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 discussed 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 recommendations 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 task 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 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 to 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 with 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 and are attached. The ordinance implementing the recommended code amendments introduced for first reading on August 24, 2022 and approved on September 14, 2022 is now in effect.
During the most recent Cannabis task force meeting, the task force had a lengthy discussion on the financial challenges facing the cannabis industry and the financial considerations Councilmembers should consider when evaluating any changes to the 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 unlicensed 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 retail 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 move readily across the state. Cathedral City’s cultivation taxes are higher than other Coachella Valley cities.
The task force believed decisions regarding the cannabis industry and city tax revenues need to focus on the long-term survival of the industry within Cathedral City. There is concern the current tax status of the industry is not sustainable. Current trends indicate there will be fewer retail stores and cultivators resulting in the loss of valued jobs and city revenue. The task force believes lowering tax rates are necessary for the long- term survival of the industry.
As Council requested, the task force briefly discussed the manufacturing taxes on the per piece products produced, primarily pre-rolled joints. At a wholesale price of approximately $1.50 each, the 40 cent per piece tax represents an effective tax rate of approximately 27%, or 1,350% higher than surrounding cities. A manufacturing tax rate in the range of 3 to 5 cents per piece would come closer to the target rate of 2%.
During the November 30, 2022, study session, Council instructed Staff to evaluate (i) competitive advantages or disadvantages facing Cathedral City cannabis businesses resulting from Cathedral City tax structures; (ii) the business environment facing Cathedral City cannabis business owners; and (iii) the impact of the cannabis industry on Cathedral City’s police and fire departments.
DISCUSSION:
The issues confronting the cannabis industry are the result of numerous factors outside the control of any one city council. Local taxes however are within the control of local councils. While changes in local tax rates will not alleviate the negative other-cause impacts, changes to our local cannabis tax rates signal to Cathedral City cannabis businesses (i) the cannabis industry is a valued industry sector, (ii) modifications to existing tax rates can reduce or eliminate financial incentives for Cathedral City cannabis to relocate to adjacent cities (e.g., manufacturing), and (iii) tax relief is still relief and can help reduce the number of problems facing the cannabis industry. To quote a cannabis cultivator, “while there are multiple holes in the boat, plugging one of the holes helps keep our heads above water as we are actively bailing water. It gives us time to solve other problems and adapt to or navigate our way around a changing industry”.
There are multiple forces impacting the Cathedral City cannabis industry. One cannabis owner when asked what was causing problems within the industry, he stated, “death by a thousand cuts”. This business owner went on to state issues impacting the local cannabis industry range from (i) costly monthly private banking fees ($1,500 to $2,000 or more per month); (ii) downward retail pricing pressure resulting from a growing black market; (iii) bank loans more than 30% per annum, (iv) federal taxes being paid on net gross revenue (gross revenue less cost of goods) verses what all other businesses are typically allowed (gross revenues after deducting standard business expenses and costs of goods sold) and (v) high city taxes result in sales lost to lower tax cities and the black market.
Neighboring Jurisdictions’ Taxes
Staff reviewed cannabis taxes in the cities of Palm Springs, Palm Desert, Desert Hot Springs, and Coachella. Currently, La Quinta, Indian Wells and Rancho Mirage do not allow cannabis businesses. On July 20, 2022, the city of Indio authorized the opening of no more than five dispensaries within city limits. A dispensary tax rate has not been determined however, given other Valley cities’ 10% retail tax rate and city of Coachella’s 6% retail tax rate, Council is discussing a retail fee approximating a tax rate of 5% or 6%. Dispensaries are the only type of cannabis business the Indio City Council has authorized.
Coachella Valley City Cannabis Tax Rates by Discipline
City Retail/
Dispensary Cultivation Manufacturing Distribution Testing Cathedral
City
10% on
Gross
Proceeds
$15.00 per sq.ft.
$.05/Crude gram
-
$.10/Distillate gram
-
$.40/Other type item*
Zero** Zero
Coachella
6% on
Gross
Proceeds
In 2023: 3% of
Gross Receipts.
In 2024: 2% of
Gross Receipts
2% on
Gross Receipts Zero Zero
Desert
Hot
Springs
10% on
Gross
Proceeds
$10.20 per sq.ft. Zero Zero Zero
Palm
Desert
10% on
Gross
Proceeds
$13.00 per sq.ft. 2% on
Gross Receipts Zero Zero
Palm
Springs
10% on
Gross
Proceeds
$10.00 per sq.ft. 2% on
Gross Receipts Zero Zero
Indio
Evaluating
5% or 6% on
Gross
Proceeds
Not allowed Not allowed Not allowed Not
allowed
Note:
*: Given current wholesale price of approximately $1.50 per item on pre-rolls, the .40 cent per item tax represents an effective tax rate of 27%. **: For cannabis products produced within Cathedral City, there is zero tax on distribution.
Cannabis Industry through the eyes of Cathedral City cannabis business owners:
The City Manager’s office contacted all currently licensed Cathedral City cannabis businesses and requested participation in an online survey and interview. Out of 41- total businesses, 13 businesses responded. Eleven businesses completed the survey and were interviewed. Survey and interview results are summarized in Exhibit “A” and Exhibit “B”.
Police and Fire Department Calls for Service
The Police Department pulled call for service records dating back to January 2020, for Cathedral City cannabis businesses. Fifty (50) cannabis businesses were evaluated and included businesses within the cultivation, manufacturing, and dispensary space. There were 184 calls for service. Of the 184 calls, 37 calls, or 20.11%, were Fire Department/Medical related. The remaining 147 calls were handled by the Police department. Of the 147 calls, 122 calls were routine in nature (patrol check, trespass, suspicious circumstances, or other disturbance). During the reporting period, there was 1 brandishing-a-weapon, 2 domestic disturbances, 1 burglary, 5 thefts, and 10 transient- related calls for service. Exhibit “C” summarizes the various calls.
As previously stated, the issues confronting the cannabis industry are varied and largely outside the control or influence of our City Council. What is within the control of this Council are local taxes. The cannabis task force and city staff have concluded the following changes will bring some relief to Cathedral City cannabis businesses, may stabilize local sales, and decrease or eliminate financial incentives for Cathedral City cannabis businesses to relocate to other lower tax jurisdictions.
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. In calendar year 2022, total cannabis taxes paid to Cathedral City were $3,693,000 (est.).
Based on 2022 collections, each 1% reduction in the retail tax should result in a revenue loss of $125,000/year.
A reduction in the cultivation tax rate to from $15 to $10/square foot would result in a revenue loss of $710,000. The reduction assumes current cultivation activity remains constant and no Cathedral City businesses relocate their operations to take advantage another jurisdiction’s tax environment.
A reduction in the per gram or per item manufacturing tax would have a negligible cost impact as there are very few manufacturers left in the City. If manufacturers returned to Cathedral City to resume manufacturing operations, a reduction in manufacturing taxes could then result in additional taxes.