Two years in, California’s legal marijuana industry is stuck. Should voters step in?

SACRAMENTO —  Two years after California began licensing pot shops, the industry remains so outmatched by the black market that a state panel recently joined some legalization supporters in calling for significant changes — perhaps turning again to voters to address the problems.

In its annual draft report, the Cannabis Advisory Committee warned Gov. Gavin Newsom and California legislators that high taxes, overly burdensome regulations and local control issues posed debilitating obstacles to the legal marijuana market.

With tax revenue about a third of what was expected and with only about 800 of an anticipated 6,000 licensees open for business, the panel said, officials may need to consider “revisiting the ballot initiative process.”

“Despite the state’s committed efforts to bring cannabis businesses fully into the regulated commercial market,” the report said, “as much as 80% of the cannabis market in California remains illicit.”

The 22-member advisory panel — made up of industry leaders, civil rights activists, local officials, law enforcement and health experts — noted that California is expected to generate $3.1 billion in licensed pot sales in 2019, making it the largest market for legal cannabis in the world. But nearly three times as much — $8.7 billion — is expected to be spent on unlicensed sales.

Proposition 64 legalized growing, selling and using marijuana for recreational purposes in November 2016, and the state began issuing licenses on Jan. 1, 2018. Officials originally estimated the state would take in $1 billion annually in tax revenue from cannabis, but the fiscal year that ended in June saw just $288 million collected. The current state budget projects $359 million in tax collections.

Before passage of Proposition 64, almost 1,800 dispensaries were selling marijuana for medical purposes, which was legalized by California voters in 1996. So far, 568 retail stores have received licenses, as have 230 delivery firms. By comparison, Colorado — with some 15% of California’s population — has more than 1,000 pot shops.

“Proposition 64 so far hasn’t lived up to most of our expectations,” said Michael Sutton, an environmental activist and one of the two official proponents of the initiative. “It’s no secret that a number of factors have conspired to make the rollout take longer than we thought.”

Newsom, who was a leading proponent of Proposition 64, has called for patience, saying he always expected it would take at least five years for a legal industry to fully develop. But his administration plans to consider “substantial system changes” in 2020 to boost the legal market and tamp down on the illicit market, said Nicole Elliott, the governor’s senior advisor on cannabis. The changes will be aimed at streamlining the permit process and “pushing local jurisdictions to understand the benefits of regulation versus continued prohibition,” Elliott said.

The governor is also facing pressure from state legislators and industry leaders to postpone an increase in taxes on cannabis cultivation scheduled for Jan. 1, including a bump tied to inflation that will raise the levy on cannabis flower from $9.25 per ounce to $9.65.

The legal marijuana industry’s struggles, including being banned from some cities, have been blamed for workforce reductions at major cannabis firms, including Eaze and Flow Kana, both of which recently cut 20% of their staff, while Weedmaps pared its workforce by 25%.

Jerred Kiloh, owner of Higher Path dispensary in Los Angeles, said while his business is doing well, layoffs have been widespread among most of the 165 members of the United Cannabis Business Assn., for which he is president.

“Seventy percent of my members have had to do layoffs,” Kiloh said.

Among the obstacles facing the industry is that some 75% of California’s cities have banned marijuana stores, said Lindsay Robinson, executive director of the California Cannabis Industry Assn. Licensed sellers also complain that state and local taxes can add 45% to the cost of cannabis, putting them at a competitive disadvantage with illegal sellers.

“Currently, illegal retail operations outnumber legal shops 3-to-1,” Robinson said. “Almost two years into legalization, we continue to be plagued by local bans, untenable taxation, onerous regulations, an illicit vape crisis, slow growth and a thriving illicit market.”

Opponents of legalization said the continued proliferation of black-market pot sellers and growers is not a surprise, given flaws they say exist in Proposition 64, including a lack of sufficient enforcement against unlicensed sellers.

“They’re able to undercut the price of the legal market and sell whatever, whenever, to whomever,” said Kevin A. Sabet, president of the national group Smart Approaches to Marijuana. “Did we really think they’d just disappear?”

