Taxes Could Ruin Legal MarijuanaBy admin_45 in Blog
$1 billion: that’s how much California initially anticipated receiving in annual tax revenue by legalizing the sale of recreational marijuana. Here’s what actually happened:
- CA will likely bring in just under $500 million in marijuana tax revenue this fiscal year.
- That’s lower than the $630 million forecasted in former Governor Jerry Brown’s budget.
- Current Governor Gavin Newsom’s new budget projects the state will generate $355 million in marijuana excise taxes by the end of June according to press accounts.
That is worse than underwhelming. Consider that Washington State received $319 million in legal marijuana taxes and license fees in fiscal year 2017, while Colorado collected $247 million in 2017. They have populations of just 7.5 million and 5.7 million respectively. California is the largest US state with nearly 40 million people.
Why is this important? There was a wave of Democratic gubernatorial candidates that ran on legalizing recreational marijuana to boost state tax revenue in the last midterm elections. Many of them won and are trying to pass a bill through their state legislatures as soon as this year. These include: New York, Illinois, Connecticut, Minnesota, New Mexico, and New Jersey.
If new states want to legalize retail cannabis sales and meet their respective tax revenue goals, they need to heed the lessons of California and public equity investors in the space likewise should understand the issue as they assess the size of the addressable market here. Marijuana legalization in the US is far more complex than either group likely realizes.
With that said, there’s three major issues at play in California:
#1 – The taxes are too high, allowing the black market to remain relevant.Fitch predicted this consequence in 2017: “California's high cannabis taxes will encourage black market sales and limit potential local government revenues from this new market… Effective tax rates on nonmedical cannabis will be as high as 45% when accounting for both state and local levies… By comparison, Oregon taxes nonmedical cannabis at approximately 20% and Alaskan taxes range from 10% to 20%.”
The upshot: California should reduce its marijuana tax rates to better compete with the black market, and other states should learn and get it right out of the gate.
#2 – California may have legalized the sale of retail cannabis, but most cities still prohibit it. Fewer than 20% of cities in the state allow stores to sell recreational marijuana (89 out of 482). For example, 93% of Los Angeles County’s 88 cities ban retail sales. One solution that’s supposed to go into effect: businesses will be allowed to deliver anywhere in the state aside from public land in the hopes that people use those services rather than buy from the black market in communities where they don’t have access to legal adult-use sales.
#3 – The regulations are too onerous and complicated. There are a lot of problems here, so we’ll just highlight a couple.
- The Bureau of Cannabis Control has issued about 550 temporary and annual licenses to marijuana retail stores compared to initial projections of upwards of 6,000 in the first few years. To put this in perspective, the Los Angeles Times reports that “some 1,790 stores and dispensaries were paying taxes on medicinal pot sales before licenses were required starting Jan. 1.”
- Why haven’t they issued more licenses? Marijuana businesses need a local license before getting one from the state. That’s tough to do when retail sales are banned in most cities. Obviously, this is not an issue for the black market, which is not restricted by location or burdened by regulatory and compliance costs.
- Moreover, California’s marijuana market is still governed by a slew of emergency regulations. The Bureau of Cannabis Control, California Department of Public Health and California Department of Food and Agriculture have tweaked these regulatory provisions over the past year, and are still working on final non-emergency regulations to adopt. In the meantime, marijuana businesses have been left confused and forced to adapt to regulatory changes, such as different labeling requirements on marijuana products.
To sum up, we’ve covered the legal retail marijuana industry since its infancy five years ago and remain enthusiastic about its prospects. That said, California is a key example of how the same regulations that made the recreational cannabis market possible can also hurt its growth. The right deregulation will ultimately drive growth rates for the industry and valuations for public pot companies over time. This is why it is taking so long for New Jersey, for example, to legalize retail marijuana sales through its state legislature. Lawmakers have the benefit of learning from states like California that missed the mark, even with the tailwind of an entrenched medical market with existing infrastructure and a distribution pipeline.
The bottom line for investors in public pot stocks: pay attention to state and local tax rates and regulations as new markets open up because this underappreciated factor will profoundly affect the industry’s total addressable market.