CDTFA’s Cannabis and Tobacco Programs

In this post, we discuss three Governor’s budget proposals for the Department of Tax and Fee Administration’s (CDTFA’s) cannabis and tobacco programs. Our key findings and recommendations are:

The state faces significant cannabis and tobacco compliance problems. Accordingly, we recommend that the Legislature approach the Governor’s proposals not as one‑time workload adjustments, but as components of a broader, more sustained effort to address these policy challenges. To support this sustained effort, we recommend that the Legislature set up opportunities to revisit program resources in the 2027 and/or 2028 budget processes.
The administration has been spending General Fund on cannabis tax enforcement, which should be funded exclusively by the Cannabis Tax Fund. By proposing a Cannabis Tax Fund augmentation for these costs, the administration acknowledges that spending General Fund for this purpose is not ideal. We recommend that the Legislature adopt a modified version of this proposal and consider whether new provisional language is needed to prevent such problems from recurring.

Background

Cannabis Tax Program. CDTFA’s Cannabis Tax Program administers a 15 percent excise tax on retail sales of cannabis products. Some of the revenues from this tax pay for CDTFA’s administration of the program, including enforcement activities. Most of the revenues pay for child care, environmental protection, and other types of programs.

Tobacco Tax and Licensing Programs. The department runs three tobacco‑focused programs:

The Cigarette and Tobacco Products Tax Program administers a $2.87 per pack tax on combustible cigarettes and a 54 percent tax (adjusted annually) on the wholesale cost of other tobacco products, such as e‑cigarettes, cigars, and chewing tobacco. Most of these revenues pay for health care or early childhood programs.
The Cigarette and Tobacco Products Licensing Program (hereafter, “Tobacco Licensing Program”) monitors tobacco retailers for compliance with various state laws. This program is a key element of the Master Settlement Agreement that California and 45 other states reached with the four largest cigarette manufacturers in 1998.
The California Electronic Cigarette Excise Tax Program administers a 12.5 percent tax on retail sales of e‑cigarettes.

Flavor Ban. In a November 2022 referendum, voters approved Chapter 34 of 2020 (SB 793, Hill), which bans most sales of flavored tobacco products. (“Flavored” refers to non‑tobacco flavors, such as menthol cigarettes or fruit‑flavored e‑cigarettes.) This law established a fine for each violation of the ban, but it did not create a clear structure for enforcement.

Unflavored Tobacco List. In the 2023‑24 session, the Legislature passed and the Governor signed Chapter 849 (AB 3218, Wood) and Chapter 462 (SB 1230, Rubio). These laws require the Attorney General to establish a list of unflavored tobacco products to simplify enforcement of the flavor ban. The laws also give CDTFA various tools to enforce the flavor ban, such as citations, product seizures, and license suspensions.

2025 Actions on Licensing Funding. Funding for the Tobacco Licensing Program comes from license fees. Revenues from these fees go into the Cigarette and Tobacco Products Compliance Fund (hereafter, “Compliance Fund”). In 2025, the Legislature and the Governor took a couple of actions to align the Compliance Fund more closely with projected program costs under the new flavor ban laws. First, the budget act included a one‑year $3.5 million increase in the appropriation for the Tobacco Licensing Program. Second, the Legislature passed and the Governor signed Chapter 269 (AB 573, Rogers). This law will raise the annual license fee from $265 to $450 on July 1, 2026. It also authorized CDTFA to make further fee adjustments to cover program costs.

Governor’s Proposals

The January Governor’s budget includes three proposals for CDTFA’s cannabis and tobacco programs:

Cannabis Tax Compliance and Enforcement. The Governor proposes a $5.6 million augmentation from the Cannabis Tax Fund in 2026‑27 and ongoing to address compliance and enforcement in the Cannabis Tax Program. This would bring the total Cannabis Tax Fund appropriation for this program to $17.9 million.

