With the passage of Issue 2 on November 7, it’s high time we took a look at the tax implications of the new law, which includes a 10% excise tax on sales of cannabis from a licensed dispensary. Dubbed “An Act to Control and Regulate Adult Use Cannabis” (the “Act”), the passage of Issue 2 created new chapter 3780 of the Ohio Revised Code (“R.C.”). Unlike Issue 1, which amended the Ohio Constitution, the provisions of the Act can be altered by the Ohio legislature. Already, State Treasurer Robert Sprague (not a current member of the legislature) has called the 10% rate “way too low,” saying it would have to be at least 20% to pay for the new infrastructure needed for the regulation and services related to adult use cannabis. Sprague also noted, “they’re going to have to change the way the tax is divvied up,” expressing a preference that more revenue go to the state rather than local governments.[1]
Revenue Projections
The 10% excise tax is not the only tax to which adult use sales will be subject. Ohio sales tax will also apply to each sale of adult use cannabis at a dispensary, adding another 5.75% for the state and anywhere between .25% and 2.25% for the county, depending on the local add-on rate. Although Treasurer Sprague correctly noted that the rate in the Act was “one of the lowest in the country,” Ohioans living near the northern border may be aware that the state up north also imposes a 10% excise tax plus a 6% standard sales tax rate on adult use cannabis sales, making Ohio’s current rate competitive with its neighbor. Whether an increase in Ohio’s excise tax rate will send residents across the border for their purchases depends on a number of factors, including the overall price inclusive of tax, comparative distance between the nearest Ohio and Michigan dispensaries, and whether the purchaser has good tunes to listen to on the way. A more important concern is keeping the tax low enough that the legal adult use market undercuts the black market for the same product. In the latter, there are no taxes collected (even though they are due and payable) but prices are typically elevated to compensate for the risk of participating in an illegal activity.
The Drug Enforcement and Policy Center at the Ohio State University Moritz College of Law has estimated the expected revenues (excise plus sales tax) from adult use cannabis in Ohio, based on the current rates (16% to 18.25%). Using other adult use states to help with modeling, particularly Michigan because of its almost identical tax structure for cannabis sales, the Center projects between $182,007,709 and $218,409,251 in year two (first full year) of operations, increasing to between $276,287,702 and $403,620,296 in year five. The range in the year two estimate is due to different assumptions about the relative price of the cannabis product itself; the range in year five is partially that and partially due to different assumptions about the annual growth rate in sales, though all assumptions include a diminishing rate of growth after year two.[2]
How would the revenue be used?
Prior to any possible change by Ohio’s legislature, the tax revenue from the adult use excise tax is to be split as follows:
- 36% to the municipal corporations or townships that have dispensaries, “for any approved purpose.”
- 25% to the Department of Mental Health and Addiction Services (“MHAS”) “to alleviate substance and opiate abuse and related research in the state under section 3780.30 of the Revised Code.” R.C. 3780.30 is a new section that provides guidance on the use of these funds and states that treatment and prevention services supported by [this] money must be certified by MHAS.
- 3% is split between the Division of Cannabis Control, newly established within the Ohio Department of Commerce to regulate the adult use cannabis industry, and the Tax Commissioner to defray the costs of administering the new excise tax.
- The other 36% will fund the “Cannabis Social Equity and Jobs Program,” to be established and managed by the Ohio Department of Development (“DOD”) in coordination with the Division of Cannabis Control. This program is described in new R.C. sections 3780.18 and 3780.19. Per R.C. 3780.18(H), “in the interest of remedying the harms resulting from the disproportionate enforcement of marijuana-related laws, [the] program shall provide financial assistance and license application support to individuals most directly and adversely impacted by the enforcement of marijuana-related laws who are interested in starting or working in cannabis business entities.” In administering this program, DOD will establish a system of certifying program applicants based on demonstrated social and economic disadvantages that they face. If done effectively, this program should bring some of the business benefits of the adult use program to small operators that might otherwise be shut out by established players in other states who have the means to establish themselves in Ohio.
The sales tax that will be collected in addition to the excise tax has no special limitations or allocations under the Act.
Flour Power
Many tax practitioners enjoy the sales tax space because of the thorny conceptual issues that arise, and the application of Ohio’s current sales tax law to adult use cannabis products leads to at least one such issue: does the sales tax apply to so-called “edibles,” foods such as brownies and gummies that have cannabis or its THC derivative baked (or otherwise processed) into them? And if the tax applies, what is the statutory basis for this application? The question arises because of the exemption found at R.C. 5739.02(B)(2) for “sales of food for human consumption off the premises where sold,” of all exemptions perhaps the most frequently used by consumers in Ohio. This statutory exemption is required by Article XII, Section 3(C) of the Ohio Constitution, which provides the legislature with the power to impose excise and franchise taxes, but states that “no excise tax shall be levied or collected upon the sale or purchase of food for human consumption off the premises where sold.” If cannabis edibles are ultimately held to be “food” as that term is used in Article XII, Section 3(C), they could not be subjected to either the adult use excise tax or the sales tax.
The Ohio Department of Taxation (“Department”) might very well take the position that the food exemption does not apply to cannabis-containing edibles, meaning these toothsome products will be subject to the sales and excise taxes, removing a possible economic incentive for consumers to favor edibles over smokable cannabis: flour over flower, so to speak. The Department already taxes edibles sold legally as medical marijuana and this position is consistent with the sales tax holiday provision passed as part of the biennial operating budget (H.B. 33) that excepts “an item that contains marijuana” from the mostly broad, holiday-related exemption. See R.C. 5739.01(UUU).
