Ask Our Experts 3/31/2019: California’s Business Environment Since Rollout of Statewide Adult-Use Program   

By Beau Whitney, VP and Senior Economist, New Frontier Data

 

Q: Has California’s business environment improved since the initial rollout of its statewide adult-use program?   

 

A: The California rollout was and continues to be rather messy. Taxes and fees remain the major obstacles for participation in the legal markets. Some communities like Berkeley and Oakland have either lowered their city tax levels or are in discussions to do so. Local fees are also impacting legal participation. A per-square-footage tax on cannabis businesses is being assessed, mainly in Northern California, to such an extent that it is being dubbed as “prohibition through legalization”. In some instances, the local fees amount to $80,000 per year for a 20,000-square-foot business, regardless of whether the company generates any revenue. Other taxes are on gross receipts, equally onerous to the extent that the illicit market is thriving.

Those taxes and fees are in addition to taxes on the harvest by weight, levied before any sales to customers are made. Such barriers to entry and obstacles to the normalization of doing business are significant examples of why California was $90 million short of the state’s $175 million forecasted tax revenue in 2018.

At the recent Cannabis Business Conference in Sacramento, overt statements from policy makers (including both state assemblymen and state senators) described how everybody knows that taxes are a problem, yet nothing is going to be done about it. Industry representatives at the conference, ceding the tax conundrum, cited other significant problems for operating a cannabis business in California:

1. Temporary licenses issued to growers and operators to get them into the legal system are set to expire, and many of the permanent applications have not yet been processed. As a result, many businesses wishing to participate in the legal system will need instead to shutter their operations. Concerns have been raised in Sacramento at the legislative level, but no solution has been agreed upon. Other states have mechanisms in place to keep temporary applicants in their systems, but California does not.
2. Products tested before revised standards were deployed are now set to expire, rendering those products unsellable. Other states instituted some grace periods for older products in order to ensure that nearly all those products could be sold, thereby limiting both retailers’ and suppliers’ exposure to lost revenue. Instead, California now sees millions of dollars’ worth of product at risk. Many fear that if significant amounts of inventory are rendered legally unsellable, they ultimately will be sold through gray or illicit markets by business owners desperate to limit their losses.
3. For products that are properly distributed and taxed, there is no clear policy specifying which distributor is required to collect the tax. Distributors in California are in charge of collecting the sales and harvest taxes for the states, making them critical cogs along the supply chain. Yet, it is quite common in California for distributors to sell to other distributors, which enables a given distributor access to markets that they might not cover without the help of another distributor. What is not clear, however, is who collects the taxes: Is it the first distributor?, or the last in the chain?, or is it someone else involved in the middle? Such lack of clarity in the regulations was considered the most critical issue among the distribution community in attendance at the conference. If distributors themselves are uncertain about who is to collect the taxes, it logically follows that many taxes are going uncollected, a situation leaving distributors being economically exposed for failure to collect or pay enough taxes due the Golden State.

Solutions to such issues are needed at the legislative level before California’s legal market can normalize. Based on a consensus from lawmakers at the Sacramento conference, there is no appetite for making sweeping changes, rather just minor tweaks around the edges. Pending such, investors may not expect improvements or a normalized market in California for several years yet: Meantime, it remains the wild West, roughshod with a significant and thriving illicit market.