Failure to Launch: The case for Canadian excise tax reform
Since 2018, cannabis legalisation in Canada has generated billions in GDP and tax revenue, created tens of thousands of jobs, and made deep dents in the illicit market. But as the market matures, the cannabis excise tax system is threatening the financial viability of smaller and independently-owned operators - the lifeblood of the Canadian cannabis industry.
Hanway Associates is pleased to have collaborated with Tantalus Labs and the #Stand For Craft campaign to co-author ‘Failure to Launch’, a report that calls attention to the urgency of cannabis tax reform in Canada.
The problem? An excise tax that doesn’t match market realities.
Canadian cannabis producers and processors pay excise duty when they supply product to wholesalers. Excise duty is set at 10% of the product’s price, with a $1 per gram minimum floor. This setup yields a manageable 10% tax rate when wholesale pricing is $10 per gram (approx £6.40) or more - but average pricing has long sat far below this level.
Many Canadian craft producers currently achieve wholesale prices of $4 per gram or less - an effective tax rate of 25%. This proportion is higher still for some processed products and formats with a lower cost-per-gram.
With such a high proportion of operator’s revenues falling to excise tax, many craft Canadian cannabis producers are struggling just to break even.
Financial modelling by #Stand for Craft finds that even as operators scale from a start-up to $20m annual revenue, the $1 per-gram excise floor stands in the way of producers generating positive revenue. Report survey data from over 40 Canadian craft cannabis producers supports this, revealing that over 60% of respondents had failed to make a profit in the last year. Even among those that were profitable, not a single company turned a profit for more than 3 months out of the year.
A cost that Craft Cannabis can’t afford
Without meaningful tax reform, hundreds of cannabis operators are at risk of folding. Small-to-medium and privately-owned companies form the backbone of Canada’s cannabis sector. Of 850 licences, 350 are held by micro-cultivators and processors.
In contrast, there are just two-dozen publicly-traded Canadian cannabis companies with quarterly revenues over $2.5m. Independent cannabis operators invest in and hire from local communities across Canada, particularly in rural areas that have struggled with economic decline, and in regions where illicit cannabis production has thrived.
While excise duty rates affect all cannabis operators, large publicly-listed companies have so far survived in the face of growing losses thanks to significant investor subsidy. Most craft cannabis producers lack this access to capital, and are unable to sustain their razor-thin margins. Ironically, this threat faces craft cannabis producers even if they continue to secure an ever-growing market share at the expense of large, publicly-listed LPs.
On many metrics, Canadian legalisation is an economic success. As of 2021, legal operations account for over two-thirds of the total cannabis industry - up from 4% in 2017. Total cannabis GDP has doubled over this period, but the size of the illicit market has been slashed by third. According to Deloitte, the sector has generated more than $15 billion in direct and indirect tax revenue and created more than 151,000 jobs since legalisation.
But these successes cannot continue if many of Canada’s craft cannabis producers remain at the brink of bankruptcy. Luckily, there are many potential options to tweak the current excise system, such as a tiered tax rate that has been employed effectively in Canada’s craft beer sector. If this fails to happen, the policy successes enjoyed by the Canadian model of legalisation could easily reverse.
If the industry falters, consumers will be faced with the choice of a competitive illicit market or the offerings of a dwindling base of legal suppliers, including those consumers have already voted with their wallets to shun.
A case study for future cannabis markets
Charlotte Bowyer, Head of Advisory at Hanway Associates and report co-author says:
“The situation facing Canadian cannabis producers is relevant for all current and future cannabis markets across the world. For regulated cannabis to compete with the illicit market, legal cannabis businesses must be able to financially sustain themselves. In Canada, excise taxes now represent the biggest systemic blocker to the economic viability of the industry.
There are many balances to be struck through cannabis taxation - covering the costs of regulation, not overly-incentivising consumption, and keeping prices competitive with unregulated alternatives. The tax burden on producers themselves is one that cannot be overlooked.
It is important for countries developing their own legal cannabis frameworks - be that Germany, Mexico, Switzerland or Portugal - to consider not just the policy objectives that they wish to advance, but the economic realities that must be balanced to help see these through.”
You can read coverage of the #Stand for Craft campaign in Forbes, StratCann and Leafly and access the full report here for free.