In search of a legal basis for the Department’s position on edibles, we begin by looking at the definition of “food” found at R.C. 5739.01(CCC)(1):
- “Food” means substances, whether in liquid, concentrated, solid, frozen, dried, or dehydrated form, that are sold for ingestion or chewing by humans and are consumed for their taste or nutritional value. “Food” does not include alcoholic beverages, dietary supplements, soft drinks, or tobacco.
While the edible cannabis product meets the form requirement (a rather low bar) and is sold for ingestion or chewing by humans (one hopes), the Department, presumably, would base its position on the “consumed for their taste or nutritional value” clause. Cannabis is not known for its flavor, nor for contributing to the growth or replacement of bodily tissue (i.e., nutrition). However, an argument could be made that an edible is consumed for its taste (i.e., emphasis on the brownie, not the cannabis), and while the nutritional value of a brownie or gummy bear may be questionable, there is no reason cannabis cannot be baked into a more nutritious product. One can imagine the marketing of a “Whole Wheed Bread” sporting a tagline such as “whole grain for the whole brain.” Stranger things have been done to avoid the reach of a tax levy.
Looking at the specific exceptions to the “food” definition, it might appear at a glance that the exception for “dietary supplements” applies to edible cannabis products, since they are “not represented as conventional food for use as a sole item of a meal or of the diet,” a part of the “dietary supplement” definition found at R.C. 5739.01(CCC)(2)(a). However, that definition also requires that, to be a “dietary supplement,” the item must be “required to be labeled as a dietary supplement, identifiable by the ‘supplement facts’ box found on the label, as required by 21 C.F.R. 101.36,” a regulation of the U.S. Food and Drug Administration (“FDA”). Cannabis is still illegal under federal law, is not defined as a dietary supplement by the FDA, and does not fall under the dietary supplement labeling requirements of 21 C.F.R. 101.36.[3]
Nor is cannabis an alcoholic beverage, soft drink, or tobacco, although if cannabis is added to one of these products, it would be taxable because those products are excepted from the definition of “food.” Since it is not expressly excluded from the definition of “food” in R.C. 5739.01(CCC)(1), the most straightforward solution for ensuring the application of sales tax to edible cannabis products is for the legislature to add “anything containing cannabis or its derivatives” to the short list of exceptions in R.C. 5739.01(CCC). Of course, the imposition of the adult use excise tax and the sales tax could still be challenged based on the prohibition in Article XII, Section 3(C). The challenge would be that the edibles are “food” as used in that provision and that the General Assembly’s definition of “food” is too restrictive. This argument would have to overcome the deference given to legislative enactments and the presumption that an enactment of the General Assembly is constitutional.
Unless the General Assembly amends the definition of “food” in R.C. 5739.01(CCC)(1), the position that edibles are taxable appears to rest on the proposition that an edible is not consumed for its taste or nutritional value. Given the significant price differential one can expect between an ordinary food product and a similar product that contains some form of cannabis, the Department may have some objective support, the extra money supporting the notion that the product is not purchased for “mere” taste or nutritional value. However, increasing supply and competition within established markets typically lead to lower prices, and this seemingly objective support could go up in smoke.
Other Changes We Might See
Gov. DeWine has publicly discussed other statutory changes, in addition to the issue of the tax rate and disbursement of funds. Other topics mentioned in media accounts include:
- Mirroring indoor cannabis usage prohibitions to those already in place for tobacco usage
- Requiring child-proof containers and warning labels on products
- Protecting children from cannabis-related advertising
- Limiting the concentrations of THC that might be contained in products sold
- Establishing Driving Under the Influence (“DUI”) standards to prevent and enforce safe operating of motor vehicles similar to existing DUI laws for alcohol usage
The Governor has requested of the General Assembly that these statutory changes be enacted prior to the initiated statute’s December 7 effective date, though timing for any legislative action has not been announced.
If you enjoyed this cannabis Buzz or have any questions related to the regulatory regime created by the passage of Issue 2, please contact any of our ZHF professionals.
[1] “Sprague, Faber Say Issue 2’s Tax Rate Much Too Low,” Hannah News, Nov. 2, 2023.
[2] Hrdinova and Ridgway, “What Tax Revenues Should Ohioans Expect If Ohio Legalizes Adult-Use Cannabis? (2023 Update),” Ohio State Legal Studies Research Paper, no. 791 (2023). Available at: https://ssrn.com/abstract=4537855. Another study, “Cost-Benefit Analysis of Ohio’s Recreational Cannabis Legalization” (Oct. 2023) by Scioto Analysis, modeled the revenue at “just over $190 million.” While not specifying the year projected, the study notes that the Ohio State study’s year two projection was “very close to our own estimate,” so the Scioto Analysis study likely intended the $190 million estimate to apply to the first full year of revenues.
[3] For more on the topic of edible cannabis product labeling, see Knutson, “Packaging and Labeling Requirements for Cannabis-Infused Edibles,” Food Safety Magazine, Aug. 8, 2023, available at: https://www.food-safety.com/articles/8796-packaging-and-labeling-requirements-for-cannabis-infused-edibles