BILL ANALYSIS                                                                                                                                                                                                    



          SENATE COMMITTEE ON
          BUSINESS, PROFESSIONS AND ECONOMIC DEVELOPMENT
                              Senator Jerry Hill, Chair
                                2015 - 2016  Regular 

          Bill No:            AB 2770         Hearing Date:    June 27,  
          2016
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          |Author:   |Nazarian                                              |
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          |Version:  |June 16, 2016                                         |
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          |Urgency:  |No                     |Fiscal:    |Yes              |
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          |Consultant|Mark Mendoza                                          |
          |:         |                                                      |
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            Subject:  Cigarette and tobacco product licensing:  fees and  
                                       funding


          SUMMARY:  Prohibits revenues derived from the taxes imposed upon the  
          distribution of cigarettes and tobacco products be appropriated  
          to the State Board of Equalization (BOE) for the purpose of  
          implementing, enforcing, or administering the California  
          Cigarette and Tobacco Products Licensing Act of 2003 (Licensing  
          Act); requires BOE to report back to the Legislature, no later  
          than January 1, 2019, regarding the funding adequacy of the  
          Licensing Act; requires the report to include information on the  
          State Auditor's recommendation to eliminate the excess fund  
          balance in the Cigarette and Tobacco Products Compliance Fund  
          (Compliance Fund).

          Existing law:
          
          1) The Licensing Act creates a comprehensive regulatory scheme  
             governing the distribution and sale of cigarettes and tobacco  
             products in this state, and requires the BOE to license  
             manufacturers, importers, distributors, wholesalers, and  
             retailers of cigarettes and tobacco products.  (Business and  
             Professions Code (BPC)  22970 et seq.) 


          2) Requires a retailer to have a license to sell cigarettes and  
             tobacco products in this state.  Requires a retailer to  
             obtain a separate license for each retail location that sells  







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             cigarettes and tobacco products. (BPC  22972)


          3) Requires a retailer license be valid for a 12-month period  
             and be renewed annually.  (BPC  22972(d)) 


          4) Requires retailers to pay an annual fee of $265 for each new  
             retail location, beginning June 9, 2016.  (BPC  22973 (d)) 


          5) Requires retailers to file an application for license renewal  
             accompanied with a $265 per location renewal fee, for  
             calendar years beginning on and after January 1, 2017, in the  
             form and manner prescribed by BOE.  (BPC  22973(e))


          6) Requires that the wholesaler and distributor license be valid  
             for a calendar year upon payment of the license fee. (BPC   
             22975(b)).  


          7) Requires distributors and wholesalers to pay a $1,200 fee for  
             each new location where cigarettes and tobacco products are  
             sold, beginning June 9, 2016.  


          (BPC  22977.1(b))  
          8) Requires distributors and wholesalers to file an application  
             for license renewal accompanied with a $1,200 fee beginning  
             on and after January 1, 2017.  


          (BPC  22977.1(c))
          9) Imposes an excise tax of $0.87 per pack of 20 cigarettes.   
             Revenues from the tax on cigarettes and other tobacco  
             products are distributed as follows:  



             a)   $0.10 to the General Fund (GF) (Revenue and Taxation  
               Code (RTC)  30101 and 30462);










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             b)   $0.50 of the per pack tax and an equivalent rate levied  
               on non-cigarette tobacco products to the California  
               Children and Families First Trust Fund  (Prop. 10) (RTC   
               30122 and 30123);



             c)   $0.25 of the per pack tax and an equivalent rate levied  
               on non-cigarette tobacco products to the Cigarette and  
               Tobacco Products Surtax Fund 


             (Prop. 99) (RTC  30122 and 30123); and

             d)   $0.02 to the Breast Cancer Fund (RTC  30101 and  
               30461.6).





          1) Imposes a tax upon the distribution of tobacco products,  
             based on the wholesale cost of these products at a tax rate  
             that is equivalent to the combined rate of tax imposed on  
             cigarettes.  (RTC  30123)





          2) Imposes an additional tobacco products tax at a rate  
             equivalent to the $0.50 per pack cigarette tax.  (RTC   
             30131.2)


          This bill:

          1) Prohibits revenues derived from the taxes imposed upon the  
             distribution of cigarettes and tobacco products be  
             appropriated to the BOE for the purpose of implementing,  
             enforcing, or administering the Licensing Act.








