Assembly Budget Subcommittee No. 5 on State Administration

Good afternoon and welcome to Assembly Budget Subcommitee 5 on State Administration hearing today. And I just have to share that I got my little coffee and they wrote, Sharon, you got this, queen. So anyhow, welcome everybody.

Today our hearing will focus on our tax agencies, the California Department of Tax and Fee Administration, Board of Equalization and the Franchise Tax Board. This is an in person hearing with all panelists testifying in person.

We will take questions from Members of this Subcommitee after each panel and public comment will be taken at the end of each panel. So every panel then will ask those wanting to comment at each panel.

If you are unable to attend this hearing in person, you may submit your comments via email to the Assembly budget [email protected] all right. With that, we are going to start on our first panel and we our first topic is cannabis and tobacco programs. And if we can have our panelists come on up.

Welcome to our Member Assembly Member Ward from San Diego. And if you can, make sure you please introduce yourself as you make your comment. Sure. Thank you. Welcome everybody.

Good afternoon, Madam Chair and Members of the Committee, I'm Trista Gonzalez, the Director of the California Department of Tax and Fee Administration. I'm joined at the table by Jason Mallett, our Chief Financial Officer. I'd just like to provide a brief overview as we get started.

In fiscal year 2024 and 2025, the CDTFA administered 42 tax and fee programs that generated just under 98 billion in revenue supporting essential public services across California. Of this amount, more than 30 billion was distributed to local governments, including counties, cities and special taxing jurisdictions.

Our focus is fair, efficient revenue collection and enforcement activities that protect compliant businesses. And we have steadily improved our efficiency by reducing the cost to administer every $100 of revenue from approximately $0.81 in fiscal year 2019-2020 to $0.65 in fiscal year 2024 and 2025.

This year's proposals strengthen our ability to enforce new laws involving flavored tobacco, intoxicating hemp and cannabis and maintain the systems that support California's revenue infrastructure. These resources allow CDTFA to continue removing illegal products from the market, protect our communities, and ensure tax fairness across industries. We remain committed to modernization, transparency and responsible Administration of these state programs.

Jason, great.

Thank you.

Thank you, Trista. Hi, Madam Chair and esteemed Committee Members. My name is Jason Mallett, the CFO of the Department of Tax and Fees. And just to frame a little bit extra on what Trista had said, so our revenues were roughly 98 billion last year, just over 80% of that is sales tax.

Another 10% is fuel, and the remaining 10% are the other 41 tax programs. So we'll jump into the BCPS now, if that works.

Thank you. Yes.

Great. All right, so we'll start with cannabis. I'd like to frame the discussion a bit first. So cannabis was legalized in 2016 through Prop 64 with official retail sales beginning in 2018. The policy was structured so the Department of Cannabis Control issues the license to the operators, and CDTFA collects the taxes. Originally, there were three taxes.

There was the cultivation tax on the harvested plant. There was the excise tax on the product, and then also the sales tax on the product. From the outset, there was a steep learning curve for taxpayers because of the three different taxes. There were also challenges in bringing the previously illicit market into the legal system.

So to encourage compliance, starting in 2022, AB195 was passed and simplified the tax code by doing two things. One, it eliminated the cultivation tax, and two, it shifted the excise taxpayer from the distributor to the retailer. AB 195 helped address the learning curve for taxpayers, but our team Members still are finding a significant amount of illicit product.

From CDTFA's perspective, we really have two goals, and this is how it's been and how it continues to be. The first is to bring sellers of illicit product into the legal market through education, outreach, and enforcement. And the second is to collect the right amount of tax as per the law.

This BCP request is for $5.6 million from the cannabis Tax Special Fund, which would increase funding to the level of actual spend last fiscal year 2425. This proposal effectively removes the annual shortfall in the cannabis tax Fund that the General Fund had covered. And with that, I'd like to open it up for any questions.

Why don't we go ahead and do the other bcp? zero, sure. And then we'll go ahead and open it up for questions.

Sounds good. So move on to hemp. Okay. Yes. Okay. Okay. So the background on AB8 is that it was passed last year, and it really does two things. It strictly prohibits tobacco licensees from possessing or selling cannabis or intoxicating hemp at their business. And the second thing is it integrates intoxicating hemp into the state's cannabis framework.

