Aug 07

Back-breaking taxes and competition from the illicit market threaten legal businesses in the Golden State

There’s a misconception that cannabis businesses are rolling in profits, but the truth, particularly in California, is that many in the market are struggling to survive.

In some ways, the obstacles faced by licensed businesses mirror those in other states that have launched regulated cannabis programs: the licensing process is too slow; the testing and traceability requirements are onerous; everything costs more for marijuana businesses, from goods and services to insurance and real estate; banking and financial services are largely unavailable; taxes are too high.

High taxes are pushing consumers into the illicit market.

But California is a different story in size, scope and monumental expectations. For more than two decades, California has been the undisputed epicenter of cannabis culture and entrepreneurship — as well as ground zero for the nation’s fruitless War on Drugs. But the Golden State has failed to live up to its potential for a multibillion-dollar legal market.

State-licensed businesses face a wide range of challenges, not the least of which is competition from the illicit market. In Los Angeles, there are fewer than 200 licensed cannabis retailers, but hundreds, if not thousands, of unlicensed dispensaries. The same can be said of cannabis farms in Northern California.

“On one hand, it’s not fundamentally fair that people who want licenses have not been able to get licenses,” says Ruben Honig, executive director of the United Cannabis Business Association, a trade group representing more than 160 dispensaries. “On the other hand, it’s not fundamentally fair for those businesses that have licenses, especially in the city of Los Angeles, that are laying off employees and suffering.”

The Taxman Cometh
Reducing or eliminating the illicit market is always one of the stated goals of cannabis legalization. Yet, when states and municipalities tack on crippling tax rates, the opposite happens. Higher prices in the legal market fuel the illicit market and send consumers — many of whom were once loyal dispensary shoppers — back to the street-corner dealer.

Chiah Rodrigues of Mendocino Generations says the taxes are affecting everybody in the supply chain from cultivators to the consumer. She says the tax rate is as high as 57% in some jurisdictions.

In Mendocino County it’s a relatively low 27% — but a flat-tax structure on small and medium-sized growers is “ridiculous.”

“We’re getting taxed in Mendocino County on product you don’t sell,” she says. “If you have a 10,000-square-foot cultivation space, you’ve got a $5,000 minimum tax rate. If you sell enough cannabis to go over that, you pay a 2.5% tax rate on top of the $5,000. On my farm, I paid $4,200 of the tax, based on my sales for last year. So I had to pay the $800 difference because I didn’t sell enough.”

Taxes, she says, should be structured just like every other business.

“Don’t get me wrong, I’m happy to pay taxes,” Rodrigues says. “But it needs to be a fair tax that is in line with the actual business you’re doing. What industry pays tax on something you don’t sell?”

Stopping a Second WarOver the past year and a half, Honig has watched members of the UCBA face extreme difficulties in keeping their doors open.

“2018 was really a year of survival,” he says.

But enforcement is a complicated subject in a state where the wounds of prohibition run so deep.

On one hand, legal operators cannot be successful if they’re competing against a thriving illicit market. But many people would rather avoid the militaristic enforcement actions of the past.

“The last thing that we want to see is the continued inflammation of the War on Drugs,” Honig says. “Los Angeles has been ground zero for that, and especially South Los Angeles.”

Mendocino Generations is a membership-based organization of about 50 farms.

Growers in Northern California have also been terrorized over the years by federal law enforcement. Mendocino Generations co-founder Chiah Rodrigues says her heart still races every time she hears a helicopter. Lately, the helicopters have returned to the skies over the Emerald Triangle, hovering over licensed and unlicensed farms alike.

“This is what we had to deal with during the Reagan era,” she says. “This is why I have PTSD and why I’m in the regulated market. It’s the worst feeling.”

The competition and growing mistrust between licensed and unlicensed growers have created a situation where neighbors are turning against each other, Rodrigues says. There are licensed farmers that are reporting unlicensed farms in the area. There are also illegal growers calling the authorities on their licensed neighbors to report compliance violations.

“It’s happening on both sides,” Rodrigues says.

Many believe the illicit market will continue to thrive until tracking and tracing is implemented from seed to sale.

In July, the Mendocino County Sheriff’s Office conducted a multi-agency raid on cannabis farms based on suspected involvement in water diversion or environmental degradation. “Operation Clean Sweep” resulted in the removal of more than 42,000 cannabis plants.

In Los Angeles, and other parts of the state, unlicensed retailers continue to outnumber their legal counterparts. Honig says the city needs to take civil action to enforce the rules and differentiate legal businesses.

“There’s a fine line between enforcement and reinvigorating the War on Drugs,” he says. “(But) we cannot sacrifice our existing licensees just because the market hasn’t shaken itself out.”

It’s even more complicated in the city of Los Angeles, Honig says, because he feels the authorities have been given more than enough tools to shut down unlicensed businesses. Yet, those efforts so far have not been successful.

Honig says a comment by Assemblyman Tom Lackey at a recent meeting struck him as poignant: “Regulations that are not enforced are merely suggestions.”

“We need to continue to hold Los Angeles to the fire to enforce their rules and regulations,” Honig says.

Technology Tug-of-War

Alkhemist co-founders James Chung and Conrad Jun.

One measure Honig says would help the regulated market is Assembly Bill 1417, which would punish technology platforms that advertise unlicensed marijuana businesses. The UCBA-sponsored bill would impose a $2,500-a-day fine per violation.

“We do not believe that technology platforms, especially cannabis-specific technology platforms, should be able to advertise for the illegal industry,” Honig says. “I don’t think they’re doing anybody a service and they’re confusing the consumer.”

Weedmaps, a California company, opposes the bill and continues to allow marijuana businesses to advertise on its site, with or without a license. Its Seattle-based rival, Leafly, supports it.

On March 1, 2018, “we made it official that the Leafly Dispensary Finder would no longer list any unlicensed California dispensaries or delivery services,” said Laura Morarity, Leafly’s vice president of corporate affairs, adding that the company worked to actively remove unlicensed marijuana retailers.

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