BILL ANALYSIS Ó SENATE COMMITTEE ON BUSINESS, PROFESSIONS AND ECONOMIC DEVELOPMENT Senator Jerry Hill, Chair 2015 - 2016 Regular Bill No: AB 2770 Hearing Date: June 27, 2016 ----------------------------------------------------------------- |Author: |Nazarian | |----------+------------------------------------------------------| |Version: |June 16, 2016 | ----------------------------------------------------------------- ---------------------------------------------------------------- |Urgency: |No |Fiscal: |Yes | ---------------------------------------------------------------- ----------------------------------------------------------------- |Consultant|Mark Mendoza | |: | | ----------------------------------------------------------------- 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 AB 2770 (Nazarian) Page 2 of ? 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); AB 2770 (Nazarian) Page 3 of ? 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. AB 2770 (Nazarian) Page 4 of ? 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 AB 2770 (Nazarian) Page 5 of ? 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 AB 2770 (Nazarian) Page 6 of ? 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 AB 2770 (Nazarian) Page 7 of ? 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 AB 2770 (Nazarian) Page 8 of ? 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 AB 2770 (Nazarian) Page 9 of ? 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 AB 2770 (Nazarian) Page 10 of ? 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." AB 2770 (Nazarian) Page 11 of ? SUPPORT AND OPPOSITION: Support: First 5 California Opposition: None on file as of June 21, 2016. -- END --