The Bill is implemented in two stages. In phase one, which started this January of 2026, it banned tobacco licensees from selling cannabis or intoxicating hemp. And it requires the CDTFA to seize cannabis and intoxicating hemp from tobacco shops and issue penalties and suspend or revoke a tobacco license for for having cannabis or intoxicating hemp.

The penalties are escalating based on the retail value of the seized goods and the number of violations. There are basically three steps to the escalating penalties. The first is we seize, cite and fine 1 to $2,000. On the second violation, we seize, cite, fine 2,000 to $5,000 and suspend the tobacco license.

And on the third violation, we seize, cite and fine 5 to $10,000 and revoke the tobacco license. That's the first phase that started in a month ago in January. Two months ago in January. The second phase is in January of 28.

This expands the definition of cannabis product to include intoxicating hemp and brings intoxicating hemp into the cannabis tax program. So to implement AB8, CDTFA requests 3.3 million in 2627 and ongoing. This is based on the two implementation phases. The 3.3 million is split between the Cigarette and Tobacco Compliance Fund and the Cannabis Tax Special Fund.

In the budget year, the split is 8515 between the compliance fund and the cannabis fund. And that is based on the percentage of seizures that we the seizure volume that we had last year. And then after the budget year, the split is roughly 80:20 between the compliance fund and the cannabis fund.

As intoxicating hemp is integrated into the cannabis tax program, the rationale for our request is there's significant new workload. One, there are new inspections now that intoxicating hemp is banned. Two, there are now citations through the escalating penalties I described and seizures.

And I would just like to note that doing a citation and a seizure takes twice as long as doing a basic inspection. Three, disposing and destroying the illicit product. Four, we have to go back to the seller again to do another inspection to enforce the escalating penalties for the second and third violation.

And then five, we need to ensure due process during the legal proceedings. So that's the introduction on hemp. Happy to answer any questions.

All right, so sorry. So I said that we would just ask questions at the end, but let me ask the Members, since we have three Members with this, if you, if you have any questions at this point of either. Okay,

let me ask the LAO if you'd like to make any comments LAO on either the first two presentations.

Yes, Seth Kerstein with the LAO. So my comments are going to focus on the two main questions raised in the agenda on this item. So. So the first of those questions is how much should CDTFA spend on cannabis and tobacco enforcement.

So this is fundamentally a policy choice, and the information we've reviewed doesn't point to an obvious right answer regarding that policy choice. So we recommend that the Legislature approach the governor's proposals not as one time workload adjustments, but as components of of a broader, more sustained effort to address these policy challenges.

To support that sustained effort, we recommend that the Legislature set up opportunities to revisit program resources in the 2027 or 2028 budget process. And the second question, the second major question that your agenda raises for this item is how should the state pay for these enforcement activities?

And so here our main concern is the administration's recent use of of General funds to support the cannabis tax program. So this arrangement that's been in place for a little while raises equity and efficiency concerns and it does not reflect, as far as we can tell, the legislature's or voters intent.

And so by proposing a cannabis tax Fund augmentation for cannabis enforcement costs, the Administration acknowledges that spending General Fund for this purpose isn't ideal. So we recommend that the Legislature adopt this proposal with a few modifications.

First, we recommend that you reduce CDTFA's General Fund appropriation by the amount of the department's annual General Fund spending on the cannabis tax program. Second, we recommend that you direct the Administration to switch over all funding for the cannabis tax program for from the General Fund to the cannabis tax Fund immediately rather than waiting until July.

And third, we recommend that you consider, based on this experience, whether new provisional language is needed to prevent this type of problem from recurring in the future. So those are the main takeaways from our analysis, and I'd be happy to go into more detail if the Committee has questions.

Any other comments from LAO? You'll have some other chances here. All right. We talked about the cannabis tax, also the hemp. And did you want to go into more detail on the flavored tobacco?

Sure, we can go into the flavored tobacco. Okay. Okay.

Okay, so California's flavor ban on tobacco that started in fiscal year 2223 did not authorize CDTFA to seize flavored tobacco unless the excise tax wasn't paid. Last January 25, AB3218 and SB1230 enabled CDTFA to seize flavored tobacco.

