Dumpster Fire: What Went Wrong with California Cannabis?

17 Jun Dumpster Fire: What Went Wrong with California Cannabis?

Cannabis is supposed to be relaxing and fun. What’s not to like about giggles, munchies, and a brief break from the mundane? Unfortunately, news from California’s Emerald Triangle is anything but upbeat these days.

Report after report portends doom with headlines like “the world’s largest legal weed market is going up in smoke” (The Economist), “California pot industry facing ‘extinction event‘” (SF Gate), “Despair in Emerald Triangle as CA legal cannabis collapses” (CalMatters), and “Legal cannabis sales are on a bad trip in the latest reckoning for the once-booming industry” (Fortune).

Is it really that bad?

Yeah, it is.

Legal sales have been on a downward slide for over two years with no signs of relief on the horizon. At its roots, the main cause appears to be the overwhelming dominance of the illicit market, which is estimated to be twice the size of the regulated market (Politico).

The result: Cascading business failures across the industry.

Supply Chain Woes

One in five cultivators have voluntarily surrendered their licenses this year. Others are letting their licensed fields go fallow, unable to fund this year’s harvest on the heels of last year’s losses.

Things are no better in other corners of the industry. A year ago, there was a stunningly diverse and innovative brand community. In May 2022, there were close to 1500 brands in the market, according to Headset. A year later, less than a thousand remain.

Further up the supply chain, distributors are also buckling under. A 2022 report estimated that licensed California cannabis distributors are sitting on over $600 million dollars in aging accounts receivable that retailers are unable or unwilling to pay. Herbl, which touted itself as the largest distributor in the state has collapsed, leaving hundreds of brands in fear that they won’t be paid for their product.

As for California’s cannabis retailers, numerous industry observers are warning that hundreds of dispensaries will be out of cash and credit by the end of the year. The probable closure of a significant percentage of California’s retailers will further destabilize the overall industry as cannabis farmers and manufacturers lose access to legal-market customers.

And for all the talk of social equity and “righting the wrongs” of the war on drugs, all of this is taking place in an industry where there are no bankruptcy protections, where individuals carry personal liability for business taxes owed regardless of the corporate structure, and where businesses are barred by federal tax law from writing off normal business expenses.

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

Fatal Flaws

When Proposition 64 passed in November 2016, it established 27 voter-mandated goals. Five of these goals were about getting rid of the illicit market and providing a reasonable pathway to licensure.

From Prop 64: “It is the intent of the People in enacting this Act… 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….”

The failure to achieve these voter-mandated goals is at the root of much of the industry’s anguish. So, what happened? With the benefit of hindsight, it’s clear that Proposition 64 had two fatal flaws: high taxes and local control.

Just how high are California’s cannabis taxes? For comparison, the State Excise tax on a bottle of wine is a palatable four cents. The state excise tax on an eighth ounce of cannabis is $4.90 or over 100 times greater. Added to that, California products are taxed throughout the supply chain. A single cannabis product can be hit with a local cannabis cultivation tax, a local manufacturing tax, a local distribution tax, and a local retail tax. Heck, we’re even hit with a “road tax” for merely transporting products into some jurisdictions. Then there’s the hefty state excise tax and sales tax.

These taxes compound throughout the supply chain (meaning our taxes are taxed), resulting in a cumulative burden that goes a long way toward explaining why illegal products are typically half the price of licensed products.

That’s hardly the way to “tax the growth and sale of marijuana in a way that drives out the illicit market….” as required by Prop. 64. In the absence of real tax reform, enforcement against illegal cannabis will continue to be a losing game of whack-a-mole.

Local Control Means No Control

The second fatal flaw is the notion of “local control.” Local control refers to California’s dual approval approach, which means that every cannabis facility must secure local authorization and a state license. In concept, that doesn’t sound so bad. But in practice, it means that over 60% of jurisdictions have banned cannabis retail.

By allowing municipalities to opt out, California has, in effect, surrendered most of the state market to illicit operators and criminals. Otherwise put, “local control” means no control. In these (legal) cannabis deserts across the state, unregulated, untaxed, and untested cannabis is king.

The Changing Face of the Illicit Market

Adding to these woes, the face of illegal cannabis has changed in important ways. Thirty years ago, much of California’s underground cannabis economy was represented by off-the-grid, mom-and-pop growers hidden in the backwoods of Humboldt and Mendocino County.

Today’s illicit actors are a different breed altogether. Rumors abound about well-capitalized cannabis licensees playing both sides of the fence and using massive profits from the illegal sale of cannabis to undercut their competitors in the regulated market. Most recently, mega-cultivator Glass House Brands was sued by the rabble-rousing CEO of Catalyst for “knowingly entering into illicit sales – both inside and outside California.” (Glass House countersued for defamation.) Top Shelf was accused by an employee whistleblower of illegally shipping at least $2 million worth of legal cannabis out of state. And the ever-popular Stiiizy brand was put on the defensive after a WeedWeek investigation suggested the company had an illegal pipeline of products from the company’s licensed Los Angeles factory to New York.

The glut of unregulated, intoxicating so-called “hemp” products poses additional challenges. Despite state prohibitions, a growing number of companies are openly selling highly intoxicating synthetic cannabinoids under the guise of hemp. Chapo Extrax, for example – which proudly proclaims itself “the newest drug cartel in town” – sells gummies online with 175mg of uber-potent synthetic THC per piece, making it many times stronger than anything sold in the regulated market (which caps THC at 10mg per serving). Consequently, while legal cannabis sales plummet, poison control reports related to unregulated cannabinoid products are on the rise.

These synthetic knock-offs are undermining the integrity of California cannabis, as well as endangering consumers. Moreover, many of these companies flagrantly market to children and imitate common snack foods – practices that are banned in the regulated industry.

Yet, to date, there’s been virtually no enforcement against purveyors of these designer drugs, which have more in common with “bath salts” than traditional cannabis.

These products are easily purchased in California despite a state ban on intoxicating hemp:

Towards a Solution

There is still an opportunity to make changes that will enable California to build the vibrant, regulated, tax-generating industry Californians asked for in passing Prop 64. But that will require immediate and important changes to ensure that adult consumers across the entire state have access to legal cannabis that’s competitively priced.

It means significantly reducing the state and local taxes and prioritizing sensible law enforcement strategies that keep up with the rapidly changing market. It also means overhauling the dysfunctional two-tiered structure that allows local authorities to ban legal cannabis while unregulated markets flourish.

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 also have a robust cannabis market that’s poised to be a dominate force in the national and even global markets in a post-legalization world. To ensure that, we need to address the urgent issues at hand.

Tiffany Devitt heads up regulatory affairs for CannaCraft and March and Ash and sits on the board of the California Cannabis Industry Association (CCIA). © Copyright, Project CBD. May not be reprinted without permission.