committee recommends authorizing a Vermont deduction against income tax for business-related expenses of cannabis businesses to balance the effects of federal income tax. While the federal landscape is bound to change — especially with the departure of Jeff Sessions — in favor of the cannabis producers, this policy would create a competitive advantage for Vermont businesses at least in the short term.

Local Control and Local Taxes

The subjects of local control in licensing/zoning legal cannabis businesses, their potential costs, and the potential revenues to hosting communities are complicated for any state and topic. However, Vermont is very different from other states — especially Western states — in that municipal governments do NOT actually have much power to operate independently of the State government thanks to the Vermont Supreme Court’s strict interpretation of the so-called Dillon’s Rule.

Among other things, this interpretation means that if municipal governments want to collect extra local taxes, they must change their municipal government charters, which also requires legislative approval. Right now, the only two types of extra local taxes collected in Vermont are the Local Option Sales Tax and the Local Option Meals/Rooms/Alcoholic Beverages Tax.

Vermont municipalities with a local option sales tax, via Secretary of State website

This is significant because in this report, the tax-and-regulate commission recommends that legal cannabis sales would be subject to the 1% Local Option Sales Tax.

“The local option sales tax would be an important source of revenue for municipalities to absorb the costs of legalizing recreational marijuana. However, only those municipalities that already have a local option tax or complete the statutory process to adopt one will have access to this funding stream to cover their costs related to marijuana.”

This means that until others make a charter change — which requires local approval AND state legislative approval — only fourteen cities/towns in Vermont currently collecting the local option sales tax would be able to collect the proposed 1% local retail sales tax.

While recommending this local option sales tax structure — the easiest for the Tax Department to implement — the committee acknowledges funding ALL Vermont municipalities by either a statutory percentage or dollar amount of the total marijuana tax revenue, even if that town bans legal cannabis businesses.

“This would avoid inequities since the impact of marijuana activities will be felt in every town, regardless of whether a town or city hosts any marijuana establishments. Communities without marijuana establishments, including those that opt out of hosting, should still receive funding to alleviate the effects of operations based in other municipalities as well as local consequences that arise from personal use and cultivation, including highway safety, odor, zoning, etc. Towns that host marijuana establishments should be allocated a larger portion of the revenues.”

The Vermont League of Cities and Towns (VLCT) has spent the past three years vehemently opposing any legalization, but with the mandate to capture as much local funding as possible from a regulated system, a seat on the Governor’s commission, and multiple lobbyists in Montpelier, the VLCT will continue to have significant influence on the regulation process especially related to local control.

While the report recommends the local option sales tax, it does also provide a few alternative options that would more directly support municipal governments, including giving municipalities the statutory ability to vote on and impose a separate local tax on cannabis sales without making charter changes.

I’ve personally suggested that the state stay out of local zoning completely and let cities and towns make their own host community agreements directly with the businesses that want to operate … More about the advantages and disadvantages of that system in a future column.

Who Does What and How Much Will it Cost?

The tax and regulate subcommittee responsible for this report includes representatives from some of the various state agencies that will be charged with actually implementing and enforcing a regulated cannabis system in Vermont. Those agencies include: the Agency of Agriculture, Food and Markets; the Department of Taxes; Department of Financial Regulation; and the Department of Liquor and Lottery.

These agencies are crucial because as regulation rolls out, it’s the state agencies — not the legislature — who will be responsible for actually enforcing the new laws. As the legislature is preparing bills, the costs of regulation (how much state agencies say they need to carry out regulation) will be a significant financial consideration. While this subcommittee report is not yet finalized and the numbers far from finished, there’s valuable insight into who would be responsible for what, as well as the internal competition within the Scott administration for funding.

 

Agency Responsibilities New staff requested Proposed 3yr budget for FY2020-22 Notes
Department of Agriculture, Food, and Markets Compliance assistance and training; develop/enforce testing standards; license and oversee cultivators; collect test samples; register commercial labs; create and enforce quality standards Five (5) total: program lead; chemist; attorney; field inspector; program admin $1,140,000 Includes new analytical testing equipment in 2021; genetic drift control mentioned as possible 2020 topic for program to address
Department of Taxes Track cannabis products (seed-to-sales); compliance assistance and training; Seven (7) total:

business coordinator; attorney; tax examiner (x2); data management; program auditor; collections

$2,082,000 Includes $750,000 for tracking software; assumes state will not accept tax payments in cash
Department of Public Safety Unclear: Includes $330,000/year for the state’s 50 certified Drug Recognition Experts (DRE) $4,440,000 – $4,840,000 Includes ~$350,000 for saliva testing equipment + $60,000 for annual saliva testing costs;

