Four Years After Legalization, California Has Had Unexpected and Often Disappointing Results

“I knew Prop 64 would pass, and that was fine with me,” recalls Rev. James K. McKnight, Pastor of the Congregationalist Church of Christian Fellowship in South Central Los Angeles, where low-level cannabis convictions are among the highest in the state. “The law promised social equity, social justice, second chances.”

But no one told him it was going to take years to take effect.

Californians had high expectations when they overwhelmingly voted in 2016 to legalize adult-use cannabis with Proposition 64: the Control, Regulate, and Tax Adult Use of Marijuana Act. Over time, thousands of shops would generate millions of dollars in tax revenues. State government was committed to training and financial assistance for entrepreneurs, minorities, and marginalized people. Jobs would be created. Investors would be generous. What could possibly go wrong?

Turns out quite a bit. High taxes and stringent regulations are squeezing nearly every sector, say frustrated cannabis entrepreneurs, who warn that the burden is making their businesses unsustainable. Despite wide support on the state-wide ballot, city and county-level NIMBYism (not in my backyard) has restricted licensing and hobbled retail sales—hollowing out the promise of tax revenue and jobs. Competition from the new licit market has driven up prices and availability on the medical side.  Social equity programs are toothless or don’t exist.  And the illegal market thrives.

“We know there are problems and we know what they are,” explains California State Treasurer Fiona Ma. But she estimates Sacramento will need five to seven years to correct them.  Does the industry have that long?

From high hopes to low returns

The optimism generated by the passage of Proposition 64 was infectious. Sacramento estimated it would collect as much as $643 million in new tax revenue in 2018-2019. That figure could only grow, according to lawmakers, advocates, and bullish investors.

But the lawful cannabis industry was slow to roll, even with a year to prepare. The state collected only $250 million in cannabis taxes, less than half of what was expected. Sales were stronger in calendar 2019, topping $3.1 billion, still not meeting expectations.

California was not the first in the nation to legalize cannabis, but its sheer size—not to mention competition from its own robust illicit market—made it hard for authorities to rely on other states’ experiences when designing their own program.

In 2016, “nobody knew how to value the market,” says Ma. “We looked at other states, the strength of medical [sales], anecdotal evidence, we tracked the big companies.” But even then, she said, all they could do was project sales based on existing factors.

“There have been unrealistic expectations within the industry,” says Adam Spiker, co-founder of the Southern California Coalition, a cannabis trade organization. He says high hopes were fed by regulators, politicians, advocates, analysts, journalists, and the canna-biz itself.

“I think [legalization] wasn’t so easy for the legacy operators, who are still having a hard time getting organized,” Spiker explains. “Don’t forget, they’ve done this a number of times before, whether in local jurisdictions or the state and failed. A lot of times the folks who came out of the shadows ended up getting raided, getting persecuted for doing so, and there was a lot of distrust in government.”

Rising taxes and red tape

“No industry is as regulated and taxed as cannabis,” says Ma. “Even liquor isn’t a comparison.”

That’s putting it mildly. The state levies a 15 percent excise tax on retail sales, in addition to the general sales tax of 7.25 percent. Cultivators pay $9.25 on every ounce of flower they produce. Most of the cities and counties that permit sales also levy their own taxes on retailers. The cash register price of every gummy, tincture, and pre-roll sold in California is roughly 40 percent tax, according to the California Department Food and Agriculture.

“When I was consulted about the tax rates, I said 3 percent to 5 percent is probably manageable,” says Ma. “When they put it at 15 percent, I knew right off the bat it was too high.”

Lawmakers have introduced bills that would permanently lower taxes on all levels of the cannabis conduit. But many believe these efforts could be too late for the licit market to establish a sustainable position.

California’s industry is dominated by small companies, few of which have the resources to hold on.  “My members are dying,” Spiker says. “They are already taking hard-money loans just to make payroll.”  In the last year, the SCC has lost four legacy board members who gave up on the licit market.

Sean Szameik agrees.  A veteran ganjapreneur with experience in nearly every corner of the industry,  he’s no stranger to the bureaucracy. In  2017, when the Pasadena City Council passed an ordinance to shut off power and water to his legacy, or unlicensed, Golden State Collective, Szameik and others collected nearly 13,000 signatures—one-third of Pasadena residents—to have it overturned.

“It’s a ridiculous process,” he says, one that has even crippled enterprises with financial backing and experience.  “I know people who have been paying rent on properties for three years, but can’t get a permit.  Now how long do you think they will last?”

Too little too late for social equity programs

Paying rent for years on unlicensed business properties is one of the many unfair ways entrepreneurs of color have had to break into the industry that they literally founded and have been jailed for participating in. But with Proposition 64,  it was supposed to be different.