Flavored Tobacco Products. The Governor proposes augmentations of $3.8 million in 2026‑27, $3.7 million in 2027‑28, $3.7 million in 2028‑29, and $1.2 million in 2029‑30 and ongoing from the Compliance Fund for the Tobacco Licensing Program to enforce AB 3218 and other flavor ban laws. The Governor proposes covering an additional $2 million of annual flavor ban enforcement costs by using existing Compliance Fund appropriations that the department has not been spending.

Hemp‑Derived Cannabinoids. The Governor proposes $3.3 million of augmentations in 2026‑27 and ongoing to address enforcement responsibilities stemming from a new law on hemp‑derived cannabinoids (Chapter 248 of 2025 [AB 8, Aguiar‑Curry]). In 2026‑27, $2.8 million of these appropriations would come from the Compliance Fund to pay for costs in the Tobacco Licensing Program, while $0.5 million would come from the Cannabis Tax Fund to pay for costs in the Cannabis Tax Program. $0.2 million of these costs would shift from the Compliance Fund to the Cannabis Tax Fund starting in 2027‑28.

Two Main Questions for the Legislature. These proposals raise several issues for the Legislature to consider. Our analysis of these issues in the next two sections revolves around two overarching questions:

How much should CDTFA spend on cannabis and tobacco enforcement?
How should the state pay for these activities?

How Much Should CDTFA Spend on Cannabis and Tobacco Enforcement?

State Faces Significant Cannabis and Tobacco Compliance Problems. The licensed cannabis industry’s ongoing struggle to compete with the illicit cannabis market is widely recognized. Tobacco compliance has received less attention, but some data suggest that this also has become a significant problem under the flavor ban. From 2021‑22 to 2024‑25, tobacco tax revenues dropped 14 percent per year—much faster than the 2 percent historical average. Potential explanations for this decline include:

A drop in actual tobacco consumption—the flavor ban’s intended outcome.
Consumers shifting their purchases from tax‑compliant products to tax‑noncompliant products.

CDTFA’s inspections of licensed smoke shops frequently result in seizures of illegal cannabis and/or tobacco products. 85 percent of the department’s tobacco seizures include products that violate the flavor ban. This suggests that flavor ban compliance problems likely have contributed to the revenue declines noted above.

Cannabis and Tobacco Spending: Diverging Trends. In recent years, appropriations for the Cannabis Tax Program and for the Tobacco Licensing Program have grown modestly. The actual amounts spent on the two programs, however, have followed markedly different trends. Actual spending on the Tobacco Licensing Program declined from $9.1 million in 2021‑22 to $6.9 million in 2024‑25, while actual spending on the Cannabis Tax Program grew from $8.4 million in 2021‑22 to $16.2 million in 2024‑25.

New Laws Make Tobacco Inspections More Expensive. The flavor ban and hemp‑derived cannabinoid laws add to CDTFA’s enforcement costs in several ways. For example, they make inspections more complex; make citations and seizures more likely; and raise projected costs for transporting, storing, and destroying seized products. The Governor’s proposals aim to address these costs without making major changes to the total number of inspections. Under these proposals, Tobacco Licensing Program spending would be 180 percent higher in 2026‑27 than 2024‑25 despite the number of tobacco inspections increasing by just 14 percent.

Despite “Workload” Framing, Level of Enforcement Is a Policy Choice. For programs to work as expected, departments must complete many tasks. For example, when taxpayers file returns, CDTFA must process every return. We often call these tasks workload. Proactive enforcement activities—such as field inspections—are different. There is no fixed number of inspections that must be conducted. Instead, the right number of inspections depends on costs and benefits—some of which, like deterring illegal activities and promoting fair competition, can be very difficult to quantify. The Governor’s proposed level of spending on cannabis and tobacco enforcement is just one among a range of reasonable policy options available to the Legislature.