Existing DRE are funded

Education & Prevention Programs No specific details included in initial report No specific details included in initial report $8,000,000 – $12,000,000 No specific details included in initial report
Department of Liquor + Lottery Regulating all commercial marijuana activities, including licensing and enforcement of wholesale and retail outlets No specific details included in initial report No specific details included in initial report DLC would be the primary licensing and enforcement body for all wholesale and retail cannabis sales likely necessitating more training resources and staff

Some analysis: from both the report and the tax and regulate subcommittee meetings themselves, it’s very clear to me that the Department of Liquor and Lottery want to have a central role in the regulation of cannabis in Vermont, specifically in licensing and enforcing wholesalers and retailers. There are specific advantages and disadvantages to the realities of the state regulating cannabis like alcohol, but it’s clear they want all of the control over private businesses, but none of the liability.

While there’s only one paragraph about medical marijuana (see below), the report dedicates a full page to the merits of setting up a state Control Model, similar to the three-tiered system used to regulate alcohol. This system would make the state the sole distributor and the retailer and allow municipalities to prohibit sales in their town by opting out. As mentioned above, the problem with the state control model is that the state then has the risk and liability of possessing and distributing a federally-illegal substance.

Department of Public Safety estimated three-year budget for new costs of regulating cannabis

Who Pays For Setting Up Regulation?

One of the mandates of the Governor’s Executive Order is a requirement that the Commission recommend a regulatory and revenue system which completely self-funds the regulatory infrastructure at both the State and local level.

In order to meet this mandate, the committee outlines several options for how to front-load the funding:

  • Delay the start date for retail sales 18-24 months after sales are actually legalized
  • Higher licensing fees for initial applications then lower annual renewal fees
  • Stagger the number of licenses issued in startup phase of first 1-3 years
  • Create a one-time excise tax with an automatic sunset to collect taxes before sales begin
  • Create a retail license auction system so that a limited number of retail licenses may be sold to the highest bidders
  • Require licensees to provide upfront capital to pay for the regulatory structure with payments structured as a loan to the state that accrues interest
  • Create a captive pool or marketplace where business buys and trades operating shares, similar to a carbon emissions trading model
  • Create a fund similar to clean water fund that may be drawn from early in the year then required to be balanced out by the end of the year.

Board of Control

Another fundamental question is, “who’s in charge of all of this?”  Recognizing the need to centralize the administration of a regulated cannabis program,

The Board would have certain specified administrative and quasi-judicial powers in relation to licensing and enforcement. The Subcommittee recommends creating a Board that is either an independent executive branch authority with access to the administrative resources of one or more agencies, or alternatively embedded within an executive branch entity such as the Department of Liquor and Lottery or the Agency of Agriculture, Food and Markets.

This would effectively mean that while the legislature would create the laws, the control over licensing, regulation, and distribution would actually be an Executive branch function. In addition to the two agencies mentioned above, the report suggests that the Department of Health and Department of Public Safety should also be included and that “the Vermont Marijuana Registry should also have an advisory role on the Board or be regulated by the Board.”

The report recommends that “public members and members with industry expertise should also be involved in the Board,”  but not necessarily actual voting members of this hypothetical board. Creating the board would also include a conflict of interest provision prohibiting members or members’ immediate families from maintaining any financial interest in the marijuana industry, and from holding any elected or appointed political office.

Types of Licenses

This question of structure is probably where we should have started, but going in chronological order of the report itself (about 85 pages total), it’s not until later that we get any insight into the actual licenses. To frame the license structures, the report itself reminds the reader that for all license types, one of the primary concerns is preventing diversion.

Overall:

  • Vermont residency will not be a requirement for any license types, but for scoring cultivation license applications, preference will be given to Vermont residents.
  • In order to prevent monopolies, licensees will only be able to hold one license per category.
  • Background checks will be required for all decision-makers at licensees. Prior non-violent drug convictions should not be considered disqualifying, but felonies would be disqualifying; there would be an appeals process for specific denials (e.g. if you have a nonviolent cannabis felony).
  • All licenses will be specific to the individual(s) and non-transferrable.

1. Cultivation

  • Overseen by the Agency of Agriculture, Food, and Markets (AAFM); cultivation GPS locations will be shared with AAFM, but not publicly available
  • Cultivation licenses will be structured on a tiered basis according to the total square footage of the canopy size of flowering plants, and possibly also including the drying, curing, storage space
  • Unlimited number of licenses for the smallest size tier, possibly 500ft^2 – 1000ft^2
  • At the start of legalized sales, only smallest tier licenses available to encourage small producers to enter; medium and larger-scale cultivators phased in over time
  • Maximum fee amount per tier, but final fee amounts to be determined by licensing authority (Control Board)…so, tbd

