California didnt bring in as much tax revenue as expected during the first three months of legal marijuana sales, with experts blaming the shortfall on the states still-thriving black market.

First quarter revenue from cannabis taxes totaled $34 million, according to figures released this week by the Legislative Analysts Office. That put California on track to take in just one-fifth of the $175 million in marijuana revenue that Gov. Jerry Brown projected in his most recent budget for the first six months of the year, and about one-eighth the $1 billion in yearly revenue promised by proponents of Proposition 64, the 2016 ballot measure that legalized recreational marijuana in California.

The slow start frustrated, but didnt totally surprise, entrepreneurs working in the newly legalized industry.

“January, February and March were a bit of a sobering time for us,” said Derek Peterson, founder of Irvine-based Terra Tech, which owns Blum dispensary in Santa Ana along with other marijuana businesses throughout the state.

Everyone expected a “significant increase” in business after legal recreational sales started Jan. 1, Peterson said. And, initially, that happened. Sales during the first two weeks of January were strong, with many Californians excited to begin buying legal, recreational cannabis without a doctors recommendation. But the rush quickly ebbed, Peterson said, and overall first-quarter sales were “20 to 25 percent softer than what we had anticipated.”

The reason, according to Peterson and others in the industry, is that high taxes and a lack of licensed operators are driving customers back to a well-entrenched black market. And that logjam is keeping many cannabis retailers and others in the cannabis business in the shadows.

So far, fewer than 6 percent of Californias cannabis cultivators, and just 5 percent of its retailers, have made the jump from the black market into the newly legal industry, according to estimates from Hezekiah Allen, executive director of the California Growers Association trade group. Allen said pricey regulations and trouble getting city permits are the main obstacles, with fewer than one in three California cities allowing any kind of cannabis business to operate in their borders.

Another factor is supply. Terra Techs Peterson said a state rule that requires licensed vendors to do business only with other licensed vendors is limiting the variety of cannabis products that legitimate shops can offer for sale. As a result, some shoppers are turning to unlicensed stores to get the products they like.

Then there are the taxes, which are causing sticker shock for some shoppers.

All cannabis legally sold in California now comes with a 15 percent excise tax. Cultivators also pay a tax by weight, which bumps up the retail price. Then theres regular state sales tax, which typically runs between 8 and 10 percent. Also, 57 cities and eight counties have tacked on their own taxes, which range from 2 to 20 percent.

Those taxes apply to legal operators but not black market stores, and prices reflect that. A quick search Wednesday via the online dispensary directory Weedmaps showed the cheapest price for an eighth-ounce of marijuana from a legal shop in Santa Ana at $28 while an unlicensed shop in nearby Anaheim sold similar strains for $15.

Some of those problems are starting to correct themselves as more businesses get licensed, Peterson said. Hes also optimistic that proposed legislative fixes will help.

On Tuesday, a bill that would cut the marijuana sales tax rate from 15 percent to 11 percent and suspend all cultivation taxes until June 2021 unanimously passed the Assembly Business Professions Committee.

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Though it may seem counter intuitive, Mark Isidro — a legislative assistant with the office of Assemblyman Tom Lackey, R-Palmdale, who introduced the bill along with Assemblyman Rob Bonta, D-Oakland — insists that cutting taxes will actually boost state revenue by drawing more businesses and shoppers into the regulated market. He pointed to Washington and Oregon, where marijuana tax revenue jumped after tax rates were slashed. And he believes Californias sluggish start to the legal cannabis business will help, not hurt, the tax reduction bill.

State cannabis regulators and economists arent yet concerned about the low revenue numbers.

“I think we always knew it was going to be a process to get the legal industry up and running in California,” said Alex Traverso, spokesman for the Bureau of Cannabis Control.

Seth Kerstein, an economist with the Legislative Analysts Office, said his agency actually predicted first-quarter revenues would be a bit lower than whats come in so far.

He expects the tax flow will pick up significantly in the second quarter, as more businesses get licensed and enforcement against black market operators gets tougher. And while he doesnt believe California will hit $175 million for the first six months, Kerstein said his agency stands by its prediction that California will take in $1 billion each year in marijuana taxes once the regulation roll-out is complete in another couple years.

Those special cannabis taxes arent the states only source of revenue from legal marijuana, either.

California took in another $27.3 million in regular state sales tax from marijuana businesses in the first quarter of 2018, according to Kerstein. (Official numbers from the California Department of Tax and Fee Administration are due out Friday.)

Then there are application and licensing fees paid to the three state agencies that regulate the cannabis industry. While many of the states 6,000 sanctioned businesses are operating with temporary permits, which are free, most have either already applied or are in the process of applying for annual permits. Those cost $1,000 per application, plus owners must pay annual license fees that range from $500 to $125,000.

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Those fees, rather than tax revenue, are what will ultimately cover the states costs to regulate cannabis once start-up funds are paid back.

The Department of Finance will be revising its cannabis tax revenue projections Friday, spokesman H.D. Palmer said, as Gov. Brown releases his revised 2018-19 budget during a press conference in Sacramento.

Cannabis revenue is a small fraction of the states massive budget, and a shortfall in projected revenue doesnt threaten Californias financial stability, Kerstein said. But the slow start to the cannabis business does mean it probably will take longer to pay back a general fund loan used to front the costs of cannabis regulation. And, for now, it will mean less money, to a range of causes called out in Prop. 64, including youth drug prevention programs, marijuana research and environmental remediation.

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