Trade‑Offs Depend on Personnel Constraints. As we discussed in The 2025‑26 Budget: CDTFA’s Tobacco Programs, CDTFA has had some difficulties hiring and retaining field enforcement personnel, many of whom are limited peace officers. The trade‑offs from enforcement spending hinge crucially on this issue:

If personnel availability is a binding constraint, then the key question is how to balance the benefits of enforcement in one program versus another (for example, cannabis versus tobacco).
If personnel availability is not a binding constraint, then the key question is how to balance the benefits of enforcement in each program against the fiscal costs. These costs could take the form of lower spending on other programs or higher taxes or fees. For example, if CDTFA spends all of the money that the Governor has proposed, the department might need to raise tobacco retail license fees as soon as 2027‑28.

As the Legislature weighs these trade‑offs, it also must consider a related question: which taxes and fees should support each program? We turn to this in the next section.

How Should the State Pay for These Programs?

Taxes and Fees Typically Fund Their Own Administration. CDTFA administers a variety of tax and fee programs. The costs for each program typically are funded exclusively by the tax or fee revenues collected by the program itself. For example, when Proposition 64 (2016) established the excise tax on cannabis, it followed this standard model by authorizing continuous appropriations for the Cannabis Tax Program from the Cannabis Tax Fund. Under the Governor’s budget proposal for the Cannabis Tax Program, this appropriation would increase to match current program spending.

Administration Has Been Spending General Fund on Cannabis Tax Enforcement. January budget documents show that CDTFA’s spending on the Cannabis Tax Program has come not just from the Cannabis Tax Fund, but also from the General Fund. For example, in 2024‑25, $13.1 million of CDTFA’s Cannabis Tax Program spending came from the Cannabis Tax Fund, while $3.1 million came from the General Fund. The administration tells us that this spending came from CDTFA’s General Fund appropriation in the budget act.

Department‑Level Perspective. The administration appears to have approached this issue by trying to “work within CDTFA’s budget.” Viewed through this department‑level lens, one could argue that spending General Fund on the Cannabis Tax Program makes sense. By redirecting these resources, the administration has responded to major compliance challenges within the Cannabis Tax Program without changing any of CDTFA’s existing appropriations.

Statewide Budgeting Perspective. A plain‑language reading of the budget act gives each department substantial flexibility to use appropriations as it sees fit. The Legislature grants this flexibility with the understanding that the administration will strive to respect the Legislature’s and voters’ intent and use resources efficiently, transparently, and equitably. Viewed through this statewide budgeting lens, the administration’s use of General Fund to support the Cannabis Tax Program does not make much sense.

Respecting Legislature’s and Voters’ Intent. The Legislature makes annual General Fund appropriations to CDTFA to administer taxes that raise General Fund revenue directly, such as the sales tax and alcoholic beverage tax. As far as we know, Proposition 64 and the Legislature’s budget actions have not conveyed any intent to use the General Fund to support the Cannabis Tax Program. In contrast, as noted above, Proposition 64 authorizes continuous appropriations from the Cannabis Tax Fund to pay for the Cannabis Tax Program, requiring no action by the Legislature. The administration could have avoided imposing these costs on the General Fund by adjusting CDTFA’s appropriation from the Cannabis Tax Fund, but it has not yet done so.

Using Resources Efficiently. A core principle of efficient budgeting is to use money that has the least valuable alternative use. Departments’ unspent General Fund appropriations eventually revert to the General Fund, and the administration can accelerate these reversions if desired. Money returned to the General Fund can be spent on a much wider array of programs than those supported by the Cannabis Tax Fund. Consequently, shifting enforcement costs from the Cannabis Tax Fund to the General Fund is inefficient.

