Excessive taxes, local control allows California illicit cannabis market to thrive

The chief financial officer of the cannabis company MariMed was recently asked where her team was considering expanding. Her reply: “Not California.” 

Susan Villare is not alone in that sentiment. Numerous well-capitalized businesses are pulling up stakes and abandoning substantial investments rather than face mounting losses. Many investors describe the market as “brutal” and “toxic.”

Currently 2 out of every 3 cannabis purchases are made in the illicit market. Evidence suggests that disparity is getting worse. Legal sales have been on a two-year slide. 

Another symptom of turbulent times is business failures. About 15% of cultivators have surrendered their licenses this year; others are letting fields go fallow, unable to fund this year’s harvest.

Things are no better further up the supply chain. A year ago, there was a robust brand community. In May 2022, there were close to 1,500 brands in the market. A year later, less than a thousand remain.

Distributors are also struggling. A 2022 report estimates that they are sitting on about $600 million dollars of invoices that retailers are unable or unwilling to pay. 

As for California’s cannabis retailers, numerous industry observers are warning of yet another “extinction event.” The probable closure of hundreds of dispensaries will further destabilize the industry as farmers and manufacturers lose access to legal-market customers.

For all the talk of equity and “righting the wrongs” of the drug war, all of this is taking place in an industry without bankruptcy protections, where individuals carry personal liability for business taxes, and where businesses are barred from writing off normal expenses.

In other words, behind the industry’s potential demise are thousands of intimate, personal stories of financial ruin. 

Proposition 64, the 2016 initiative to legalize cannabis, began with the statement: “It is the intent of the People … to take marijuana production and sales out of the hands of the illegal market … to tax the growth and sale of marijuana in a way that drives out the illicit market …”

Our failure to achieve these voter-mandated goals is the root cause of much of the industry’s distress. So, what went wrong?

With the benefit of hindsight, it’s clear that Prop. 64 had two fatal flaws: high taxes and local control.

The state excise tax on a bottle of wine is 4 cents. For an eighth-ounce of cannabis, it’s $4.90 or over 100 times more. Products are also subjected to countless local taxes. A single product may be taxed at cultivation, manufacturing, distribution and retail. Some jurisdictions even charge a “road tax” for merely transporting products.

These taxes compound the supply chain, resulting in an aggregate burden that’s 50% or more of the original price. 

That’s hardly the way to “drive out the illicit market.” Absent larger tax reforms, cracking down against illegal cannabis will continue to be a losing game of whack-a-mole.

The second fatal flaw is local control, or the requirement that cannabis businesses receive permits from both the local jurisdiction and the state. That sounds reasonable. But in practice, it’s led to cannabis retail bans in much of the state. 

By allowing municipalities to opt-out of legalization, the state has essentially ceded two-thirds of the market to criminals. In these dry zones, unregulated, untaxed and untested cannabis is king, and consumers are still partying like it’s 1999. 

Cannabis is one of California’s great heritage industries, along with wine, technology and entertainment – industries we’ve nurtured and fostered with supportive legislation and regulation.

By right, we should have a robust cannabis market that’s poised to dominate in a post-legalization world. But achieving that will require immediate changes to ensure legal cannabis is more accessible and less expensive for consumers.