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Transitioned: Life in the Fully Regulated Market

Posted by An-Chi Tsou | Jul 10, 2018 | 0 Comments

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It's been a few weeks since we hit the ominous July 1 date that marked the end of California's transition period to the regulated market. Cannabis businesses are now required to have all products pass certain testing standards before putting them on retail shelves. In addition, products must meet stricter packaging and labeling requirements. Many industry members have been dreading the July 1 deadline for months now, with valid concerns about the inevitable bottleneck at the testing point of the cannabis product life cycle due to the sparse number of licensed testing labs in the state. Since the date has passed, there have been reports that some retail stores have had to lay off employees or even shut down their businesses due to a lack of inventory.

While some media outlets have referred to the post-July 1 testing and packaging regulations as “new,” making it appear as if the state blindsided businesses and thereby are responsible for their demise, the stricter regulations triggered by the July 1 date were published when the emergency regulations were first adopted at the end of 2017. Based on that fact, it may seem easy to blame business owners for not being aware of these regulations. However, if we take a deeper look at the implementation of California's cannabis laws, the reasons for the struggles by cannabusinesses in the post-transition period world are much more complicated.

Big business is booming, especially in terms of cultivation. As of mid-July, nearly 1,000 of the 4,588 licenses issued by the California Department of Agriculture's CalCannabis Cultivation Licensing division are held by just 16 businesses. These businesses hold 25 or more licenses each, with half of the businesses holding significantly more. Moreover, the top three license holders account for over 10 percent of all cultivation licenses; the top licensee holds 200 small mixed-light cultivation licenses. To put that into perspective, that allows for 2,000,000 square feet—or nearly 46 acres—of canopy. With so much product, these businesses have a leg up in negotiating lower costs for materials and equipment required to maintain compliance. The little guy, meanwhile, is left hanging.

Ancillary services in the cannabis industry come with a mean surcharge. It's part risk management, part opportunity. But the burden of this cannabis “tax” pales in comparison to the woes of the actual cannabis tax structure. All cannabis businesses are subject to two state cannabis-specific taxes—the cultivation tax ($9.25 per dry-weight ounce of flower, $2.75 per dry-weight ounce of leaves, and $1.29 per ounce of fresh cannabis plant) and the 15 percent excise tax—in addition to state and local sales taxes. These taxes are applied across all businesses, regardless of total revenue. Where are the incentive and financing programs to encourage small business development? Other industries have a wide variety of creative incentives, from exemptions from sales and use taxes, to income tax credits, to small grants and financing options. Considering that we are still in the infancy of the regulation of the cannabis industry, California should make sure we do it right by ensuring that small cannabusinesses have the fiscal opportunities to thrive.

Lastly, we still have an insufficient number of local governments allowing for commercial use. It's hard to blame cities and counties since implementing a local regulatory framework is challenging with state regulations still in flux. About one-third of cities and counties allow for any type of commercial cannabis activity, and those that do vary wildly in what types of businesses they are permitting: only cultivation, just manufacturing and distribution, a small handful of storefront retail operations.

So where does California go from here? The licensing authorities and Legislature need to make some bold moves to fix the current regulation of the industry. Final license regulations must be adopted sooner to help encourage local jurisdictions to come online with industry regulation, and they must include incentives for small businesses, particularly those located in underserved communities or owned by those disproportionately impacted by the war on drugs. At the very least, the California Department of Tax and Fee Administration appears to be moving forward, recently announcing they will release a discussion paper on July 20 in anticipation of their meeting on their rulemaking process for cannabis taxes on August 2. Furthermore, legislation that assists cannabusinesses in their transition into the regulated market, such as SB 1294 (Bradford), SB 930 (Hertzberg), and AB 1741 (Bonta) must be passed. As quick refresher, SB 1294 requires the Bureau of Cannabis Control to invest time and resources into social equity considerations, while SB 930 and AB 1741 help mitigate banking issues.

The Legislature is on summer recess, so these bills won't provide relief to the industry any time soon. Seeking other outlets for change, some are anticipating industry folk to air their grievances regarding the post-transition period regulatory environment at the next Cannabis Advisory Committee meeting on July 19 in San Diego. Would this be a good thing? Absolutely. And more power to them. Regulators need to understand how their actions are impacting those on the ground and hear convincing arguments for why and how they can make the California cannabis market work. Otherwise, California will once again lose ground to other states in this burgeoning industry.

About the Author

An-Chi Tsou

Senior Policy Consultant.

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