2. Processor:

  • Overseen by the Agency of Agriculture, Food, and Markets (AAFM); processor GPS locations will be shared with AAFM, but not publicly available
  • Extraction methods limited to CO2 or Ethanol
  • In the retailer section, the subcommittee recommends restricting or prohibiting the sale or gifting of materials used for home extraction.
  • Processors may also be allowed to transport.
  • No number, size, or annual cost provided

3. Retailer:

  • Overseen by the Department of Liquor and Lottery
  • Sales only allowed at the retailers’ licensed location, no mobile sales at Farmers’ Markets or via food trucks permitted
  • Residential deliveries should be further considered
  • No consumption at any retail locations, including no free samples;
    • No self-service, including vending machines
  • Recommend considering a prohibition of drive-through facilities
  • Restrict sales to certain hours, such as 7:00am – 10:00pm
  • No discounts or gifts conditioned on the sale of other items (e.g. no ‘buy two joints, get the third half off’)
  • The subcommittee represents creating a separate ‘sales representative’ license similar to the sales representative license for alcoholic beverages, which would only be available to the smallest tier of cultivators. This would allow small tier cultivators with a sales representative license to sell products directly to consumers, but would still be subject to the same rules as retailers (testing, no consumption on site, hours, etc)

4. Transporter:

  • Overseen by the Department of Liquor and Lottery
  • Wholesalers and processors may be allowed to transport, but this more specific license would be available
  • If residential deliveries are allowed, the transporters could possibly distribute but would need additional training

5. Testing:

  • Overseen by the Agency of Agriculture, Food, and Markets
  • Create testing license that will allow both in-state laboratory testing of products, and in-state research by public or private institutions
    • This would allow for state funding to be used for public health research
  • Licensed laboratories would be run by the private sector, but regulated by the State

Advertising, Edibles, and Other Details:

While not everyone owns a cannabis media company and care as much as me personally, the subcommittee suggests that the advertising restrictions will be the same on cannabis as are presently on the alcohol industry:

  • Ads may not be enticing to minors — Ads may not use images of minors, cartoon characters, toys or items that are typically marketed to those under 21, candy-shaped edibles, etc
  • Ads may not promote excessive use — ads may not display consumption, encourage use because of intoxicating effects, or encourage excessive or rapid consumption
  • Ads may not contain deceptive, false, or misleading statements — ads may not assert that cannabis is safe or make claims to being ‘organic,’ unless the plants used are produced, processed, and certified according to national organic standards
  • Prohibited modes of advertising — marijuana establishments may not advertise products via flyers, television, radio, billboards, print or internet unless the licensee can show that no more than 30% of the audience is reasonably expected to be under 21 (this is the same as Colorado).

Significantly, this subcommittee is not recommending a prohibition on edible products. Rather, the edible restrictions are related to packaging and dosage. For packaging, the report recommends a similar approach to Colorado and Washington with child resistant packaging. The labels would also all have a universal THC symbol and have warnings of the products.

In terms of dosage, the subcommittee is also recommending following the lead of Colorado and Washington in requiring that products have no more than 10mg of active THC per serving and that there be a maximum of 100mg of THC per package.

Finally, the subcommittee recommends prohibiting the sale of any marijuana mixed with products containing caffeine, nicotine, or tobacco, or alcohol, out of a concern for cross addiction between products. For any questionable products, the subcommittee recommends a listing committee that would act similarly to alcohol and ensure that marijuana products are suited for the market through a vetting process.

Not Allowed…Yet:

The report affirms the Office of the Vermont Attorney General’s July 23, 2018 advisory memo that expressly prohibits ‘gifting marijuana for a fee’ and said that “Any transaction whereby goods or services are exchanged for consideration with a purported gift of marijuana shall be prohibited.” In addition to that provision, the report also says that you can’t sell conditional cannabis, in which you’d be required to buy a non-cannabis item in order to buy cannabis.

The report takes a pretty enlightened perspective on the question of residential delivery and recommends, “further consideration” as either an initial provision, or within the first few years of implementation of regulated sales. While there are stated concerns about home delivery of cannabis (same concerns that prevent residential alcohol delivery in Vermont), the subcommittee accurately acknowledges that where delivery is not provided, the illicit market provides it anyways so it’s best to at least consider a delivery option with roll-out.

At least in the initial roll-out, the only place that you’d be legally allowed to consume cannabis is a private place. The subcommittee not only recommends preventing consumption at any of the licensed cannabis businesses mentioned above, but also does not recommend creating a license for a social club or lounge.

From both being present for the discussions, and from the report itself, the lack of lounges or social clubs isn’t necessarily a condemnation of the concept. Rather, the question of “where can I consume legal cannabis” is simply perceived as being too complicated to be included in the initial regulation roll-out by both this committee and thus far, the draft legislation.