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          2) Restates that BOE is required to report back to the  
             Legislature no later than January 1, 2019, regarding the  
             adequacy of funding for the Licensing Act.  Requires the  
             report to include data and recommendations about whether the  
             annual licensing fee funding levels are set at an appropriate  
             level to maintain an effective enforcement program. 

          3) Requires that the report mentioned in Item #2), above,  
             include information on BOE's compliance with the State  
             Auditor's recommendation in the State Auditor's March 2016  
             report to eliminate the excess fund balance in the Compliance  
             Fund.

          
          FISCAL  
          EFFECT:  This bill has been keyed "fiscal" by Legislative  
          Counsel.  According to the Assembly Appropriations analysis  
          dated on May 18, 2016, this bill would result in minor costs to  
          provide a required report six months sooner than required under  
          current law and to provide additional information.  

          
          
          COMMENTS:
          
           1.  Purpose.  The  Author  is the Sponsor of this bill.   
              According to the Author,  AB 71  (J. Horton, Chapter 890,  
              Statutes of 2003) was intended to reduce illegal sales of  
              cigarette and other tobacco products within the state.   
              However, the one-time licensing fee is not adequate to cover  
              costs associated with maintaining a viable enforcement  
              program.  Inadequate funding of this program can lead to  
              lack of field enforcement or a reduction in compliance  
              staff, which leads to further decrease in funding.  Field  
              enforcement is crucial to help maintain Master Settlement  
              Agreement (MSA) compliance and enforce the Stop Tobacco  
              Access to Kids Enforcement (STAKE) Act.  This bill benefits  
              businesses as it stops violators from circumventing the law  
              and competing with legitimate businesses.  The goal of the  
              licensing program is to decrease untaxed tobacco  
              distributions and reduce illegal sales of cigarettes and  
              tobacco products.  Furthermore, this bill protects the  
              viability of tobacco health and education programs by  








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              ensuring that the licensing program is funded by the  
              licensing fee revenue.  This bill will eliminate the need to  
              divert tobacco excise taxes, from their intended purpose, to  
              instead pay for the deficit in the tobacco licensing  
              program.

           2.  California Entered Master Settlement Agreement.  In the  
              1990s, many states sued tobacco companies for damages  
              related to the effects of smoking.  In 1998, 46  
              states-including California-and the four largest cigarette  
              manufacturers settled these lawsuits with a MSA.  The MSA  
              imposes a variety of obligations on participating tobacco  
              companies, including a requirement to make annual payments  
              to each settling state.  Annual MSA payments to California's  
              state and local governments total hundreds of millions of  
              dollars.



           3.  Licensing Program Supports Activities Related to MSA.   
              Under the MSA, states must maintain accurate records of  
              cigarette sales and must "diligently enforce" various  
              payment requirements related to those sales, including the  
              payment of state excise taxes.  To fulfill California's  
              obligations under the MSA, the Legislature created new  
              programs administered by BOE and Department of Justice,  
              including a new Cigarette and Tobacco Products Licensing  
              Program.  





           4.  BOE Licensing Act.  In 2003, AB 71 enacted the Licensing  
              Act, which established a statewide licensure program  
              administered by BOE to help stem the tide of untaxed  
              distributions and illegal sales of cigarettes and tobacco  
              products.  Prior to the bill, BOE's Investigations Division  
              had been encountering a large number of cigarettes and  
              tobacco product distributors who were unlicensed.  The  
              purpose for being unlicensed is to conceal the nature of  
              their business and to evade the tax.  These unlicensed  
              distributors normally maintain minimal assets and are  
              typically transient, which hinders BOE'`s ability to collect  








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              the taxes due and payable.




              The Licensing Act requires every retailer, distributor,  
              wholesaler, manufacturer and importer to obtain and maintain  
              a license to engage in the sale of cigarettes or tobacco  
              products.  Once licensed, businesses are subject to  
              recordkeeping and inspection requirements.  Currently, BOE  
              has approximately 38,000 retailers and 1,000 distributors  
              and wholesalers licensed to engage in the sale of cigarettes  
              and tobacco products in California.  

