Legalizing marijuana was supposed to slow illegal activity in California. It hasnt

The owner of a family-run cannabis farm, tucked away in a rural Riverside County community known for marijuana cultivation, says hes paid taxes and lab tested his crops for years.

At the start of this year, he thought he was well situated to join Californias newly legal recreational marijuana industry.

But the market, quite literally, refused to come to him.

Proposition 64, Californias cannabis law, allows each community to decide where commercial marijuana is allowed — or if its allowed at all. The farmers community said the closest area where he can legally grow his crop is miles away. He cant get a state business license unless he uproots his family and sells his land at a loss.

So the farmer plans on quietly staying put, with his 24 plants, for as long as he can before authorities force him out of business.

Hes hardly the only marijuana entrepreneur in California whod prefer not to be a criminal.

Consider the double life of the guy who runs a marijuana delivery service.

As hes tried, and failed, to get a state license this year, he said hes laid off several employees and, officially, shuttered his business.

But behind closed doors the industry veteran is staying afloat by brokering the sale of prized California cannabis to buyers in states where weed isnt yet legal. Wholesale cannabis fetches twice its domestic price out of state, with none of the taxes.

“A lot of people would like to be full-on legitimate,” the delivery operator said. But “you have to pay rent, you have to be able to eat, so youve got to do what youve got to do.”

Multiply those stories by a few thousand, and youve got a glimpse of the size and scope of the illicit side of Californias marijuana industry.

Their stories — as well as market research, police activity and other measures — suggest that even as a legal market for recreational marijuana is starting to take root in California, the illicit side of the weed business is only growing stronger.

Rocky transition[hhmc]

California established a gray market for cannabis 22 years ago when it legalized medical marijuana. Though the drug technically was legal only for medical patients, in reality it also was easy to find and relatively cheap for recreational users, too. So when Prop. 64 was approved by voters — promising to legalize, tax and regulate cannabis for all adults — no one expected the gray market to dissolve overnight.

And data indicates it hasnt.

Two years ago, industry trade groups estimated that California was home to 50,000 growers and some 12,500 dispensaries. But in the year that Prop. 64 has been in effect, the state has issued licenses to only a fraction of those businesses; about 5,500 growers and 600 retailers.

Experts say thats why Californias cannabis tax revenue is, so far, falling well below budgeted projections.

“Weve still got tons of illegal grows,” said Sgt. Tyson Voss, who heads up the Riverside County Sheriffs Marijuana Eradication Team. “And dispensary storefronts, a bunch of those just opened up.”

Just as there are bootleggers for alcohol 85 years after the end of prohibition, there are marijuana farmers and sellers in California who say they dont intend to change the way theyve operated for years. They call themselves the “free peoples market,” and they prefer the risk of arrest over the fees and strict oversight that comes with joining Californias newly regulated market.

Their risk is minimized by the fact that Prop. 64 has reduced the penalties for most marijuana crimes and eliminated others entirely.

“There are clearly some people who just want to ride it until the wheels fall off,” said Kenny Morrison, founder of the California Cannabis Manufacturers Association.

But that attitude accounts for only part of the states current illicit market.

There are ambitious newcomers who hoped to make a mark in Californias newly legal weed industry. There are also many long-time industry veterans who wanted to leave behind the anxiety and limited opportunities of the states former gray market. Operators from both camps are ending 2018 with at least one foot planted firmly in the illicit market.

The reason: They have no pathway to get licenses, a result of local bans, zoning rules and pricey registration fees. Theyve also been frustrated by a lack of access to start-up capital, a lack of viable real estate and the sluggish rollout of local commercial cannabis programs.

“There are thousands of people who would love to participate in the regulated market who are totally locked out,” said Casey ONeill, a longtime Mendocino County cannabis farmer whos on the leadership board for the California Growers Association trade group.

ONeill says he knows people whove spent their life savings trying to comply with state rules, only to discover some barrier to entry they cant overcome.

Many, ONeill added, are “heartbroken” to be shut out of an industry they helped build. But most of these businesses are small farms with little capital — and no way to get more, since the the federal rules on marijuana make legal business loans out of reach.

As a result, ONeill said, people are stuck choosing between their ethics and the need to feed their families. Those people, he added, “have definitely propped up the unregulated market.”

A temporary problem?[hhmc]

Regulators and researchers are confident that any boost Prop. 64 is giving to the states illicit cannabis market is only temporary.

A final draft of state regulations is slated to be adopted in January, which, many say, will remove much of the uncertainty that operators have faced during the first year of legalization.

Also coming is a fundamental shift in Californias strategy regarding the illicit market.

Early this year, regulators tried the carrot approach to regulation, encouraging operators to join the legal market. Recently, theyve turned to the stick — cracking down on operators who arent making any effort to join the regulated market. The Bureau of Cannabis Control in recent months has partnered with other state and local authorities, serving search warrants at a handful of unlicensed shops and delivery services. More resources will be dedicated to enforcement in 2019.

But some argue the crackdown alone wont work, saying the state needs to expand the number of licenses it issues and find other ways to bring operators into compliance.

“Enforcement without opportunity is a broken paradigm,” said cannabis farmer and trade group leader ONeill.

So far, only about one in three California communities allows any form of cannabis business, according to a database of local policies compiled by the Southern California News Group. More cities are coming on board each quarter, but ONeill and others note that the pace is much slower than anyone anticipated.