Last year, we requested one year limited term funding for 3.5 million because the volume of the seized product was not yet known.

Now that we have better visibility on volumes and the related cost to seize and destroy illicit flavored product, we're comfortable requesting ongoing funding of 3.8 million in 26-273.7 in in 27-28, and 1.2 thereafter from the Cigarette and Tobacco Compliance Special Fund.

Our request ratchets down from 3.8 million in 26-27 to 1.2 in 2930 because we expect our enforcement push in the early years to yield benefits of greater compliance in the out years. So that's the introduction for the flavor bin.

Thank you. All right, any comments on the flavored tobacco from our LAO, Seth Kerstein?

LAO, my prior comments were sort of intended to cover the all three of the proposals.

And I apologize because I had you go out of order on some of these. All right, so let's get back to where we were. Any of our Members have any comments on these funds or BCPs, Comments or questions?

I do.

Oh, I'm sorry. There you go. Working.

Hello. oh, there we go. Thank you to our Chair for convening today's Subcommitee hearing. I wanted to ask a question specifically around what's going on around some of the enforcement with cannabis dispensaries and some of the things that we see advertised online.

I represent places like Echo park and Silver Lake in Los Angeles, Dodger Stadium area, and we have a number of license dispensaries in my district. And then at the same time, we also know that it is, you know, very easy to find a lot of unlicensed illegal cannabis dispensaries online, including doing a simple Google search.

Can you talk to us a little bit about what enforcement you're doing in that space? How can we help our licensed cannabis retailers in this space?

Sure. And I'll give you a brief summary and then we'll call up a few of our colleagues as well. So just to frame the discussion around how much spending we're spending on cannabis, to Mr. Kirstein's earlier question, just let me give you a couple stats and then we'll get a little deeper on the activities, if that's okay.

All right. So last fiscal year, our cannabis revenues were Roughly a billion 1,635 million was from the excise tax and 430 was from sales and use tax. Against that revenue of a 1,000,000,001 we spent roughly $16 million. Roughly 11 from the special Fund.

And then the overage was from the five and a half was from the General Fund. Regarding our enforcement activities, we have some statistics here. So on cannabis. So we conducted. Last fiscal year, we conducted 590 inspections for cannabis. Of that 590440 were at tobacco shops, convenience stores, gas stations, and the remaining 150 were at cannabis dispensaries.

In terms of our seizures against the 590 inspections, we. We did 540 seizures. Of the 540440 were at the tobacco retailers and 100 were at cannabis retailers. And just on your question of legal versus you know, licensed versus unlicensed, all 100 of our seizures at cannabis dispensaries were at unlicensed locations last year. Like 100%.

Thank you. And that's really helpful. You know, I think for me, like, increasingly that's, you know, one of the things that I continue to want to see from the Department is really looking at the enforcement. I know we're obviously having a Committee hearing today to really look at, you know, taxes and the role of your agency.

In my district, there was a store in Silver Lake that showed an increased sale sales from a little over 12,000 in October 2024 to an increase of almost 16,000 in October of 2025 by some of the increased enforcement around some of the unlicensed cannabis retail retailers in the area.

And so I think that that is a positive for the state, for my district, for making sure that we really even the playing field for folks who are actually doing the things that we're asking them to do, which is to get a license, to pay a sales tax and to do it the right way.

And so those are some of. And I know you know this, I know I'm speaking to the choir, but I really just wanted to add that emphasis that those are things that I am encouraged by. So hearing some of the things that you're saying around enforcement is good.

And in terms of the revenue that we collect back is there. Can you talk to us about the value of some of these seizures and these inspections? Like, what value are you seeing to your agency and to the state?

Sure, sure. And actually, if I could just respond to the comment on leveling the playing field. I mean, that is a major reason why our expenses have increased over the last few years for cannabis. You know, there's a financial reason, you know, the billion dollars of revenue that we're protecting, but there are also non financial reasons.

And I think this goes back to Mr. Kirstein's point about how much do we want to spend as a, you know, as a state on this? Some of the non financial reasons. I think first is what you said, fair competition. We do not want to give someone elicit an advantage over selling product by a licensed seller.

Of course that would drive, that's a competitive disadvantage and that would drive those sellers who are licensed to, to either go out of business or potentially move to illicit sales. And then of course there's the public health angle.

