What’s keeping tax revenues down and the black market high? A look at California city licensing
Why is the Cannabis black market alive and well?
This is an easy question where Cannabis is still illegal. But seriously, why is it alive and thriving in states that have legalized adult use Cannabis? Why in California, with over $3 billion in legal sales, where you can go to a store on the posh Venice street Abbot Kinney or use a platform like Eaze for home delivery, would revenue from the black market dwarf legal sales with an estimated $8.7 billion in 2019? Why are people dying in legal adult use states from black market THC vaporizing cartridges when they can buy safe cartridges from a store?
One reason that doesn’t get enough discussion: California cities.
A look at Prop 64
California Proposition 64 exists to snuff out the black market. It even says so as the first item in its intent section that it seeks to:
"Take nonmedical marijuana production and sales out of the hands of the illegal market and bring them under a regulatory structure that prevents access by minors and protects public safety, public health, and the environment.” Prop 64, Sec. 3(a).
The California regulatory architecture also gives significant control to city governments. Prop 64’s intent section further says that it will:
c) Allow local governments to enforce state laws and regulations for nonmedical marijuana businesses and enact additional local requirements for nonmedical marijuana businesses . . .
and
(d) Allow local governments to ban nonmedical marijuana businesses as set forth in this act.
Putting together subsections (c) and (d), Prop 64 is clear that an adult use operator having a state license is not sufficient to open. The city must also authorize an operator. Prop 64 gives cities the discretion to not allow any Cannabis businesses to open.
California cities have an important role, and have been responsible for a bottle neck in the market
California cities have overwhelmingly exercised their discretion to stay away from Cannabis. 80% of California municipalities do not allow any type of adult use Cannabis businesses. And the municipal governments that allow it have been slow in issuing licenses.
In the 21 months adult use Cannabis has been legal in California, 874 licensed dispensaries are operating statewide. That is minuscule compared to the more than 3,000 illegal dispensaries operating before Prop 64. In California’s largest city Los Angeles, the disparity is more dramatic. Los Angeles has issued 187 dispensary licenses compared to 1,000 shops operating illegally pre Prop 64.
The licensing process is also arduous and costly. License applicants that are not equity applicants have to wait as long as 3 years before getting a hearing.
What this practically means
Consumers lose, and rationally choose the black market
The delays in cities issuing licenses, and many municipalities opting out entirely means demand dwarfs legal supply. In LA pre Prop 64, there was demand to support nearly 10x the current supply of legal dispensaries.
The depressed supply of legal dispensaries has led to high prices in the legal market. Take a look at the price disparity between dispensary and street prices in California for high quality ounces:
Dispensary price/ounce: $226.69
Black Market: $146.03
http://budzu.com/prices/usa/california
Compare that to Oregon, which has been more liberal in issuing dispensary licenses and has greatly weakened the black market. Oregon has issued 661 total retail licenses for its population of 4 million compared to California’s 874 with has a population of 40 million:
Dispensary price/ounce: $138.89
Black Market: $165.33
http://budzu.com/prices/usa/oregon
In a recent UC Berkeley poll, 68% of Californians support legalized adult use Cannabis, which is an increase from 57% of votes in favor of Prop 64 in 2016. 63% also support retailers operating in their community.
So let’s say you’re a cannabis consumer in California. Until 2018, you were buying your products on the black market. Today you have a choice: higher prices from more scarce dispensaries or continue your current buying habits at lower prices at more convenient locations. If you don’t care about the legal, health, and moral implications of participating in the black market, it is rational to continue with the black market.
The California black market doing nearly 3x in annual revenue versus the legal market shows that many consumers are making that rational decision.
The black market wins
By cities keeping the supply of stores low compared to the strong demand for Cannabis, they are fueling the black market. Cities are creating an ecosystem where the black market has an advantage in distribution and price. This means that events like the current THC vaporizer crisis, which is the result of tainted black market cartridges, and has affected 110 Californians and killed two, is likely to continue in California.
The state loses tax revenue
Tax revenue to the State of California is far below expectations. When Prop 64 passed in 2016, the government expected $1 billion in annual tax revenue by this time. In January 2019, Governor Gavin Newsom’s proposed budget forecasted $355 million in 2019, and $514 million in 2020. In May, the Governor’s office revised its forecast down to $228 million and $325 million respectively.
Tax revenue from Cannabis is supposed fund public health programs to prevent and treat serious substance abuse in youth, train local law enforcement to enforce the new law with a focus on DUI enforcement, invest in communities to reduce the illicit market and create job opportunities, and provide for environmental cleanup and restoration of public lands damaged by illegal marijuana cultivation. Because of lower than expected tax revenue, that is not happening.
Failed attempts to force change
The California legislature tried to act, and Assemblyman Phil Ting offered AB-1356 as a solution. The bill would have required cities with over 50% of their residents voting in favor of Prop 64 to issue retail dispensary licenses in proportion to operating liquor licenses. Assemblyman Ting pulled the bill when it became clear it wouldn’t have the 2/3 vote necessary due to strong lobbying from the League of California Cities and the California Association of Counties. They argued successfully the state should not dictate to the local governments whether and how many Cannabis dispensaries they should open.
There have been a number of ballot initiatives in municipal elections. They have typically been in cities that have banned adult use retail stores or business from operating, and would require the city to issue a defined amount of licenses. Almost all have failed.
Recommendations going forward
The State of California, municipalities, and the pro-Cannabis community should come together to create policy that weighs the shared interest in snuffing out the black market, bringing in tax revenue, and respecting municipalities control over who does and doesn’t do business in their jurisdictions.
There should be statewide legislation
Legislative change must come from the state-level. Investing in a statewide solution is the strongest leverage point because lobbying efforts need only be focused on a relatively small group of people. Conversely, it would be more expensive and time intensive to run city-by-city ballot initiatives and mobilizations to compel cities to issue licenses. The past municipal initiatives have already shown the anti-Cannabis vote tends to show up in greater proportion than their actual numbers in the smaller scale and less public municipal elections.
The State of California should incentivize cities, not compel them
While AB-1356 may be rational policy, politically it ignored the #1 rule of working with local governments: respect their sovereignty. Local governments want the state to respect their local authority. Similar to how states want the federal government to respect theirs. Instead of a compulsory approach, which AB-1356 did in requiring municipalities to issue a defined amount of licenses, a more realistic political strategy is for the state to craft legislation that uses financial and service incentivizes to municipalities that hit licensing benchmarks.
AB-1356 made a reasonable assumption in pegging recreational dispensary licenses in proportion to active liquor licenses. But politically it was an obviously bad decision. A resolution must come from collaboration with municipal governments, and it must show them the state understands, respects, and meaningfully addresses their concerns.
The pro-Cannabis community needs to get active
Members of the pro-Cannabis community should be meeting with their elected officials regularly to make clear the overwhelming support for more dispensaries and not just rely on industry lobbyists. Community members should use their dollars to reward friends in state and municipal office with campaign contributions and volunteer their time on re-election campaigns. The community should see skeptical elected officials as potential friends and continue to engage them in dialogue. Heading into the election season, they should ask candidates for position papers on access to recreational Cannabis so elected officials can go on the record and crystallize their position.
Balancing good policy with an effective political strategy would unite all legitimate elements in California to use economics to snuff out the black market, increase tax revenue, and give the people what they want—greater access to Cannabis.