Similarly, there’s no mention of a “cannabis lodging license,” but it’s an idea that’s been discussed among advocates and industry stakeholders as a way to advantage small businesses and economic opportunities for the tourism industry.

What About Medical?

Great question. Any kind of adult use legislation will have direct or indirect consequences for Vermont’s nearly 6,000 currently-registered medical marijuana patients, and whether medical marijuana laws change or not, the system still has an impact the entire recreational and medical market.

For those reasons, there are medical marijuana recommendations in this report, but it’s also safe to assume that dispensaries and patient advocates will lobby for medical marijuana reforms in independent bills rather than go all-in on an enormously complicated tax-and-regulate bill. Both in person and this report, the subcommittee expressed concern for the potential danger to the medical marijuana program and unintended consequences on patients and dispensaries.

Patients:

The most significant impact on the entire potential cannabis program is the recommendation that medical marijuana sales be specifically exempt from the proposed marijuana excise tax and sales tax. The report also recommends maintaining or even decreasing patient registration fees and making it easier to get a card via either a simplified process or broader qualifying conditions. The report also recommends allowing patients to purchase from any dispensary they choose instead of a single dispensary as is presently required.

Although specific amounts are not listed, the report also recommends a higher maximum dosage for registered medical marijuana patients than the 100mg maximum recommended for adult use edibles.

Dispensaries:

As mentioned in an earlier section, there is a legitimate possibility that a Cannabis Board of Control created to regulate and oversee adult use cannabis would also be responsible for overseeing and regulating the state’s medical marijuana registry instead of the current Department of Public Safety.

When it comes to the licensing of medical marijuana dispensaries for adult use sales, the subcommittee would recommend allowing dispensaries to participate in the adult use license, but with the same conditions as other participants and without changing their rules for operating existing medical marijuana dispensaries.

Medical marijuana dispensaries should continue to be required to be vertically integrated while operating under medical licenses. This is particularly important to ensure expertise and quality control. However, if a dispensary is operating under a recreational market license, they will not be required to be vertically integrated. They may, like other recreational market licensees, hold not more than one license per license category.

However, later in the report (page 41), the subcommittee shares a much broader range of crossover for dispensaries between the respective medical and adult-use markets.

The question of degree arises, whether dispensaries will automatically qualify for recreational licenses due to the requirements they currently meet, or whether they will need to reapply, and if so, whether they will be given any preference in the application process…

Additional considerations are whether dispensaries will be allowed to purchase from the commercial market to supply patients, and if dispensaries will be allowed to sell their product to the commercial market if it meets the relevant retail standards.

More questions than answers, but it’s very safe to assume that all of Vermont’s present and future medical marijuana dispensaries will be largely-integrated into the adult use market as the only organized entities in Vermont presently licensed and approved to cultivate, package, and distribute any kind of regulated THC cannabis. That said, patient and caregiver concerns have also clearly been heard and incorporated throughout the process and the intent of the subcommittee is clearly to define and distinguish the medical marijuana program rather than destroy it.

CONCLUSIONS:

This report isn’t finalized yet, but by the time that it completely done and submitted to the Governor next month, there will already be draft legislation which might or might not correlate to these recommendations.

Keep in mind that this report happened without the pressure of an active legislative session or a fully-engaged public or stakeholder process. The entire commission process was created by the Governor and his team more for political than practical purposes.

That said, even the biggest Phil Scott cannabis critics — myself included — have to acknowledge that this process represented the first time that the acting state agencies were forced to get involved in the actual details of regulation (i.e. which agency does what, how much it will cost, etc), involved a group of objectively intelligent people and will generate more discussion.

Under the semi-public surface of this process, I also personally learned a LOT about the non-legislative stakeholders who make up the tax and regulate subcommittee and will be significant voices in the larger cannabis conversations for the next few years to come.  Politics makes strange bedfellows and with more political interests involved, voices in the cannabis community are increasingly being amplified and involved.

Stay tuned, the real fun is just getting started…

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SAVE THE DATE: CANNABIS IN THE CAPITOL, FEBRUARY 13, 2019

Heady Vermont is proud to announce that on Wednesday, February 13, 2019, we will host our second annual Cannabis in the Capitol day of education and advocacy. We’ll have much more political reporting and commentary before February, but save the date and join us in Montpelier for a day of advocacy training, legislative outreach, press conference, and an evening Vermont cannabis showcase in the cafeteria from 4-7 p.m.

Read the full Tax and Regulate Subcommittee report here:

[pdf-embedder url=”http://headyvermont.wpengine.com/wp-content/uploads/2018/11/TR-Report-to-MAC-Oct-2018-FINAL-1.pdf” title=”TR Report to MAC-Oct 2018-FINAL (1)”]

TR Report to MAC-Oct 2018-FINAL (1) (1)

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