California Shows How to Grow a Black Market Part 1 Retailers

August 14, 2019
Copyright 2019 Tony Lima. All rights reserved.

[This is part one of my ongoing research on the California marijuana market. This article is very long and is posted below is a PDF file. I have included the first four or five paragraphs to give you the basic findings.]

“If you put the government in charge of the Sahara, in five years there would be a shortage of sand” – Milton Friedman

California Shows How to Grow a Black Market

 

Executive Summary

California pot buyers face a choice. They can pay a hefty premium and buy from a state licensed dispensary. Or they can buy their marijuana on the street and risk … what? Marijuana possession is pretty much treated as a misdemeanor, if that. The state’s main enforcement action seems to be ongoing raids against black market growers. It’s easy to predict that California is going to collect considerably less in taxes and fees from pot sales than they originally forecast. In fact California’s policies almost guarantee that the black market will not just survive but will actually thrive.

Using recent data, it appears that dispensary prices for California marijuana are roughly twice the price of the illegal street version. About half that difference is caused by taxes. But the other half has two causes. First, heavy-handed regulation, annual licensing fees, and upstream taxes on growers and manufacturers all push up costs. Second, the abrupt transition from an almost completely unregulated to a heavily regulated market means there are few licensed retail outlets in the state. Ironically this has led to a surplus in the wholesale end of the market. Needless to say, the higher legalized price is encouraging the black market.

Combined with an excess supply at the wholesale level, marijuana businesses are fleeing California. The result has been less tax revenue for the state, and a resurgence of the black market.

Background

Californians accepted an offer from the pot industry in the November, 2017 election: legalize recreational use and tax us.  The payoff was, presumably, more tax revenue for the state, as well as freedom from worrying about even a misdemeanor penalty for possession (marijuana, not demonic).  Some voters, presumably those who regularly consume this product, may have also believed income taxes would be reduced when the state started receiving this new revenue stream.  But, never fear.  California’s politicians and bureaucrats have taken actions that ensure a thriving black market into the foreseeable future.  They include a tax on growers as well as licensing fees on sellers, county-level control of the distribution system, regulations, and licensing requirements.

There are four business sectors: growers, manufacturers, retailers, and laboratories.  Distribution may also be an issue at both the wholesale (grower to retailer) and retail (retailer to consumer) levels.  The final regulations make it clear that “A delivery employee may deliver to any jurisdiction within the State of California.” Also “A delivery employee may only deliver cannabis goods to a physical address in California.”[1]  In this article we will focus on the retail end of the business.

Within the retail sector there are three levels: Type 9, Type 10, and Microbusiness (Type 12).[2] Type 9 retailers do not have storefronts. They rely on delivery only. Type 10 retailers do have storefronts. Microbusinesses must include any three of the four business sectors: grower, manufacturer, retailer, and laboratories. In other words, Microbusinesses have some degree of vertical integration. We focus on Type 10 retailers mainly because there’s a lot of data readily available.

[1] California Bureau of Cannabis Control (CBCC), section 5416 “Delivery to a Physical Address” pp. 61-62. Available at https://cannabis.ca.gov/wp-content/uploads/sites/13/2018/07/Bureau-of-Cannabis-Control-Proposed-Text-of-Regulations.pdf. Accessed July 16, 2018.

[2] Speech and Discussion Validating Cannabis. http://www.sadvc.org/california-cannabis-business-license-compliance-non-storefront-retailer-medicinal-m-type-9  Accessed July 30, 2019.

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.