Using Resources Transparently and Equitably. The administration has argued that allocating some Cannabis Tax Program costs to the General Fund is reasonable because the General Fund benefits from cannabis retail enforcement. Retail sales of cannabis generally yield revenue from the sales tax as well as the cannabis excise tax, so cannabis retail enforcement can bolster revenues for both taxes. On some level, this is intriguing: why not allocate program costs to all funds that benefit, regardless of whether those benefits are direct or indirect? In practice, allocating tax and fee program costs based on indirect benefits can create several problems:

The spillover effects of each program on all other programs can be very difficult to quantify credibly.
Even if spillover effects were known, the resulting funding system would be needlessly complex. Each program would be supported by a potentially large number of funds, and the share of costs allocated to each fund would vary across programs for reasons that few observers would understand.
Laws often prohibit certain funds from paying for indirect benefits. As a result, attempts to allocate costs based on indirect benefits can place disproportionate burdens on the funds that are not subject to such restrictions.

This is why, as described earlier, costs for each program typically are funded exclusively by the program’s own revenues. In the case of the Cannabis Tax Program, we note:

The administration has not presented any arguments linking the General Fund’s share of costs to its share of indirect benefits.
This is not part of a broad, systematic effort to allocate costs based on indirect benefits.
Most sales tax revenues go to local government programs, so they likewise derive benefits from cannabis enforcement. CDTFA has not, however, used reimbursements from local governments to support the Cannabis Tax Program. They have justified this by citing legal restrictions on the use of such reimbursements. This has resulted in a disproportionate burden on the General Fund.

Lessons Learned From Tobacco Licensing Program. A somewhat similar problem arose in 2006, when the Legislature and the administration started to redirect tobacco tax revenues to support the Tobacco Licensing Program. At the time, some argued that this was justified because those tobacco tax funds derive benefits from the enforcement provided by the Licensing Program. When we reviewed this issue in The 2015‑16 Budget: Cigarette Tax and Licensing Programs, we did not find this argument compelling. We recommended that the Licensing Program be funded exclusively through license fees, which is how it is funded today.

LAO Recommendations

Approach Proposals as Pieces of a Bigger Policy Puzzle. Cannabis and tobacco compliance present an ongoing policy challenge for the Legislature. Accordingly, we recommend that the Legislature approach the Governor’s proposals not as one‑time workload adjustments, but as components of a broader, more sustained effort to address these policy challenges. To support this sustained effort, we recommend modifying the proposed augmentations for the Tobacco Licensing Program to set up opportunities for the Legislature to revisit program resources in the 2027 and/or 2028 budget processes:

Going into 2027, a key question is whether CDTFA can hire and retain enough inspectors to carry out the desired level of enforcement. The Legislature may wish to monitor this issue by scheduling some of the proposed funding to expire after 2026‑27, requiring CDTFA to report on vacancies in key areas, or some combination of the two.
Assembly Bill 573 requires our office to publish a report on tobacco retail enforcement by December 1, 2027. If this could lead to budget adjustments, the Legislature may wish to schedule some of the proposed funding to expire after 2027‑28.

Direct CDTFA to Stop Spending General Fund on Cannabis Tax Program Immediately. By proposing a Cannabis Tax Fund augmentation for cannabis enforcement costs, the administration acknowledges that spending General Fund for this purpose is not ideal. We recommend that the Legislature adopt this proposal with the following modifications:

Direct the administration to stop spending General Fund on the Cannabis Tax Program immediately, rather than waiting until 2026‑27.
Direct the administration to use its continuous appropriation authority to augment CDTFA’s allocation from the Cannabis Tax Fund by the proposed amount, prorated to cover the remainder of 2025‑26.
Direct the administration to make any future adjustments needed to support the program without spending any money from the General Fund.
Reduce CDTFA’s General Fund appropriation by the amount of the department’s annual General Fund spending on the Cannabis Tax Program (as these funds clearly are not needed).

Consider Provisional Language. As discussed earlier, the administration’s use of General Fund to support the Cannabis Tax Program raises equity and efficiency concerns, and it does not reflect the Legislature’s or voters’ intent. This raises some significant questions about the judgment exercised by the administration in its use of the budgetary flexibility granted by the budget act. Accordingly, we recommend that the Legislature consider whether new provisional language is needed to prevent such problems from recurring.