Cannabis revenue is below California's expectations, but growing
One year after California legalized the recreational use of marijuana, legal cannabis is off to a slower-than-expected revenue start.
Until the state and its cities work out some of the challenges faced by the industry, it won’t be a stable enough revenue source to support revenue bonds. But some industry observers see it turning that corner before too long.
The state's recreational dope industry is struggling against headwinds from its continued illegal federal status, some local government resistance, and competition from illegal and medicinal sales.
Only 89 of California's 482 cities permit retail shops to sell marijuana for recreational use.
So far, the estimated revenue from cannabis sales in California has failed to meet expectations. Proposition 64 legalizing recreational marijuana use took effect Jan. 1, 2018.
State officials have predicted that legal cannabis could bring in up to $1 billion in yearly revenue. The highest range of estimates by the Legislative Analyst's Office is for up to $410 million this fiscal year, below the $630 million estimated for the 2018-19 budget. Quarterly increases have been strong, the LAO said.
In the third quarter, the Department of Tax and Fee Administration reported $93.1 million in receipts from the state's cultivation tax on cannabis, its 15% excise tax on retail sales, and the state's regular sales and use tax on those sales. That figure does not include local tax collections. That number was up 16% from the second quarter.
In November's election, 72 of 79 local ballot measures to impose cannabis measures were approved.
Rudy Salo, a partner with Nixon Peabody, whose firm represents cannabis businesses in states where it is legal, said there are signs that the industry could have enough stability as a revenue source by 2019 or 2020 to back municipal bonds.
Salo pointed to the inclusion of the legalization of hemp in the recent federal farm bill as a positive harbinger for the industry.
U.S. Senate Majority Leader Mitch McConnell, R-Kentucky, a proponent of legalizing hemp, signed the 2018 Farm Bill conference report Dec. 11 with a pen made of Kentucky hemp. The Senate passed the Farm Bill that day on a vote of 87-13 and the following day the House approved the bill 369-47.
McConnell has long supported legalization of industrial hemp, a non-psychoactive cannabis plant, used to make clothes, cosmetics and as an ingredient in many foods. Kentucky farmers hope to replace fading tobacco crops with hemp.
Removing one kind of cannabis plant from the federal drug schedule could open the door to legalizing marijuana, Salo said.
“Both hemp and marijuana come from the same cannabis species, but are genetically distinct and are further distinguished by use, chemical makeup and cultivation methods,” according to leafly.com, an online publication that covers the cannabis industry.
There was a huge shift in attitude by the federal government this year, Salo said.
“I didn’t think it could happen this quickly,” Salo said. “But with hemp legalized through the farm bill, Attorney General Jeff Sessions out of office and Democrats controlling the House, I think it could happen this year.”
Sessions rescinded a trio of Obama-era memos Jan. 4, 2018, that stipulated a policy of non-interference with marijuana-friendly states. The move meant that federal prosecutors across the country had to decide how to enforce federal laws regulating pot possession, distribution and cultivation in states where it is legal.
The remaining federal obstacles, however, were underscored in December with the release of a study commissioned by the State Treasurer's Office, the results of which deflated the idea that a state-owned back was a viable option for the California cannabis industry.
Following a year-long review, the Cannabis Banking Working Group chaired by Treasurer John Chiang recommended against such a state bank.
“While today’s announcement may not lay out the path some of us had hoped, it did reinforce the inconvenient reality that a definitive solution will remain elusive until the federal government takes action — they must either remove cannabis from its official list of banned narcotics or approve safe harbor legislation that protects banks serving cannabis businesses from prosecution,” Chiang said Dec. 27 during the hearing at which the report was released.
California's cannabis businesses are classified as legal by the state, but illegal by the federal government, because federal law categorizes cannabis as a Schedule 1 drug, according to the treasurer's office.
This stalemate created numerous banking issues for these businesses: by putting banks that might accept deposits from cannabis businesses at risk of losing the federal authority to operate, as well as forcing cannabis businesses to deal in large amounts of cash, which made them targets for violent crimes. Security and procedural concerns about dealing with a cash-only industry also created problems for state and local government revenue-collecting agencies.
"It is not only unfair, but a public safety risk to require a legal industry to haul duffel bags of cash to pay taxes, employees, and utility bills," Chiang said. "The reliance on cash has painted a target on the backs of cannabis operators, and has made them and the general public vulnerable to violence and organized crime."
Chiang created the CBWG, comprised of 18 representatives including law enforcement, regulators, banks, taxing authorities, local governments and the cannabis industry, to work at solutions to the state-federal conflict.
The treasurer's office asked San Diego-based Level 4 Ventures to work with the state Attorney General's Office on the practicalities of forming a state bank.
In lieu of creating a state bank, Level 4 Ventures recommended the state project office work on improving access to existing banks for the industry. The feasibility report noted that there is a high probability that federal regulators would not issue the necessary master account for a public bank to operate, and if that happened the state would end up wasting the estimated $35 million in startup costs for such a bank.
The consultants also weighed and discarded forming a public credit union, state purchase of a private bank and various financial technology solutions involving a cryptocurrency.
California Attorney General Xavier Becerra and the California Department of Justice concluded in a separate analysis that a state-run financial institution would violate several federal criminal statutes that carry severe potential penalties.
"In the two years since the passage of Proposition 64, I have been proud to lead this fight and will continue to look for alternate ways to support our legal businesses, the will of our citizens, and stakeholders across the state," Chiang said last week. "But today's news makes it clearer than ever that the path forward must include action by the federal government."
Los Angeles projected cannabis tax revenues of $40 million, but only allocated $30 million of that in this year’s fiscal budget in case revenues failed to meet expectations, according to Ben Ceja, an assistant city administrative officer.
"For fiscal year 2018-19 our budgeted revenue from Cannabis (medical and recreational) sales is $40 million," Ceja said. "Through November 2018, we are tracking about $1.25 million behind plan. We are just now reviewing December receipts."
News around marijuana legalization has been so mixed that on Friday news reports that California had failed to hit revenue targets for cannabis were posting the same day that other publications were declaring 2018, the Year of Marijuana, Salo said.
“It was an extremely interesting year nationally and internationally,” Salo said. “Canada legalized marijuana in 2018 and now the U.S. is up to 33 states that have legalized it, where only a couple of years ago, it was 23 states.”
Ten states and the District of Columbia have legalized recreational marijuana. The other 23 states have legalized marijuana less broadly, typically for medicinal uses.
The year brought the legalization of medical cannabis sales in Utah and Missouri and of recreational pot in Vermont and Michigan. The Food and Drug Administration also approved its first cannabis-derived drug in June.
Though California revenues for pot sales haven't lived up to expectations thus far, legal marijuana is a $10.4 billion industry for the U.S., Salo said.
Salo added that if someone had told him early last year he would be predicting tax revenues for legal marijuana sales could stabilize in 2019, he would have laughed.
"I would not be surprised if the federal government said this year that the states can decide," Salo said. "If that happens, the banks will be able to provide banking services including offering low-cost loans to businesses. It would also bring it into the mainstream and maybe kill the black market."