SF and California pot pros call on Newsom to fix broken cannabis market

When California voters legalized marijuana for recreational use in November 2016, it was also a victory for Gavin Newsom, who spent months traveling the state as the face of the campaign. At an election night party at a San Francisco nightclub, the then-lieutenant governor celebrated this “point of pride,” telling attendees that California had sent a “message powerfully to the rest of the nation.”

It was an important resume-building moment for Newsom, already deep into his first run for governor, who during decades in office has put himself at the forefront of political change. In a profile in Billboard magazine a few months later, he acknowledged that his legacy and that of Proposition 64, the legalization measure, were now tied together:

“Put it this way: Everything that goes wrong, you’re looking at the poster child.”

Five years later, Newsom is governor, and farmers, dispensary owners and other advocates are calling on him to rescue a legal market they say has been pushed to the brink of collapse by a steep drop in prices—and the inattention of a man who was once its most prominent proponent.

Ali Jamalian, the owner of San Francisco cannabis company Sunset Connect laid out a laundry list of issues with the current taxation system including the high rates, confusing protocols and lack of interoperability between the required software to track cannabis through the supply chain and the taxation system itself. 

“With the current taxes it’s hard to compete with the pricing of the illicit market, while also meeting the compliance standard to get in the regulated market,” Jamalian said.

It’s not all taxes causing issues for the industry. There are larger economic factors like high inflation and a downswing in consumer confidence. But Jamalian said taxes are where he sees “a large gap between industry practices and bureaucratic expectations.”

In a recognition of the challenges faced by the industry locally, the Board of Supervisors delayed the implementation of a new cannabis sales tax to the end of 2022.

Originally approved by voters in 2018, the tax was previously postponed to the end of 2021, and was recently extended again—this time to Dec. 31, 2022. The levy would hit cannabis businesses with gross receipts over $500,000 at rates between 1% and 5%.

Jamalian said he and other industry leaders have been in conversations on how to adjust the tax or put in new exemptions to help make it easier especially for new businesses. 

“I think the general public just thinks we have an incredible amount of cash stashed away and that’s just not true,” Jamalian said. “A large majority of these cannabis companies are locally owned small businesses and we all have to invest a lot to be here today. I don’t have any savings left from opening this place.”

The cannabis industry’s appeal for help is aggressively aimed at the heap of taxes that put it at a disadvantage with the robust illicit market in California. Michael “Mikey” Steinmetz, co-founder of Flow Cannabis Co., a manufacturer and distributor has proposed a boycott of the state’s cultivation tax unless there is financial relief in the upcoming state budget.

Newsom expressed support for taking unspecified steps to “stabilize the market” while unveiling his budget proposal on Jan. 10, but he seems unlikely to embrace radical changes to the system he put his name on with Prop. 64. No plan has yet materialized, and his office declined to make him available for an interview.

“It is an oversimplification to say that tax reduction will solve all of the industry’s problems,”  Nicole Elliott, director of Newsom’s Department of Cannabis Control, told CalMatters. “It’s just a vast oversimplification of the number of variables that impact the health of the legal market and that support or foster illegal activity. It is not tax alone.”

Newsom once stood, cautiously, at the forefront of the legalization movement in California. He declared at the time that he was not “pro-marijuana”—he says he has never tried it—but “vehemently anti-prohibition.”

As lieutenant governor, he formed a blue ribbon commission on marijuana policy, which issued a report in 2015 warning that legalization would be a “process that unfolds over many years requiring sustained attention to implementation.” Prop. 64 followed the next year, pitched by Newsom more as an opportunity for social justice—to erase the damage of a drug war that had disproportionately targeted Blacks and Latinos—than for new tax revenue.

After 57% of California voters approved the measure, his focus has shifted to issues including health care, homelessness and early childhood education. In his first three years as governor, Newsom rarely discussed marijuana policy publicly, even before the coronavirus pandemic response consumed his administration.

That silence has disappointed many in the cannabis industry who expected he would continue to lead on the issue.

Some steps are viewed positively—consolidating the state’s three separate cannabis licensing programs into a single department and, in what was perhaps an industry-saving move, declaring marijuana dispensaries and delivery services an essential business that could remain open during the pandemic.

But there is widespread frustration with Newsom’s inaction on the problems preventing the licensed system from competing as a viable alternative to the dominant illicit market. Legal sales in California reached $4.4 billion in 2020, according to the industry publication MJBizDaily, while experts estimate that illegal sales could be at least twice as much. 

Those problems are not entirely Newsom’s creation.

