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California has been dubbed the largest adult-use cannabis market in the world, but those playing by the rules continue to forge ahead while remaining handcuffed by the state’s tax structure and retail shortage.  

Despite being on pace to record its highest yearly sales mark—with adult-use cannabis retail tallying $3.9 billion in taxable sales through the first three quarters of 2021—California’s reality on the ground is that the illicit market still outperforms the legal one because of a price gap caused by oppressive tax burdens and multilayered bureaucracy as barriers to entry. 

Last year, the Legislative Analyst’s Office—a nonpartisan fiscal and policy research institute for California’s Legislature—estimated that adult-use cannabis businesses operate in less than one-third of jurisdictions statewide.

But that could all change under Gov. Gavin Newsom’s budget proposal released Jan. 10—pending what’s in the details. Nevertheless, Newsom signaled he’s ready to reform the cannabis program’s tax structure and retail shortage.  

“The administration intends to further develop a grant program this spring that will aid local governments in, at a minimum, opening up legal retail access to consumers,” Newsom wrote in his 400-page budget summary. “Further, the administration supports cannabis tax reform and plans to work with the Legislature to make modifications to California’s cannabis tax policy to help stabilize the market; better support California’s small, licensed operators; and strengthen compliance with state law.”

While many California cannabis businesses, especially small farms, have faced an uphill battle since 2016’s voter-approved Proposition 64 was enacted—and the subsequent adult-use sales launch in January 2018—many of their struggles originate from hand-tying policies that predate Newsom’s governorship. His term began in January 2019.

Schwass

Newsom’s proposed budget summary addresses areas that have been hindering California’s legal market since its inception, cannabis law expert Jared Schwass told Cannabis Business Times. Born and raised in Mendocino County, Schwass practices law in the cannabis space as the founder of California-based Schwass Law Firm.

“Advocates and industry insiders alike have been calling for tax reform as operators have seen plummeting wholesale prices but continue to be subject to a flat cultivation tax and excessive excise and local taxes,” he said. “However, there are no details on the tax reform supported by Gov. Newsom and, rather, puts the proverbial ball in the Legislature’s court. Whatever the reform ends up being, a tax reform that does not include the repeal of the cultivation tax will not be sufficient as many farmers are seeing the tax eat away at their already disappearing margins.”

When California’s Control, Regulate and Tax Adult Use of Marijuana Act (Prop. 64) went into effect, the state began collecting a 15% excise tax, a sales tax and a cultivation tax on cannabis. California’s current cultivation tax is based on $10.05 per dry-weight ounce for cannabis flower, $3.00 per dry-weight ounce for cannabis leaves and $1.41 per ounce of fresh cannabis plants that are weighed within two hours of harvesting, according to the California Department of Tax and Fee Administration (CDTFA).

Those three weight benchmarks all increased at the beginning of this year to adjust for inflation, as required by the state’s cannabis tax law, according to CDTFA.

Farrar

The cultivation tax “makes absolutely no sense,” said Graham Farrar, co-founder and president of Glass House Brands. His Santa Barbara-based operation encompasses more than a half a million square feet of sustainably grown, craft-at-scale cannabis.

“It’s weight-based, which means it goes up as a percentage as prices compress, and [it] hits outdoor farmers the hardest,” Farrar said.

For instance, if a greenhouse grower endures a $160 cultivation tax for a pound of cannabis that wholesales at $1,000 per pound, and an outdoor grower endures the same $160 cultivation tax for a pound of cannabis that wholesales at $500 per pound, then the tax burden would be 16% for the greenhouse grower and 32% for the outdoor grower.

Nonetheless, Farrar said the governor and his staff in the Department of Cannabis Control have succeeded in accurately recognizing a number of the main challenges that the legal cannabis industry currently faces.

“They recognize that what we need is: lower taxes and more retail,” he said. “We need to be able to have a chance to compete against the illicit market, who pay no taxes; and we need more legal access for consumers. Their proposal aims to improve both of those things, by removing the cultivation tax and making it easier for municipalities to open more retail doors.”

Farrar also pointed out that the governor needs to work with the Legislature to accomplish the goals he laid out in his budget proposal.

Perhaps one of Newsom’s most notable cannabis-related measures he’s advanced as governor was the streamlining of the state’s burdensome regulatory system last year.

Specifically, Newsom’s team helped consolidate the functions and positions of three program agencies—the Bureau of Cannabis Control, the Department of Food and Agriculture’s CalCannabis Cultivation Licensing Division, and the Department of Public Health’s Manufactured Cannabis Safety Branch—into today’s standalone Department of Cannabis Control. That consolidation, which took shape July 12, 2021, centralized regulatory oversight to help the process of simplifying participation in the state-legal cannabis market.

While Newsom’s 2022-23 budget summary cites his administration’s intent to develop a grant program to assist local governments in opening legal access to consumers, he offered little detail into that proposal, Schwass said.

“There is a great need for additional retailers throughout California, and the grant program needs to sufficiently entice more municipalities to open up,” he said.

When asked during his budget proposal’s Jan. 10 press conference to provide more details on the cannabis tax policy reforms he’d like to work with the Legislature on to help stabilize the market, Newsom reframed from getting into more specifics.

The governor first pointed out that projected cannabis tax fund revenue is $787 million for the budget cycle. Prop. 64 prioritizes expenditures associated with the regulatory and administrative workload necessary to implement, administer and enforce the state’s cannabis program, followed by research and activities related to the legalization of cannabis and the past effects of its criminalization, the budget states.

Once those priorities are met, the remaining funds, estimated to be $594.9 million, will be allocated to youth education, prevention, early intervention and treatment (60%); environmental protection (20%); and public safety-related activities (20%).

“Any [cannabis tax] reforms need to consider the impacts of revenue, impacts to those categories of funding and investments … it should consider different components to the industry, and reforms have been offered aplenty,” Newsom said. “And so, I’ll just leave it at that except to say there was intention by having that language in the budget. It is my goal to look at tax policy to stabilize [the] market. At the same time, it’s also my goal to get these municipalities to wake up to the opportunities to get rid of the illegal market and the illicit market and provide support and a regulatory framework for the legal market.”

The governor also said he hopes to work with the Legislature “in a sequenced way” so that any reform efforts create opportunities rather than more problems.

One pain point that was not addressed in the budget, but needs to be addressed, is the lack of access to the data collected by the state, Schwass said.

“Wholesale prices have been gutted, both for manufacturers and cultivators, but that has not been reflected in the consumers’ prices,” he said. “Providing access to the data would allow stakeholders to find the root of the issue and determine pathways to lower prices for consumers. Lower consumer prices will help the legal market compete against the thriving black market.”