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Staff Report
City Council
Item No. 3.D
Meeting Date: November 30, 2022
From: Charles McClendon, City Manager
Title: Cannabis Task Force Update
City Council
RECOMMENDATION:
This item is presented for information, discussion and direction only.
BACKGROUND:
Cannabis businesses became fully legal for both medicinal and adult use with the passage of Proposition 64 by California voters. The full implementation of Prop 64 became effective January 1, 2018. The industry continues to mature in Cathedral City.
Staff provided an update to the City Council at their study session on September 8, 2021, which covered the history of tax collections in Cathedral City and discussed a request from a business owner to consider a retail “tax holiday”. Council decided not to implement a tax holiday.
The Cannabis Task Force met on November 29, 2021. Topics of discussion included the Cathedral City tax structure and tax comparisons with other local cities. The results of the task force meeting were then discuss ed with the City Council on January 19, 2022. Council directed staff to conduct a deeper review of the City’s regulations related to cannabis and the tax structure and report back to the task force and ultimately to the City Council.
A staff working group met during the spring of 2022 and developed some recommended revisions to the municipal code regarding cannabis business regulations. These were reviewed by the Cannabis Task Force on April 11, 2022. The Task Force expressed agreement with the recommen dations of the staff working group regarding revisions to the code, especially those that would align the municipal code more closely with state law. The Task Force was not supportive of lifting the moratorium on new retail licenses south of I -10. The ta sk force also expressed support for some type of tax relief for cultivators, notably limiting the taxable area to the canopy space. There was some support for Council consideration of a reduction in the retail tax rate, at least on a trial basis.
The results of the task force discussion were presented to Council in study session on
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April 20, 2022. In general , Council agreed with the proposed ordinance revisions in some areas and asked for additional information on others. Council agreed with the recommendation to keep the moratorium on new retail licenses in place. A follow up Council study session was held on May 11, 2022 during which the requested additional information was presented and further discussion on taxation occurred. As a result of the discussion, Council provided direction to move ahead with the proposed ordinance revisions, asked for a further discussion on outdoor consumption lounges, provided direction to allow a phase in period for new cultivators prior to taxation beginning and also t o provide for a temporary pause on cultivation taxes during a period of non - operation. There was not support for changing the retail tax and staff was asked to revisit the manufacturing tax structure with the task force.
Further discussions were held wit h the City Council on June 8, 2022 and August 10, 2022. Resolutions amending the cultivation tax definitions to reduce the taxable space and establishing tax exemptions for pre -operational and non -operational businesses were approved on August 10, 2022 an d are attached. The ordinance implementing the recommended code amendments was introduced for first reading on August 24, 2022 and approved on September 14, 2022 and is now in effect.
Taxes in Neighboring Jurisdictions
Staff reviewed the taxes charge d to cannabis businesses in the cities of Palm Springs, Palm Desert, Desert Hot Springs and Coachella. La Quinta, Indian Wells and Rancho Mirage do not currently allow cannabis businesses. Indio recently acted to allow retail storefronts only.
Retail Taxes:
City Tax Rate
Cathedral City – 10% tax on gross proceeds
Palm Springs - 10% tax on gross proceeds
Palm Desert - 10% tax on gross proceeds
Desert Hot Springs - 10% tax on gross proceeds
Coachella - 6% tax on gross proceeds
Cultivation Taxes:
Note: Since some cities have variable rates based on the size of the facility a calculation is included showing the annual tax on a 6,000 square foot facility which is the average among all currently operating cultivation facilities in Cathedral City.
City Tax Rate Tax on 6000 sq. ft.
*Desert Hot Springs - $10.20/sq.’ $61,200
*Coachella - $15/sq.’ up to 20k; $7.50/sq.’ over $90,000 Cathedral City $15/sq.’ $90,000
Palm Desert $13/sq.’ $78,000
Palm Springs $10/sq.’ $60,000
*In addition to the square foot tax, Coachella also charges a gross proceeds tax of 4% *Desert Hot Springs previously had a two -tiered rate structure and recently eliminated the tiers resulting in a rate of $10.20 per square foot regardless of size.