You know, a lot of times youth are able to access these products that are not tested, not regulated and contain harmful chemicals. So that's on your first comment with regard to our, you asked for the value, I believe, of our seizures, is that right? Yeah. Okay.

So last fiscal year the retail value of our seizures was $17 million. The year before that it was $13 million. And the year before that in 2223 it was $36 million. And you can see there's quite a change. And actually over the last few years there's been a decrease.

And a big reason why we've seen a decrease is because cannabis, really unlicensed cannabis sellers are becoming more savvy in terms of keeping less cash on hand and less product on hand too. Consequently, we're not able to seize as much as we were we were before.

Thanks for sharing that. And in terms of how, you know, the public or any of our Assembly offices can assist with some of your enforcement, can you talk to us a little bit about that?

Like if we were to be out in our district and we're not sure whether there is a licensed or unlicensed cannabis retailer, is that something we can report to your agency? Can you talk to us a little bit about how that works?

Yes. So I'm a finance guy, so I might be a little bit off my skis here, but we have, we have audit activities and we have compliance activities. You know, a key feature of our compliance activities is referrals from the public and from lawmakers.

And I think that is if you look at the bcp, you see that while the inspection volume is relatively flat, our seizure volume is going much higher. And that is because we're able to focus on non compliant sellers. And that is thanks primarily or predominantly to referrals from People from your constituents and other constituents and law enforcement.

Thank you. I don't have any further questions, but I just wanted to emphasize those points.

Thank you. Any questions? Assemblymember, any questions? I wanted to refer back to the LAO who mentions that we are using General Fund Dollars and yet you said that you are now using the cannabis tax Fund. If you are using that, then what would the remaining General Fund Dollars be going to?

Sure, sure. And can I give a little background on how we ended up using the General Fund? I just want to make sure you have the full color because we work closely with our finance colleagues. So first, the cannabis tax special fund is continuously appropriated up to 4% of revenues. That's roughly $25 million a year.

But you know, as a Department, we have two constraints. One is we're limited to how much funds are transferred into fund. You know, we can only use up to the amount of money that's in the fund.

And the second thing is, you know, through this BCP process, we have an annual appropriation which has been stamped 10 to $10 million. So given those constraints, we really try to stay within our annual appropriation. At the same time, we can't leave illegal product on the shelf, you know, for financial and non financial reasons.

And so given creation deficit, you know, we've worked very closely finance and it was decided to use the General Fund to cover that shortfall. Okay, that's the first question you also asked about, you know, why shouldn't we cut your General Fund additionally. So let me just give a little bit of color too.

So first off, on our revenues, our revenues have grown to $98 billion, which is a 30% increase since 1920.

In the last five years, in addition to our higher revenues, our cost per dollar of revenue, our efficiency has improved by 20% before in 1920, it costs for every $100 of revenue, it cost the Department 82 cents to collect. Now in the last year, for every $100 of revenue, it cost us just 66 cents to collect.

So that's the background. As you know, over the last couple of years there have been pretty big budget cuts. And you know, we as a Department at CDTFA, we gave, we relinquished 300 of our vacancies and we believe that is the most of any tax Department in the state.

And so after that we believe that our General funding is reasonable for a few reasons. One, we're a revenue Department, so filling vacancies means more revenue for the state. For reference, every sales tax auditor we hire brings in 650k year.

In addition, our audit activities last year brought in over $850 million and our collection activities brought in a 1,000,000,003. Each of those buckets by itself is greater than our entire annual budget. The other thing I'd like to note is in the last year we've gained significant traction in making hires.

You know, the hiring market has not been as strong. That has been to the state's benefit. We've run a number of mass hiring events. I think we've run six in the last two years. We've hired 150 people altogether from those mass hiring events.

In addition, as you are as you're aware, there is an opportunity to hire experienced IRS auditors, which is also perhaps a temporary opportunity. So in any case, we need the budget to advertise and hire to make more money for the state.

We would rather have the General Fund use it to make appropriate hires and then return the excess like we have, then prematurely give you the funds and then prevent making more money for the state. We think that's a bad trade and that's the reason why we did not do a negative BCP for the 5.6 million.

Thank you. Appreciate that answer to our Lao. Any comments on that?