              Violations of the Licensing Act include, in part, the  
              following:  1) Possession, storing, owning, or has made  
              sales of an unstamped package of cigarettes bearing a  
              counterfeit California tax stamp or tobacco products on  
              which tax is due but has not been paid; 2) Sales of  
              cigarettes or tobacco products to any distributor,  
              wholesaler, importer, retailer, or any other person who is  
              not licensed or whose license has been suspended or revoked;  
              3) Retailer and wholesaler purchases of cigarette or tobacco  
              products from any person who is not licensed or whose  
              license has been suspended or revoked; 4) Distributor  
              purchases of cigarettes or tobacco products from any person  
              who is required to be licensed pursuant to the Licensing Act  
              but who is not licensed or whose license has been suspended  
              or revoked; 5) Failure to maintain records or make such  
              records available to BOE and law enforcement agency, as  
              specified; 6) A person or entity that engages in the  
              business of selling cigarettes or tobacco products in this  
              state without a license or after a license has been  
              suspended or revoked; and 7) Failure to allow an inspection.


           5.  Cigarette and Tobacco Products Taxes Revenues.  The  
              revenues from excise taxes on cigarettes and tobacco  
              products are deposited into four funds.  The allocation of  
              funds is as follows:  of the total $0.87 tax per package of  
              20 cigarettes, ($0.10) is deposited into the Cigarette Tax  
              Fund, and $0.02 goes into the Breast Cancer Fund.   
              Twenty-five cents is deposited into the Cigarette and  
              Tobacco Products Surtax Fund and may only be used for the  








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              following purposes: 


              a)    Tobacco-related health education programs and disease  
                research.


              b)    Medical and hospital care and treatment of patients  
                who cannot afford those services, and for whom payment  
                will not be made by any private coverage or federal  
                program.


              c)    Programs for fire prevention; environmental  
                conservation; protection, restoration, enhancement, and  
                maintenance of fish, waterfowl, and wildlife habitat  
                areas; and enhancement of state and local parks and  
                recreation.


              Fifty cents is deposited into the California Children and  
              Families Trust Fund and is used for programs that encourage  
              proper childhood development, including the development of  
              professional and parental education and training, informed  
              selection of childcare, development and education of  
              childcare providers, and research into the best practices  
              and standards for all programs and services relating to  
              early childhood development.


              According to the BOE, in fiscal year 2014/2015, California  
              received $835 million from taxes on cigarettes and other  
              tobacco products.  These funds were allocated as follows:


              a)    Cigarette Tax Fund - $86 million;


              b)    Cigarette and Tobacco Products Surtax Fund - $268  
                million;


              c)    Breast Cancer Fund - $20 million; and









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              d)    California Children and Families Trust Fund - $461  
                million.  


           1.  BOE Licensing Act Issues.  As AB 71 was developed and made  
              its way through the Legislature, it was determined that the  
              licensure fees would not permanently sustain the Licensing  
              Act program.  Since the Licensing Act enforces the Cigarette  
              and Tobacco Products Tax Law (RTC  30001, et seq.), and  
              directly benefits the funds established pursuant to that  
              program, the funding for the Licensing Act would eventually  
              shift to the cigarette and tobacco products tax funds:  
              General Fund, Breast Cancer Fund, Cigarette and Tobacco  
              Products Surtax Fund (Prop. 99) and California Children and  
              Families Trust Fund (Prop. 10).  However, there was concern  
              about the Licensing Act program and the impact it would have  
              on the cigarette and tobacco products tax funds if the  
              Licensing Act expenses were more than the revenues  
              generated.  To address this concern, a sunset date of  
              January 1, 2010, was incorporated into the Licensing Act to  
              ensure it would not harm the cigarette and tobacco products  
              tax funds.  Furthermore, AB 71 included uncodified language  
              to clarify that all revenues and expenses generated by the  
              Licensing Act are to be allocated in the same manner as  
              those revenues and expenses are allocated under the  
              Cigarette and Tobacco Products Tax Law to make sure no one  
              cigarette and tobacco product fund benefited or was burdened  
              when the funding shift took place.  In 2006,  AB 1749  (J.  
              Horton, Chapters 501, Statutes of 2006) repealed the sunset  
              date for the Licensing Act due to the amount of additional  
              excise tax revenues generated.  The BOE has estimated that  
              the Licensing Act and enhanced cigarette tax stamp generates  
              an additional $66.8 million in cigarette excise tax  
              annually.  The Licensing Act generates an additional $24.5  
              million in additional tobacco products tax.  The resulting  
              additional sales and use tax revenue is estimated to be  
              $44.4 million annually.