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Manufacturing Taxes:
Coachella - $15/sq.’ up to 20k; $7.50/sq.’ over plus 2% gross proceeds Cathedral City - $.05/gram on crude; $.10/gram on distillate; $.40/gram other Palm Springs 2% tax on gross proceeds
Palm Desert 2% tax on gross proceeds
Desert Hot Springs 0
*The Cathedral City enabling legislation requires a per gram tax on products manufactured. The current schedule was designed to approximate the 2% gross proceeds level. The mix of products produced will affect taxes paid.
Distribution and Testing Taxes:
Coachella - 2% gross proceeds on distribution, 1% gross proceeds on testing Cathedral City - 0 on product cultivated or manufactured (and taxed) in CC Palm Springs - 0
Palm Desert - 0
DHS - 0
Council asked staff a nd the task force to review the per piece element of the manufacturing tax. Crude and distillates are taxed per gram as are other oils.
Individual items, such as pre-rolled joints, are taxed on a per piece basis, currently at 40 cents per piece. Manufac turers have indicated the current rate is prohibitive causing them to operate in other jurisdictions.
DISCUSSION:
The task force had a lengthy discussion on the financial challenges facing the cannabis industry, and also on the financial considerations City Council members must take into account when considering tax policy. It was noted the tax revenues from cannabis businesses are already declining which has been the trend for the past year and half or so.
The task force identified three factors affecting the profitability of the industry:
1. Market saturation - the number of retail outlets in the Palm Springs/Cathedral City market has increased dramatically compared to three years ago.
2. Competition with the “black market”, those selling product from unli censed suppliers.
3. Taxes are higher than retailers of any other product face. The multiple levels of taxation from the state, the city and regular sales taxes make it harder to attract customers and make a profit.
Task force members acknowledged the retai l taxes charged by Cathedral City are in line with those charged by most other cities in the Coachella Valley, but indicated that businesses in those cities, notably Palm Springs are struggling as well.
Task force members also noted that cultivators also are facing increased competition and that unlike retailers, they face competition from a statewide market as product can
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move readily across the state. Cathedral City’s cultivation taxes are higher than other Coachella Valley cities.
It was the consensus of the task force that decisions regarding the cannabis industry and city tax revenue need to focus on the long -term survival of the industry in Cathedral City. There is concern the current status of the industry is not sustainable. Current trends indicate that in the future there will be a smaller number of retail stores and likely fewer cultivators as well. The task force agrees that lower rates of taxation are likely necessary for long-term survival of the industry.
As Council asked, the task force briefly discussed the manufacturing taxes on the per piece products produced, primarily pre-rolled joints. At a wholesale price of about $1.50 each, the 40 cent per item tax represents an effective tax rate of about 27%. The manufacturing tax rates for c rude (5 cents per gram) and distillate (10 cents per gram) were set to try to approximate the Coachella Valley normal manufacturing tax rate of about 2%. Thus, a tax more in the range of 3 to 5 cents per piece would come closer to the target rate.
Recommendations:
Retail tax rate reduction to 5%
Cultivation tax rate reduction to $10 per square foot
Manufacturing per piece rate of 3-5 cents.
FISCAL IMPACT:
In calendar year 2021, total cannabis taxes paid to Cathedral City were $4,971,001. For calendar year 2022, it looks like total taxes paid will be about $3.6 million. Based on estimated 2022 collections, each 1% reduction in the retail tax will result in an additional revenue loss of about $120,000 annually. A reduction in the cultivation tax rate to $ 10 per square foot would result in a revenue loss of about $750,000. A reduction in the per piece manufacturing tax would not have a cost as there is very little, if any, of this type of manufacturing occurring in Cathedral city. It could theoretically r esult in additional taxes if manufacturers resumed such operations.
ATTACHMENTS:
Cannabis Ordinance Amendments September 2022
CC Reso 2022-43
CC Reso 2022-44
Cannabis Tax Graph November 2022