The 62-page law decriminalized the possession, use, cultivation, and sale of adult-use cannabis. It also provides for the expungement of low-level drug offenses from the permanent records of tens of thousands of people, the vast majority of whom are men of color.  It also provides training for cannabis careers, grants, and loans.

Last April, the state announced it would appropriate $30 million to train disadvantaged individuals and award grants to marginalized neighborhoods. This is new money, in addition to Proposition 64’s allocation of $10 million this year and up to $50 million by 2022. Advocates welcome additional money for training and grants,but they warn that demand is still far greater than a one-time infusion will allow them to meet.

“What is $10 million going to do for us?” asks Julian Canete, President and Chief Executive Officer of the California Hispanic Chambers of Commerce. “That’s $2 million for the five biggest cities, and leaves little or nothing for the rest of the state. With the appropriate training programs and economic incentives, Canete believes that legal cannabis could be a boom for Latinx entrepreneurs. Now, three years after passage, he says, best intentions have been hobbled by too little investment and many laws that hamper opportunity.

Cedric Haynes, who heads Weedmaps’ recently launched effort to assist prospective license holders and coach licensed social equity business owners, sees other issues ahead.

“If we don’t start recognizing, appreciating, and understanding that ‘disproportionately impacted’ means the hurdles are already higher than everyone else’s and start pairing this reality with appropriate resources, then it’s a failure of the entire industry.” He adds, “Sure, diverse licensure is a goal, but it can’t stop there. This work isn’t done until these businesses are structurally and fundamentally equipped with the tools needed to succeed in the long haul.”

The emergence of pot deserts

But nowhere else is Proposition 64’s unanticipated short-comings more evident than in the dismally low number of retail licenses issued since becoming law. Retail is supposed to generate the most tax and create the highest number of jobs within the industry.

California has licensed 689 stand-alone dispensaries, plus 310 delivery services, according to the state’s Bureau of Cannabis Control. There is no limit on the number of licenses the state can issue, says Alex Traverso, a spokesperson for the BCC.  “Licenses can be attained by all who qualify” once they are approved at the local level.

By comparison, as recently as two years ago, there were as many as 1,800 medical dispensaries—also known as collectives—operating in a quasi-legal status throughout the state.

To date, there is approximately one dispensary for every 34,000 adult Californians, according to BDS Analytics. But industry experts recommend a ratio of at least one dispensary or delivery service per every 10,000 residents. Some states have done even better. There is one for every 5,500 Oregonians and one for every 4,500 Coloradoans.

What is going on? Proposition 64 legalized sales of cannabis products throughout the state, but that doesn’t mean consumers can find it everywhere: Only 89 of California’s 482 cities allow retail sales. A paucity of legal retail drives people directly to the illegal market. The reason: Local municipalities have prohibited commercial cannabis activity, resulting in so-called pot deserts.

That doesn’t sit right with people who believe that elected officials have an obligation to carry out the will of the people.  Nearly 80 percent of Californians who voted in favor of Prop 64 say that dispensaries should be allowed to open in areas that supported legalization, according to a David Binder Research poll conducted in February 2020 and commissioned by Weedmaps, the cannabis technology firm.

Earlier this year, the state assembly declined to take action on a bill that would override municipal bans where more than 50 percent of voters approved Proposition 64.  Advocates expect that a similar bill will be reintroduced by early 2021. But until then, local control is integral to California law. The state can only license businesses that have already obtained local approval.

That gives municipalities enough control to effectively ban retail outlets within their limits.  When cities and counties prohibit legal access in their jurisdiction, many say they are actually aiding and abetting the illegal market.

“Right now our goal is not to lose momentum,” says Frank Louie, Chief Operating Officer of the CalAsian Chamber of Commerce and an advocate for more industry participation by minorities.  “The lack of licenses is a real problem.”

An unlikely “savior”

In the end, it might the pandemic that saves California’s cannabis industry.

Why? As a result of the economic devastation caused by the Covid-19 pandemic, California is bracing for a severe economic downturn. Throughout the state, many jurisdictions—large and small—are rethinking their prohibitions. Mayors, city councils, and county supervisors are looking at cannabis and the tax revenue that it can generate in a whole new light.

Just one successful dispensary equals hundreds of thousands of dollars in new tax revenue, while back-end processing could generate millions more. Faced with escalating unemployment and drastic reductions in municipal services, about a dozen California cities—from Sonoma to  Yountville and Signal Hill to Lemon Grove– are exploring opening up licensing. Cannabis, it seems, is one of the few viable options.

At least in the short term, “Saint Covid, the California Cannabis Savior” as one industry insider put it, may actually provide some relief.

First posted on Green Entrepreneur – Read More