Report 2019-046 Recommendation 8 Responses

Report 2019-046: Proposition 56 Tobacco Tax: State Agencies' Weak Administration Reduced Revenue by Millions of Dollars and Led to the Improper Use and Inadequate Disclosure of Funds (Release Date: January 2021)

Recommendation #8 To: Tax and Fee Administration, California Department of

To increase the accuracy of its calculation of the tax rate for other tobacco products, CDTFA should take the following steps to update its methodology for calculating the tax by March 2021: Determine the current wholesale markup rate for cigarettes and use this rate when calculating the tax rate for other tobacco products.

6-Month Agency Response

The CDTFA completed its research on the wholesale cigarette industry and review of its internal cigarette data. To increase the accuracy of the other tobacco products tax rate calculation, the CDTFA has updated its data source and methodology for calculating the other tobacco products tax rate. These changes are reflected in the tobacco products tax rate beginning with fiscal year (FY) 2021-22.

In May 2020, the CDTFA implemented standardized cigarette tax reporting procedures for cigarette manufacturers, importers, distributors, and wholesalers. With this new data, the CDTFA was able to utilize the cigarette sales reported by cigarette manufacturers and importers to determine the average wholesale cost of cigarettes. This eliminated the need to use the wholesale markup percentage to determine the average wholesale cost of cigarettes, as was used in prior fiscal years. The rate calculation formula itself has not changed. The new data source is reliable, includes all classes of cigarettes (premium and nonpremium), represents the California cigarette industry, and provides the up-to-date wholesale cost of cigarettes.

The FY 2021-22 tax rate calculation has been completed and approved by the director. Taxpayers were notified of the new tax rate in May 2021.

California State Auditor's Assessment of 6-Month Status: Fully Implemented

CDTFA's new OTP tax rate calculation addresses this recommendation. Our initial estimate suggests that the revision to the OTP tax rate calculation has increased tobacco tax revenue by roughly $24 million, which supports programs such as early childhood education, breast cancer research, and increased access to healthcare for MediCal recipients.

60-Day Agency Response

The CDTFA is conducting research on the wholesale cigarette industry and reviewing internal data to determine how to update its methodology for calculating the tax rate for other tobacco products to increase its accuracy. The CDTFA is surveying cigarette manufacturers and distributors for cigarette wholesale price/cost information.

As background, beginning with the May 2020 filing period, the CDTFA implemented standardized cigarette tax reporting procedures for cigarette manufacturers, importers, distributors, and wholesalers. The CDTFA is evaluating whether this reported cigarette data may be useful in conjunction with the existing Tobacco Merchants Association data in determining a representative average wholesale cost of cigarettes covering all cigarette brand categories (premium and nonpremium) for the tobacco products tax rate calculation.

The tax rate calculation is expected to be complete by March 31, 2021. After review and approval by the director, taxpayer notification will follow, with the rate implementation being completed by June 30, 2021.

California State Auditor's Assessment of 60-Day Status: Pending

We look forward to reviewing CDTFA's other tobacco products tax rate calculation methodology in its next response to this recommendation.

All Recommendations in 2019-046

Agency responses received are posted verbatim.