Two years after legalization, the licensed recreational cannabis sector in California is riddled with prohibitions, unsustainable taxes, and rigid regulations which have hindered its growth and encouraged the expansion of the black market. Most experts claim that the illegal market is probably stronger nowadays than before medical cannabis was legalized back in 1996. And this could mean that Proposition 64, which legalized recreational marijuana in California in 2016, could turn out to be a colossal mistake. Here we explain why.
Two years after licensed dealers started selling recreational cannabis in California, they still only represent a quarter of the estimated market, according to a new report by the Cannabis Advisory Committee under the Bureau of Cannabis Control (BCC).
Despite the State's attempts to fully bring cannabis businesses into the regulated commercial market, the report claims that "as much as 80% of the cannabis market in California remains illicit" due to a combination of high taxes, local prohibitions, choke points in the licensing process, and strong state regulations.
This report also shows that licensed cannabis sales ascended to $3.1 billion in 2019, which makes it the largest legal cannabis market in the world. But it is also estimated that $8.7 billion have been spent on illegal cannabis sales, which means that the black market still represents more than double the amount of the legal cannabis market. Tax revenue from legal sales for the financial year that ended last June was only $288 million, less than a third of the estimated $1 billion.
So what are the reasons for this failure?
1- The combination of state and local taxes can excessively increase retail prices, reaching up to a shocking 75% in 2019. In 2020, both cultivation and sales taxes have increased again since January 1, leaving growers and retailers at breaking point. Raising tax rates is not a smart way of increasing tax revenue as legal traders have to compete with the black market, which does not have to include taxes in its prices.
2- Three quarters of the cities and towns in California have prohibited cannabis stores, which is a permitted practice under Prop 64. Due partly to this ban, California currently has only 568 licensed marijuana retailers, which represents less than a tenth of the originally estimated figure. This is equivalent to around 14 stores for every million residents. In comparison, Colorado, where cannabis was legalized in 2012, and licensed sales started in 2014, had 572 recreational marijuana retailers as of December 2, 2019, which equates to 100 stores per 1 million residents.
3- Even in places where cannabis stores are permitted, the process of obtaining a license is a red-tape nightmare, due to bureaucracy and other requirements at both local and state level. The city of Los Angeles, for instance, received more than 1600 applications for retailer licenses, and to date only 188 licenses have been granted.
4- On top of taxes and the tedious licensing process, legal marijuana businesses have to deal with other regulatory burdens, including intermediaries, analysis requirements, and numerous small regulations regarding storage, safety, transport, labeling, packaging, and waste disposal.
5- One of the greatest obstacles is precisely because the State requires businesses to digitally track every plant, from germination until its sale, to prevent the diversion of products to the black market. Participating in this tracking system is an essential requirement to obtain a license, and as a result more than 600 cannabis firms have been denied a license as of December last year purely because of not having joined the tracking system.
6- To date, the main official response to the black market has been a police offensive against unlicensed sellers, thus perpetuating the war against weed that Prop 64 was supposed to eradicate. Many believe that changes are needed to put pressure on local jurisdictions so that they understand the benefits of regulation rather than prohibition.
7- Due to marijuana's illicit nature at federal level, the banks have not been willing to operate with money from marijuana businesses, which complicates financial transactions and forces cannabis retailers to carry huge amounts of cash to pay distributors and tax agencies. If federal and state laws were changed to allow Californian cannabis to be legally exported out of the state, this would also help reduce the illegal market.
8- The great pressure suffered by the legal cannabis industry is to blame for the decrease of the work force in the main cannabis firms. Giants such as MedMen, Pax Labs, Cannacraft, Grupo Flor, Eaze, and Flow Kana, recently reduced their staff by 20%, and in the case of Weedmaps by 25% . When faced with so many constraints, it would not be surprising if the large investors start to leave to focus on greener pastures like Europe.
9- It has even emerged that many firms are struggling to pay their bills due to general shortfalls in revenue. According to some labs and auxiliary suppliers, such as software companies, the failure to pay invoices has become an 'epidemy' in the cannabis sector that could potentially cause a chain reaction.
10- In addition, the cannabis industry has also been affected by a recent health crisis related to vaping. At national level, 47 people have died and 2000 have fallen ill after vaping tobacco or cannabis. The Centers for Disease Control and Prevention recently identified the Vitamin E Acetate thickening agent as a likely culprit. Even though this crisis could serve as a way to highlight the importance of the existence of a regulated market, for now it has only provoked a significant drop in vaping product sales, which has led some firms to abandon this sector entirely.
These cracks that appeared in the Californian legal market towards the end of 2019 are a sign that many legal operators may not survive despite the huge demand for high-quality cannabis in the state. Many companies may have already crossed the point of no return regarding their profitability, and a catastrophe in the industry has been predicted for 2020. But this could be avoided if Californian officials took drastic action to alleviate the financial pressure on legal firms, whether through tax relief or other options on the table.