Cody Bass said his state-licensed Tahoe Wellness Cooperative has had trouble competing with the unlicensed market when the cannabis it sells is subject to a 15% state excise tax and a 7.75% local sales tax — in addition to the taxes on cultivators that get passed up the supply chain.

The South Lake Tahoe City Council member and board member for the National Cannabis Industry Assn. has started talking about putting a new initiative on the statewide ballot that would reduce taxes and regulatory burdens while explicitly requiring cities to allow cannabis stores if their voters supported Proposition 64. The Legislature has balked at similar proposals.

“It’s a heavy lift, but it’s within the realm of reality if we are unified,” Bass said.

On Dec. 17, the Legislature’s top advisor recommended that lawmakers consider overhauling how cannabis is taxed, including a possible potency-based tax to reduce harmful use. The Legislative Analyst’s Office also said lawmakers should consider eliminating the cultivation tax. Previous measures to require some local governments to allow sales and to reduce taxes on licensed retailers have failed to advance.

William G. Panzer, an Oakland attorney who was co-author of Proposition 215, which legalized medical marijuana in California, called the current licensing system a “nightmare.”

“There is lots of talk about it,” Panzer said of a new initiative. “I love the idea, if there is financing. You are not going to get the problems fixed through the Legislature.”

Elliott said the governor is sympathetic to the challenges of licensed cannabis operators and is willing to work with lawmakers and the industry on addressing concerns about taxation.

But some state actions are magnifying the legal market’s problems, including the tax increases on cultivation set to take effect Jan. 1, said Assemblyman Tom Lackey (R-Palmdale), who has asked Newsom to block the new levies.

The California Cannabis Industry Assn. said it was “stunned and outraged” by the tax increases.

“Widening the price disparity gap between illicit and regulated products will further drive consumers to the illicit market at a time when illicit products are demonstrably putting people’s lives at risk,” the association said in a statement.

Newsom’s office notes the automatic tax increases are required by state law.

“The governor is not given carte blanche to simply ignore these legislative mandates, and it is a dangerous precedent to suggest he do so,” Elliott said.

Some backers of Proposition 64 say it is too soon to panic and roll back taxes and regulations meant to protect consumers and the environment.

Sutton, the executive director of the Goldman Environmental Foundation, said he does not support pursuing another ballot initiative.

He suggested that California offer cities incentives to prod them to allow cannabis stores, including sharing the taxes collected by the state. More technical assistance could also be offered to help new cannabis firms get started and meet the stringent testing and tracking requirements set by the state, he said.

State agencies that license and regulate pot businesses also need to fill vacancies so they have sufficient staffing to do their job and eradicate illicit pot operations, Sutton said.

Some law enforcement officials remain concerned about the system set up by Proposition 64, arguing the persistent illicit market is a threat to public safety.

“We’re not satisfied with the way things have been,” said Citrus Heights Police Chief Ronald A. Lawrence, who is president of the California Police Chiefs Assn. “Some of this is dangerous stuff. Frankly, you’ve got some of the [drug] cartels out there who have exploited the situation in California.”

The state Bureau of Cannabis Control has begun stepping up enforcement in recent weeks. On Dec. 12, the bureau and local authorities served search warrants on 24 unlicensed pot shops and seized $8.8 million in cannabis products, while also confiscating 9,885 illegal vape pens and $128,742 in cash.

That action came a month after the agency sent more than 400 letters to property owners warning them that their tenants appeared to be engaging in unlicensed cannabis activity and noting that landlords could face civil liability, including fines of up to $30,000 per day.

But overall, “enforcement has been inconsistent and spotty at best,” said Scott Chipman, vice president for Americans Against Legalizing Marijuana.

The legal industry has faced obstacles in Washington as well.

Because marijuana is illegal under federal law, federally chartered banks have been unwilling to handle money from cannabis businesses, complicating financial transactions and requiring retailers to carry large amounts of cash to pay vendors and taxing agencies. Federal and state legislation has so far not succeeded in allowing banks to handle cash from marijuana operations.

Panzer, a criminal defense attorney who supported Proposition 64, said he expects the industry will pressure state lawmakers to consider additional reforms when the Legislature reconvenes in January.

“The only people making money in the cannabis industry these days are people putting on seminars on how to make money in the cannabis industry,” he said.