Sure. Seth Kerstein, Lao so a couple things on the cannabis tax Fund Fund issue, so we summarize in our analysis that we posted, I think sort of what we understand to be the rationale for why the Administration has been using General Fund and which I believe Mr. Mellett just summarized.

And so I mentioned initially that this raises concerns related to legislative intent, efficiency and equity and relative to the alternative which the Administration had at the time, time of simply using their continuous appropriation authority in the cannabis tax Fund to make the corresponding augmentation from that Fund.

So those concerns are first, we're not aware of any instance in which the Legislature or the voters when they enacted Prop . 64, conveyed any intent for the General Fund to be used in this way.

Second, on the efficiency side, the General Fund can be used on any of the same programs as the cannabis tax fund or on a much wider array of programs. And one of the basic core principles of budgeting efficiency is to use dollars that have the least valuable alternative use.

So in this case, that would be the Cannabis Tax Fund then sort of from an equity standpoint.

So one of the when we were asking the Administration why General Fund, one thing they pointed to was that there are positive spillovers of cannabis tax enforcement activities on the General Fund because enforcement against cannabis retailers can because those sales are subject both to cannabis excise tax and to sales tax.

Sales tax generates General Fund revenue that therefore there's a benefit to the General Fund. Of course, a similar argument could be made for local sales tax revenues, which are even greater.

So when asked why this supplementation to the cannabis tax program didn't come from Lowe's reimbursements from local governments, they cited legal restrictions on the use of those reimbursements. And so because General Fund wasn't subject to those restrictions, it bore a disproportionate burden relative to local reimbursements.

And so all those concerns we felt applied to this situation led to our analysis and recommendations as far as cdtfa retaining the 5.5 million. Yes, revenues have grown a lot relative to costs. We think that's mostly due to economic trends, more so than tax Administration issues also.

But beyond that, I think we think the Department has demonstrated through use of these funds for the cannabis tax program over this period of time that sort of that they haven't been needed for other activities. Could the Department put them to good use? Sure.

But to us that's not where the bar is set for a General Fund appropriation. Really, there needs to be some kind of concrete justification presented to the Legislature specifically for what the Department would do with those funds that it's not doing already.

Merely having the flexibility to potentially use them for some benefit doesn't clear the bar to us to justify the appropriation. And certainly tax Administration activities have a revenue benefit, but I mean, if there's a lot of money sitting on the table, we should be seeing a significant proposal for a budget augmentation to capture those revenues.

We haven't seen that from the Administration. And absent that, it's not clear to us quantitatively how the benefits and costs compare of giving this money to cdtfa.

Thank you. Lots of dialogue here and appreciate the concern.

Madam Chair Chris Hill, Department of Finance if I could just. I'm going to make a couple high level comments. I'm going to turn it over to my colleague to make a couple more comments. But I would like to note that the Administration did authorize the use of General Fund resources.

We weren't shifting dollars from the General Fund into the Cannabis Tax Fund. CDTFA was just using General Fund supported resources to assist with that workload. So I wanted to make that point clear.

First and second, if we had not allowed that to happen, it would have resulted in a drawdown of additional Cannabis Tax Fund money which would have had a knockover effect on the allocation 3 Appropriations for child care, which is why we made the decision to not allow that to happen.

And I'd also like to turn it over to my colleague for a couple more comments.

Thank you.

And just. Actually, I just want. No more. No, one more thing. I'll be it. Just to reiterate that what they did was within keeping within standard operating procedures of departments. Departments often do use resources that are funded by one fund to support workload in another fund.

And you can have a person working in one assignment one day, then they'll be helping out with another assignment the next day. And I think that's a bit of a different color than it is shifting money from one Fund to another, which I just want to reiterate, did not happen here.

Yeah, maybe you should just clarify. At no point have we attempted to state or imply that money was shifted from one Fund to another.

Just to add a little bit. When we hire people, we hire people to do a responsibility, whether it's an inspector to go to a smoke shop or a cannabis dispensary or an accountant to reconcile different funds. Our folks use their time where the market demands, and then they allocate their time accordingly.

In this case, there was a greater need in cannabis, and that's where we allocated our time.

