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California’s illicit marijuana market thrives as much of the state continues to restrict sales

Sacramento Bee 10/4/2022 Andrew Sheeler, The Sacramento Bee

In 2016, Californians voted to legalize recreational adult-use marijuana. Proponents of Proposition 64, including then-Lt. Gov. Gavin Newsom, argued that it would generate massive revenue, while decreasing illicit cannabis and drug cartel activity in the state.

Now, nearly six years later, it’s clear that promise has not been kept.

While the state has collected billions in tax revenue from cannabis sales since legalization went into effect in 2018, billions more continue to pour into a thriving illicit market.

A new report from cannabis website Leafly found that more than half of all cannabis sales in the state (55%) are in the illegal market. It means the product being sold hasn’t been subjected to the state’s rigorous testing and tracking regimen, and can contain harmful pesticides or other powerful narcotics.

California recorded more than $5.2 billion in sales in 2021, according to the California Department of Tax and Fee Administration. According to Leafly’s analysis, that means more than $11.5 billion worth of cannabis was actually sold in the state, with the majority of that money going to drug cartels and dealers.

“The purpose was to move cannabis into a regulated market,” said Wesley Hein, director of compliance and government affairs with Mammoth Distribution said of Prop. 64. “And so that’s what people felt like they were voting for.”

So why, if marijuana is legal in California, is the illicit market thriving?

Local control

Leafly found that states like California that allow municipalities to opt out of cannabis sales saw an increase in illicit commerce. States without the opt out did not.

“The irony of local control is, you have no control,” said Sean Kiernan of the Weed for Warriors Project, a group that advocates for veterans’ use of medical marijuana.

By that, Kiernan means that when local governments opt out of allowing legal sales, which can be taxed and regulated, they are simply opening the door to illicit commerce.

Kiernan, an outspoken opponent of Prop. 64, has begun circulating for discussion his own ballot proposition to override and replace it with a measure that eliminates local control.

“We simply removed it from local hands and made it like alcohol,” Kiernan said of his proposal. “If the goal is to kill the illicit market, it’s the only way forward.”

In its recent series “Legal Weed, Broken Promises,” the Los Angeles Times released a report showing how extensive illegal cannabis grows are in California, using satellite images to pinpoint their location.

Local control has a significant impact on access to legal cannabis. In California, 62% of municipalities have opted out of regulated sales. There are just three stores in the state per 100,000 population.

Compare that to Montana, where there are 39 stores per capita and 78% of cannabis sales are in the legal market. In Colorado, there are 18 stores per capita and just 1% of all cannabis sales are in the illicit market.

“People generally want to purchase cannabis legally. They need to be given the chance to do so,” said Bruce Barcott, the report’s co-author.

A spectrum, not a binary

As Hirsh Jain, a cannabis industry consultant with Ananda Strategy, puts it, California didn’t fully legalize cannabis in 2016. Only about 30% of California’s 482 cities have retail cannabis open today, Jain said.

“Legalization is not a binary, it’s a spectrum,” he said.

While the state has just over 1,000 dispensaries in operation, on a per capita basis that number should be much closer to 4,000, he said.

A number of California metros were hesitant to embrace the legal cannabis industry, though some have since come around.

Fresno is an example of a large metro area that, until recently, had no access to legal cannabis. Now, there are two cannabis retailers operating in the city, according to the Department of Cannabis Control.

Jain said that by the end of the decade, we should see many more cities come online.

“The frustrating thing though is if we made smarter market decisions, we could accelerate that trajectory,” he said.

‘Tax upon tax upon tax’

Local control isn’t the only driver of the illicit market, advocates say. California’s cannabis tax structure plays a role.

There’s the state excise tax, the state sales tax, the local excise tax, the local sales tax, and many local governments also have their own taxes on the manufacturing, distribution or cultivation of cannabis.

“You have tax upon tax upon tax,” Hein said.

Until this summer, the state had it its own tax on cultivation, which growers had to pay. Newsom and the State Legislature eliminated that tax, though the governor left open the possibility of increasing the state excise tax in a few years to make up for any loss of revenue.

What really hurts, Hein said, is that local governments are allowed to tax cannabis as much as they want.

“And that’s been a friggin’ disaster,” Hein said.

All those taxes, which cannabis retailers pass along to customers in the form of higher prices, are enough to drive Californians into the illicit market, Jain said.

“California has a particularly entrenched illicit market. People have the muscle memory of going to their dealers,” he said.

California even taxes medical cannabis, Jain said, something that makes it unique among states.

“There’s not a good moral case for taxing people’s medicine,” Jain said.

‘The only winner’

Barcott, co-author of the Leafly report, said that he isn’t taking a position on local control.

But he said localities that opt out are under the impression that they are keeping marijuana out of their community.

“I would say it’s a bit of a fantasy,” Barcott said. “That really is a vote for a legal, regulated market or an illicit market.”

Hirsh said that thus far, Democrats in Sacramento have been reluctant to discuss cutting marijuana taxes, seeing that as a Republican issue. There’s also a strong constituency of youth advocacy groups that benefit from cannabis tax revenue, and that have argued against cutting taxes that could defund children’s programs.

Jain said the opposite is true — that cutting taxes would lead to cannabis businesses thriving and generating more revenue for the state and for those programs.

“The irony is that we can all be winners here. But in the current situation here, the only winner is the illicit market,” he said.

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