           2.  State Auditor Report.  In March 2016, the California State  
              Auditor released a report concerning the costs of the  
              Cigarette and Tobacco Products Tax Program and the Cigarette  
              and Tobacco Products Licensing Program administered by the  








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              BOE. 


              The report concludes that although the BOE's enforcement  
              efforts are effective and properly funded, other funding  
              options and cost saving measures exist for the licensing  
              program.  In 2004, the BOE implemented the licensing program  
              and began licensing all entities involved in the sale of  
              cigarette and tobacco products in California, with a goal to  
              inspect annually 10,000 of these licensees.  In 2005, the  
              BOE tax program put into use an encrypted cigarette tax  
              stamp.  According to the BOE's most recent estimate, in  
              fiscal year 2012/13 the BOE's three-part approach to  
              enforcing compliance with California's cigarette and tobacco  
              products excise tax laws-licensing, inspections, and an  
              encrypted cigarette tax stamp-prevented the loss of $91  
              million in tobacco tax revenue.


              The report found since fiscal year 2006/07, license fees  
              have not covered all of the licensing program's costs.  For  
              example, in fiscal year 2014/15 licensing fees contributed  
              only $1.8 million of the $9.8 million needed to administer  
              the program.  To make up the program's $8.0 million  
              shortfall, the BOE uses money from the four funds that  
              receive cigarette and tobacco products taxes (see above).   
              Although it is legally permissible to use excise taxes to  
              fund the licensing program, the BOE has accumulated an  
              excess amount of unspent license fees that it could use to  
              offset the shortfall. 


              The report makes several recommendations for handling the  
              $8.0 million shortfall, including, encouraging the  
              Legislature to pass legislation to implement a funding model  
              that will include a license fee increase or a combination of  
              license fee increases, continued use of money from the  
              Cigarette Tax Fund, and a cigarette tax increase.


           3.  BOE Report.  In 2014, representatives from Prop. 10  
              programs expressed concern about the administrative costs  
              and funding of BOE's Cigarette and Tobacco Program resulting  
              in reduced funds for other special programs, and the  








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              Legislature required BOE to report back with other funding  
              options.  Some of BOE's proposals include: 


              a)    Instituting a recurring fee at the retail level to  
                increase the share of costs covered by the licensing fees;


              b)    Increasing the taxes assessed on cigarettes and  
                tobacco products by an unspecified amount;


              c)    Tax electronic cigarettes, dissolvable tobacco, and  
                other recently developed products by expanding the  
                definition of tobacco product; 


              d)    Paying for the cigarette and tobacco products  
                licensing program with funds from the GF; and,


              e)    Reduce spending and cap administrative costs on the  
                cigarette and tobacco products licensing program.


              The Legislative Analyst's Office briefly notes that closing  
              the funding gap through reduced spending would be risky  
              because the Legislature created the licensing program to  
              comply with the MSA requirement for diligent enforcement of  
              tobacco laws, and states found not to be diligent have had  
              their revenues reduced.


           1.  Arguments in Support.   First 5 California  offers its  
              "strong support of AB 2770 (Nazarian), which would prohibit  
              the taxes imposed upon the distribution of cigarettes and  
              tobacco products to the Board of Equalization (BOE) for the  
              purposes of implementing, enforcing, or administering the  
              Cigarette and Tobacco Products Licensing Program. The bill  
              also would require the BOE to report to the Legislature  
              annually regarding the adequacy of funding for the licensing  
              program."










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          SUPPORT AND OPPOSITION:
          
           Support:   

          First 5 California

           Opposition:  

          None on file as of June 21, 2016. 

                                      -- END --