We heard quite a bit about cannabis enforcement last year, and I know that it was noted not only by myself as a Chair of the Committee, but other Members, the concern for enforcement and really the state, if you want to say the state of cannabis.

And as you mentioned in your opening comments, we had proposition and then the beginning and there was quite a decline. And so in your. You made your remarks that we are now seeing encouragement in the market. Where are we with cannabis sales that had gone down quite a bit in the legal market?

Yeah. If I could delineate, you know, where we're seeing encouragement. I think the simplification of our Cannabis taxes through AB195 has made life a lot easier for our taxpayers because there's no more cultivation tax. The payer of the excise tax has shifted from the distributor to the retailer, and the sales tax is still paid by the retailer.

So I think there is where we see the encouragement, the positive feedback, I think on the side of unlicensed sales, that is a persistent problem and we are still finding a lot of illicit product out there.

Seth Kerstein, Lao so this is something that the Department sort of updates, provides quarterly revenue updates. And so that's sort of one of the major sources of ongoing, timely data on how the licensed market is doing over the last Couple of years.

We characterized the trend in dollar revenues as being fairly stagnant, not really sort of declining or growing a whole lot. There had been a period of substantial growth early in the pandemic and then a bit of a period of decline. And one thing. But when you look at dollar sales, it's really not.

There's not a good way to separate out changes in quantity from changes in price. And so the Department of Cannabis Control commissioned a report that was published last year that used other data sources to try to unpack those things and found that quantities had, even during this period of revenue decline, quantities had continued to grow. But that.

That had been there or I'm not. Yeah, these quantities, I think, had generally continued to grow, but there had been very substantial price declines and that. That was sort of what had been driving that trend.

All right. Well, as our viewers can see, we could spend a very good amount of time really unpacking the cannabis industry and looking at the trends, enforcement. Just. There's so much that we can. But we appreciate comments from our panelists here. And now we will open it up to any public comments.

Any public comments on item number one here.

Oh, that looks. Thank you. Thank you, Madam Chair and Members. Amy O'Gorman Jenkins here on behalf of the California Cannabis Operators Association. I really appreciate the robust dialogue and the questions that came from the Committee Members. Our association strongly supports the proposed investments in cannabis tax compliance and the implementation of the Hemp derived cannabinoid oversight.

Strong enforcement is essential to protecting public health and preserving the integrity of the legal cannabis marketplace. And as it relates to the state's economic analysis that was previously covered in prior hearings, I would note that we continue to see a 60% illicit market in the state.

And I appreciate the efforts that are being done by cdtfa, but we certainly need more. And we would support the augmentation as well as the ongoing General Fund expenditure to ensure that enforcement continues and is prioritized towards addressing illicit market activity. Thank you.

Thank you. Any other public comments? Seeing none. We want to thank our panelists and appreciate you. Thank you. We will go to item number two here, which is. I think we have some of the same panelists. We will have centralized Revenue opportunity, opportunity system, CROs, the reappropriation and.

Sure, thank you. So as background, the centralized Revenue Opportunity system, or cross, is the department's tax collection and distribution system that covers all 43 of the tax programs and the $98 billion in revenues. Cross was implemented in 2019. So we've had it for some time.

Our request is for a reappropriation of 3.8 million from this fiscal year 25-26 to next fiscal year 26-27 to deploy a significant upgrade. The upgrade will do a number of things. One, it will enhance taxpayer services. For example, there will be a single sign on and face ID to eliminate the need for passwords.

And there will be improved navigation on the screens. Two, there will be stronger data security, automatic, you know, scrambling and masking of confidential taxpayer information, and also faster restoration in the event there's a disaster. And three, it updates the programming language to current standards, which will enable easier programming in the future.

And just for the avoidance of doubt, the request is for no incremental funds. What we're asking to do, it's a timing shift from this fiscal year to next fiscal year. Thank you.

Thank you. Any comments here? See no comments. Any comments from our panel or our Members? Sorry, seeing none. Let's go ahead. I have no questions. Let's see if we have anybody from the public. Anybody from the public speaking on item number two, CROs. All right. No one is running up to the mic.

We want to thank our panelists. Thank you. Thank you. And we're going to move very quickly here to item number three, sales and uses, taxes, market price, place facilitators. Seth will stay with us. Thank you, Seth.