Gov. Gavin Newsom’s new budget summary proposes much-needed efforts to “improve access to licensing and simplify regulatory oversight of commercial cannabis activity” and “simplify tax administration for cannabis.”
The onerous red tape and costs of California’s marijuana regulations and taxes have hampered the development of the state’s legal marijuana market, while enabling its black market to continue to flourish.
Recent estimates from the United Cannabis Business Association found nearly 3,000 illicit dispensaries were openly operating within the state while only 873 were fully legal. Those estimates showed about $8.7 billion was spent on black market marijuana products last year, while only $3.1 billion was spent on products sold by legal cannabis businesses.
The ongoing prevalence of California’s black market is also affecting the state’s budget substantially. The Legislative Analyst’s Office (LAO) originally predicted that taxes on legal marijuana would generate more than $1 billion annually in state revenue. But the total for 2018 amounted to only $345 million. No other state that has legalized recreational marijuana has fallen so short of expectations. As a result, Newsom’s administration had to reduce cannabis revenue forecasts down to $288 million for fiscal year 2019 and $359 million for 2020.
The reasons for California’s woes are complex. First, the difficulty and expense of becoming a legal marijuana business have discouraged many entrepreneurs from even trying to do so. Local ordinances range from mildly hostile to outright un-permissive. The city of Los Angeles, for example, has not even begun to offer licenses for new marijuana businesses, while four-fifths of the state’s municipalities have outlawed marijuana businesses altogether. If cannabis businesses manage to receive a local license, they must still apply for a state license from one of three different regulatory agencies.
Second, California’s unregulated marijuana market was robust prior to the passage of Proposition 64, the 2016 voter initiative that legalized adult-use marijuana. The state’s Department of Food and Agriculture estimated Californians were already producing 15.5 million pounds of marijuana annually. Thus, bringing these large, sophisticated supply chains into a regulated market was always going to be a challenge even if acquiring a legal cannabis license were easy.
Third, the taxes on legal marijuana businesses are punitive. The state taxes both the wholesale and retail levels, and local governments add their own taxes. As a result, total taxes approach 45 percent, Fitch ratings found. Thus, not surprisingly, it makes more economic sense for many businesses to remain illicit and for consumers to continue to buy cheaper products on the black market.
Last month, the LAO called for major overhauls in the state’s marijuana taxes, recommending the elimination of wholesale taxes. It also advised shifting to a system where retailers collect and remit those taxes rather than the current system requiring the distributor who sold wholesale products to calculate and pay the taxes. This is an awkward calculation for a distributor, which takes no part in that sale, to make before that taxable sale has even taken place. Finally, the LAO recommended reducing overall tax rates down to 15 to 20 percent, so legal marijuana businesses can compete with unlicensed sellers.