Long before legalization, the Emerald Triangle of Mendocino, Humboldt and Trinity counties established itself as the base of marijuana cultivation for the entire country, making the transition to a regulated system uniquely challenging in California. Many long-standing farmers have been reluctant to make the jump. And despite a stated intent to give small growers a five-year head start, regulations on acreage limits adopted before Newsom became governor, though not over his opposition, opened the door for investors to link parcels into megafarms and flood the market with their crop.

Prop. 64 requires local governments to opt in, so recreational sales are still blocked in about two-thirds of jurisdictions, including some large cities such as Bakersfield and Anaheim. There are 866 licensed dispensaries in California, along with 374 licensed marijuana delivery businesses. That’s just a fraction of the number per capita in other states where cannabis is legal, including Oregon, Washington, Colorado and even Oklahoma. Growers and distributors say they have fewer shops where to sell their products now than when only medical marijuana was legal and licensing for dispensaries was looser.

In addition, taxes—stacked by state and local authorities for growing, distributing and selling—raise the price of legal marijuana by as much as 50% for consumers.

Industry advocates argue that the Newsom administration has not done nearly enough to lower costs for licensed businesses, or to expand the legal market.

“He’s responsible for setting the agenda for what’s important in the state,” said Imelda Walavalkar, chief executive officer of Pure Beauty, an “environmentally conscious” marijuana brand that has indoor growing and production facilities in Sacramento. “It doesn’t seem like a super priority for them.”

The state, for instance, has not ramped up pressure or incentives to persuade reluctant communities to permit recreational marijuana sales. Social equity programs started by some cities and counties to diversify the industry with more people of color, formerly incarcerated people and residents of neighborhoods with historically disproportionate marijuana arrest rates are taking years to get off the ground. 

Last year, Newsom vetoed the industry’s priority legislation, which would have authorized billboard advertising on California freeways, citing the need to protect children from exposure to marijuana.

Walavalkar said a vicious cycle of competition—with venture capital-backed businesses that can afford to operate at a loss to gain market share and licensed growers who continue to divert some of their crop to the illegal market to subsidize their operations—has driven prices in a race to the bottom.

“There’s just not a big margin left, no matter how you slice it or how slimmed down you are,” she said.

The situation has reached a breaking point in recent months for growers including Ingrid Tsong, who runs Beija Flor Farms in Mendocino County with her husband, Jonathan Wentzel. Prices have fallen so far that their business is now losing money, and the couple is unsure they can afford to plant a crop this year.

“It is like end of days here. We do not know,” Tsong said. “I can’t find my way through this morass.”

Tsong said she and Wentzel were skeptical of Prop. 64, because they believe it lacked sufficient protections for the well-established industry of small cannabis farmers that has long existed on the margins in California. Still, after it passed, they stepped forward to license their operation.

The combination of high taxes and fees and an acreage cap for their farm, an oversupply of marijuana on the legal market and few places to sell it, has squeezed them from all directions. Tsong said their crop last fall cost about $460 per pound to produce, a third of that from California’s cultivation tax for growers. But wholesale prices have dropped to about $300 per pound in recent weeks, compared to as much as $800 per pound at the same time last year.

The couple has already dipped into savings to stay afloat, Tsong said. Because cannabis is still illegal under federal law, they do not have access to bank loans or agricultural aid programs available to other farmers, leaving them without the capital they need to front the cost of production at the start of a new season.

While Beija Flor Farms, which harvests a piece of property that has been in Wentzel’s family through several generations of growing cannabis, is better positioned to survive than many small operations in the Emerald Triangle, the financial hit of sitting out a year is still difficult for Tsong to fathom. The couple has already pulled from their savings. 

A decision looms, as Tsong and Wentzel will need to start preparing to put plants in the ground in May. Their calculation could change if the market turns around or the state takes quick action on relief for the cannabis industry—Tsong is hoping some of the state’s $21 billion discretionary surplus can go to a tax rebate for small farmers—but even a scaled-backed crop feels like a risk.

“It doesn’t seem smart to try again given the brick wall we’re facing,” Tsong said. “If we farm this year, it honestly might just be a labor of love.”

Three days after Newsom’s pronouncement about stabilizing the market, dozens of small growers from the Emerald Triangle, social equity license holders and other activists gathered on the steps of the Capitol to demand an end to what they deemed the “war on drugs 2.0.”

Johnny Casali brought a cannabis plant, from a strain named for his mother, from his Humboldt County farm and set it next to the podium as he railed against the overtaxation that he said was destroying the legal market. Dispensary owners, shut out of traditional banking, shared their struggles with frequent break-ins by thieves who know they have cash on hand.

