What happens when a 20-year-old, largely unregulated industry snaps to a punitive and draconian regulatory framework? The exact opposite of what regulators want to happen. California has been in the process of establishing a legal framework for years, and as the deadline rapidly approaches, it seems probable that 2018 will be chaotic and harmful to businesses both old and new.
I expect that 2018 will only provide a fraction of anticipated tax revenues. This might seem counterintuitive because, after all, California has one of the highest state tax rates in the United State.
The problem lies in the difficulty of running a legal cannabis business in California, based on current proposed legislation. Here’s a quick breakdown:
- Permitting fees can be extremely high, with reports of fees exceeding $80,000 in cities such as Lynwood.
- Minimum state excise taxes, currently set at $800 per fiscal quarter.
- Some rules tax inputs instead of outputs. A number of local governments intend to tax the square footage of a grow operation’s canopy instead of pounds of product produced.
- There are even reports of municipalities planning to tax crops lost in the fires.
- There are early warning signs that there will be outrageous local taxes on cannabis retail. This will make cannabis much, much more expensive that what it is now.
- Rules are being contemplated that will force cannabis companies with over 20 employees, at any point in the year (including seasonal hires), to be open to collective bargaining from unions.
- Many localities require that a business owner secures land or a building and sets up their operation prior to applying for a permit. This means that if the permit is denied, the business owner will be on the hook for a long-term lease for a business that they can’t legally operate. In such a situation, they may lose all of their start-up investment, and have little or no recourse to remedy.
All of the aforementioned issues make it incredibly expensive to start a cannabis business, and incredibly expensive to operate if established.
Currently, competition in the California markets makes the supply of cannabis relatively abundant and affordable to patients and consumers. The current framework will remove many currently legal suppliers and make it costly for the survivors to do business. The end result will be far higher prices for consumers.
Higher operating costs and competition will greatly reduce operating margins to a fraction of what they are today. Because of low margins and operational headaches, many business owners may look to other states to establish their operations. Those who remain may simply turn to the black market, where consumers tired of feeling like the prices are being gouged will be eager to purchase. This may cause a death spiral.
So what’s the solution? We should ease into a modular framework that allows regulators to learn more about the business and how to appropriately regulate it. Allow businesses that have been operating continue to operate with soft deadlines for the permitting process. Ensure that businesses will not face raids and seizure of company assets. Keep the tax footprint small at first and put out ballot measures that allow the people to vote on taxes. This would benefit everyone in the long-term and make the black market virtually nonexistent.
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