Study Suggests California's Legal Marijuana Industry Is Over Taxed, Regulated

In the decades before U.S. states began to legalize recreational marijuana, perhaps you heard a few people argue that if the government just legalized marijuana, then taxed and regulated it, then the government would rake in a ton of money. Legal marijuana, in turn, would would suffocate the illicit market, and people would buy the legal product anyway because because weed sells itself.

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Well, it hasn’t totally panned out that way yet, at least in California, despite recreational legalization in the state this year. Many people are still buying weed on the illicit market, thanks in part to steep markups and high taxes in legal pot shops, along with local restrictions, according to survey data released Wednesday from marijuana delivery service Eaze.

“Unlicensed retailers do not have to comply with worker protection laws, test products for pesticides and processing chemicals, or remit taxes,” said a report from the company outlining the findings. “That results in a large pricing benefit.”

The findings bring into sharper view some of the difficulties of selling legal marijuana in the state. The state represents the world’s biggest recreational marijuana market.

Eaze’s results are based on 1,750 online surveys from people in California, Colorado and Eaze’s consumers. The surveys were completed between July 6 through July 12. Peter Gigante, Eaze’s head of policy research, said he hoped the data would help find ways to support licensed cannabis retailers.

The data found that one in five Californians has bought marijuana from the illicit market — that is, a market that encompasses anything from street sales to shops that couldn’t get their paperwork together — in the past three months. Eighty-four percent of those customers are “highly likely” to go back to buying from a seller without a license due to “the illicit market having cheaper products and no tax,” Eaze said in a report outlining the findings.

The survey found that 17% of California consumers bought cannabis from an unlicensed source “due to local laws that restricted access to legal cannabis.” That compared to 14% in Colorado.

“Some of these unlicensed retailers don’t have restrictions placed on them about operating hours,” Gigante said. “They can deliver late-night.”

Cut Taxes, Help Legal Marijuana Industry?

Still, the survey found that a 5% cut in the overall tax rate in California could bring 23% of customers buying weed from unlicensed sellers into the legal market. And it found that 84% Californians are “very satisfied” with the legal market.

Digging into consumers’ complaints with the legal marijuana business overall in the six months prior to surveying, 47% cited excessively high taxes, the most frequent issue. Thirty-six percent cited a lack of electronic payment options, while 32% cited “overpriced” products.

Pesticide Regulations For Legal Marijuana

Stricter state regulations for clean pot also kicked in for the industry at the beginning of last month. The new measures required pot sold in the state to meet safety standards intended to rid legal pot of pesticides and other potentially harmful substances.

The restrictions led to worries that California didn’t have enough testing facilities to get pesticide-free weed to stores. Dispensaries slashed prices, hoping to clear their shelves of untested products, ahead of the new regulations.

But stricter regulations, like safety testing and accurate labeling, have helped to attract people seeking to use pot for health reason.

“That’s where the legal market does compete,” Gigante said.

Scotts’ Hydroponic Growing Pains

California collected $34 million in cannabis excise tax revenue in the first quarter, according to the state’s Legislative Analyst’s Office. Based on that figure, the office said that revenue for the year “likely will be somewhat lower than the administration’s January estimate” for $175 million.

The weaker sales — and differing regulations from area to area in the state — haven’t hurt just private growers. The CEO of Scotts Miracle-Gro (SMG), which has a hydroponics business called Hawthorne, complained about the bumpy ride in California this year.

Scotts’ CEO, Jim Hagedorn, in May, said California was struggling with “the transition from a large and loosely regulated market for medical marijuana to an even larger but strictly regulated recreational marijuana market.”

Hawthorne’s results got dinged. In July, during an earnings conference call, he said not much had changed for the hydroponics segment.

But Hagedorn said that California, which currently represents 52% of the business for Hawthorne, was starting to recover. He expressed optimism for Hawthorne’s potential in states east of the Mississippi.

New York, New Jersey and Connecticut — where efforts to legalize recreational marijuana have grown stronger — represent potential paths of expansion, he said. He said those markets combined would be as big as California.

The federal government, he said, is unlikely to de-schedule marijuana in the short-term.

“I’m not sure that we actually, really, care that much about it,” he said. “I think what we’re looking for is sort of keeping DOJ from enforcing sort of beyond what was in the Cole memo.”

Legal Marijuana Stocks

Canopy Growth Corp. (CGC), which began trading on the New York Stock Exchange this spring, fell 0.6% Tuesday. Cronos Group (CRON) fell 2.7%.

Tilray (TLRY), the first pure-play marijuana IPO on a big U.S. exchange, dipped 0.7%.

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