Illicit Cannabis Market Will Benefit From California Tax Hikes, Expert Says

November 26, 2019

California has some of the steepest cannabis taxes in the country ー but there's no relief in sight for struggling businesses.

The California Department of Tax and Fee Administration (CDTFA) announced last week the markup rate on California cannabis will increase come Jan. 1, sparking an outcry from the legal cannabis industry which has struggled to push back against challenges like onerous regulations, slow adult-use cannabis adoption, and a robust illicit market.

"This is a huge problem because the black market outnumbers the legalized market. And the price is just increasing exponentially. Obviously, this is going to be challenging for a lot of dispensaries and cannabis operators to compete. And if they can't compete, they go out of business," said William Bogot, co-chair of Fox Rothschild's cannabis law practice group.

CDTFA, which is required to reassess the markup rate for excise taxes every six months, announced last week the rate will jump from 60 percent to 80 percent next year. The agency also announced inflation-based cultivation taxes, assessed once per year, will jump about 4 percent for flower, leaves, and fresh cannabis plants.

The California Cannabis Industry Association, a leading trade organization, said the move left its members "stunned and outraged."

"As California's regulated market spirals towards collapse from taxes on cannabis consumers, local bans, onerous regulations, slow growth, and a thriving illicit market, we believe that the CDTFA's decision to increase tax burdens on compliant cannabis operators is counter to developing a safe industry," the group wrote in a statement.

And Bogot would tend to agree. The vaping illness that has sickened close to 2,300 and killed almost 50 has been largely attributed to vape products purchased on the illicit market — which could be one major beneficiary of a tax hike. According to a report from the Los Angeles Times, legal cannabis sales are on track to hit $3.1 billion in 2019, compared to $8.7 billion spent in the illicit market the same year.

"When you legalize [cannabis], you want to make it safe for consumers and you also want to bring in revenue. But if you tax it too much, then what happens is more people go to the black market, the programs can fail," Bogot said.

But the savings that cheaper, illicit market products bring comes with substantial risk. Illicit market cannabis is not subject to the same testing requirements as legal cannabis, and studies have shown illegal products, like vapes, can contain everything from pesticides to shocking quantities of cutting agents.

Some lawmakers have heard the industry's cry. State Assemblymember Rob Bonta (D-Alameda) in January pushed for temporary tax breaks for cannabis businesses. He argued a reduced tax burden would help businesses gain a foothold against the illicit market, as well as increase tax revenue over time. His bill lacked support in the state legislature.

Bogot called Bonta's approach "smart," and urged lawmakers to consider it when assessing the potentially devastating health and business consequences of raising taxes.

"This is really a bellwether moment where I hope people are realizing that the process toward legalization requires reasonable regulations and a reasonable tax rate to keep the industry healthy, so it can be regulated and check for safety compliance," he said.