Attendees lingered after the speeches ended, enjoying a joint in the sun and waiting for a turn to talk to state Sen. Steven Bradford, who spoke at the event in solidarity.

As bill ideas circulate at the Capitol, lawmakers are poised to take up the cannabis industry’s cause this session. Bradford told CalMatters that, besides an overhaul of the tax structure, the Legislature could address prohibitive start-up costs for marijuana businesses, such as extensive environmental reviews or a requirement in many communities that dispensary owners have a storefront rented before they can even apply for a license to open.

“We’re, in essence, enabling the illegal market to continue right now,” the Gardena Democrat said. “That’s who’s winning this battle.”

What the industry really wants is broad tax relief. At the Capitol rally, farmers urged the state to eliminate the cultivation tax, which recently increased to more than $10 per ounce, or switch from a flat rate to a percentage of the price. Social equity license holders asked for a suspension of the 15% excise tax, to give their businesses a greater opportunity to establish a foothold.

Kika Keith, whose dispensary Gorilla Rx Wellness was one of the first licensed through Los Angeles’ social equity program, said campaign promises that Prop. 64 would provide redemption for communities hurt by the drug war proved to be a “Trojan horse.”

She slammed regulators for prioritizing bringing the existing cannabis market, which is predominantly controlled by white-owned businesses, into compliance. Assistance for entrepreneurs from disadvantaged backgrounds, including $55 million in grants from the state for social equity licensing programs, has been slow to reach those it was meant to help, she said.

“You give us this opportunity and then you let us swim with sharks, because you don’t provide any protections,” Keith said. “This is a state of emergency for Black and brown community members who have given up everything to be a part of this industry.”

It’s a complicated political puzzle for Newsom, who said at his budget press conference that he would “look at tax policy.” Any changes need to account for the impact on revenue, he said—an estimated $595 million in the 2022-23 budget to help fund child care slots, environmental cleanup programs and impaired driving prevention efforts.

The governor also said it’s “my goal to get these municipalities to wake up to the opportunities to get rid of the illegal market” and “to provide support and a regulatory framework for the legal market,” but did not offer any details. Tension over local control is a frequent issue at the Capitol, and there may be little appetite to dramatically curtail the rights of cities under Prop. 64.

Elliott, his top cannabis adviser, said the administration might be inclined to pursue changes that make it easier to comply with the legal cannabis system by addressing the “pain points” for operators, such as the fact that they must prepay some of their taxes on products they have not even sold. Newsom’s approach will depend on what proposals emerge from the Legislature, she said, because they will need to work together to reach the two-thirds vote threshold required of any tax measure.

“Everything’s a trade-off,” Elliott said. “It will be challenging to have anything but revenue neutrality because there are stakeholders who care about that revenue.”

Those include law enforcement organizations and unions that represent programs funded by the revenue. Public health groups also worry lowering the cost will encourage more marijuana use.

Keith Humphreys, a professor of ​​psychiatry and behavioral sciences at Stanford University who served on the steering committee of Newsom’s blue ribbon commission, said the legalization framework of Prop. 64 was more corporate-friendly than the panel’s recommendations. He said the state should crack down on the illicit market by stepping up enforcement against unlicensed operators, rather than giving incentives to cannabis businesses.

“That’s more sensible than messing with taxes,” he said.

It’s a sensitive subject in an industry that is still grappling with the legacy and the trauma of the war on drugs. While some licensed growers and dispensary owners do believe the consequences are too low to discourage those operating illegally, others argue that large-scale enforcement would be fruitless against an illicit market that is so pervasive.

Steinmetz, whose Flow Cannabis Co. has gone through multiple rounds of layoffs over the past few years as it has struggled to compete, called it “a game of whack-a-mole.” 21

Law enforcement is unable to stay on top of illegal marijuana farms, especially on public lands, which steal precious water and raise the risk of devastating wildfires. Unlicensed dispensaries, even when they are shut down, often soon pop up in a new location.

Casali, whose family started growing cannabis in Humboldt County in the mid-1970s, was arrested on illegal cultivation charges in 1992 and served eight years in federal prison. Unlike many of his peers, he opted to apply for a license for his Huckleberry Hill Farms after Prop. 64 because he was tired of a life in the shadows, running from helicopters and special agents. 

Now he worries that legalization also means the end for the small farmers like him who built California into a marijuana powerhouse.

“The people who created the system truly do not understand what we went through,” Casali said. “We’re the ones who helped create a multibillion-dollar industry and now you don’t want us.”