That patchwork, city-by-city legality of weed in California is creating huge holes in the market — holes that illicit operators have been filling for decades.

Even in communities where leaders or voters are opting to welcome the cannabis industry, zoning rules and other regulations have left thousands of businesses with no way to legally operate.

There are an estimated 1,000 cannabis growers, for example, operating in rural unincorporated areas of Riverside County, according to Gem Montes, executive director for the Inland Empire chapter of the marijuana advocacy group NORML. But the county just approved zones for commercial marijuana businesses that exclude nearly all of those farms — effectively banishing the others to go out of business or continue as illicit growers.

Montes said the city of San Bernardinos cap of 17 cultivation licenses assumes the several hundred growers already operating in warehouses scattered throughout the city will leave town.

But unregulated cannabis operators pose tough questions for cities and counties. While the long-term presence of an illicit business doesnt mean that industry is a good fit for neighbors or the environment, will refusing to license those businesses make them disappear? And if those businesses go away, what happens to the community after they leave?

Cannabis operations in parts of California, long before Prop. 64, rented warehouse space and employed residents. Indirectly, the industry was a factor in everything from increased property values to lower need for social services.

“Like it or not, the unregulated cannabis market was a massive support system for rural economies all over the state,” ONeill said.

How not to end prohibition[hhmc]

Some observers of Californias cannabis industry suggest the state hasnt yet learned from history.

In 1934, when prohibition was ending in the United States, Rear Admiral Luther E. Gregory led Washingtons Liquor Control Board with a simple plan: He made it cheap and easy for speakeasies to become licensed taverns, setting rock-bottom liquor taxes and easy-to-secure liquor licenses.

And those who ignored Gregory and tried to operate illegally came to regret it.

“(Gregory) was also ruthless about weeding out those unwilling to conform to the new law,” said William Rorabaugh, a history professor at University of Washington who has studied Americas history with alcohol and prohibition.

Gregory also was playing the long game. Once hed all but eradicated the illegal liquor market, Gregory phased in stiffer taxes on licensed sellers. The market took care of the rest.

Californias laws on cannabis, Morrison points out, are almost the exact opposite of Gregorys strategy.

Prop. 64 lowered the penalties for illegal operators, essentially inducing operators to stay in the shadows. It also launched a regulation system that includes strict rules on everything from growing to product testing and insurance. And it set tax rates that, when combined with city taxes in some communities, can add 50 percent to the price of the product.

“What theyre doing with all the barriers to entry and all the taxes and the fees is theyre stifling the ability to control the supply,” Morrison said of Californias cannabis regulations.

“That should be the focus at this time: Take whatever steps you need to take to have the regulated market actually control the supply.”

Do consumers care?[hhmc]

Nearly a year into legal weed in California, one thing is clear: illicit weed merchants have no trouble finding customers.

One in five Californians said theyd purchased cannabis from an unlicensed shop in the past three months, according to a survey conducted this summer by marijuana delivery platform Eaze. Consumers in Southern California are more likely to purchase from an unlicensed source than are consumers from Northern California, and a whopping 84 percent of all respondents are inclined to buy again from an illegal source, saying products are cheaper and sometimes better.

Illicit shops remain easy to find through online directories like Weedmaps, which still lists them despite receiving a cease and desist letter from state regulators. (The Irvine-based company declined to talk for this story.)

A comparison of products available from stores listed on Weedmaps shows the price discrepancies. Shoppers can buy marijuana for as little as $7 a gram at unlicensed shops in Orange County cities that, theoretically, dont allow such stores. But shoppers who go to licensed stores in Santa Ana — the only city in the county that permits them — generally pay $13 to $15 per gram, and up to $20 a gram when all taxes are included. That doesnt factor in other perks that illicit shops can offer, such as higher potency products and free samples.

Price isnt the only issue. Customers are willing to pay more for cannabis thats been tested for safety, properly labeled and sold in legal shops, according to a study published this September in the journal Addiction.

But theres clearly a limit to how much theyll pay, according to Michael Amlung, a psychiatry professor at McMaster University in Ontario, Canada who headed up the study.

Even if illicit weed is cheaper, the study found customers are willing to spend up to $10 a gram to support the legal market. But beyond the $10 threshold, customers start turning to the illicit market, Amlung said.

The findings are firm enough that economic models can be predicated on them. For example, a 5 percent cut in the overall tax rate of cannabis in California could drive 23 percent of illicit market customers back to the legal market, the Eaze survey found.

Other changes figure to affect illicit farmers.

For now, most states and countries still regulate cannabis as an illegal drug. But demand for California cannabis figures to go down as other states and countries move toward legalization.

Ten states have now legalized recreational marijuana, with New Jersey expected to join the list through a vote by the legislature. Canada launched its own legal commercial market in October, and Mexico is on the verge of doing the same.

Federal law in the United States also could shift, bringing new, easier banking rules for cannabis businesses that comply with state laws. Any such change would give operators a major incentive to move to the licensed market, since they could then avoid the risk of operating all-cash businesses and access to capital.

But it will take time for such changes to put a dent in Californias illicit market.

“I think it will be five or more years before it gets somewhat under control,” said Riverside County sheriff Sgt. Voss.

As they struggle to comply with state regulations and fend off competition from the illicit sector, many licensed businesses arent sure theyll be able to survive another few years until the market stabilizes.

“This has been the most challenging year that Ive ever had in my life work-wise,” said Bryce Berryessa, who operates several legal cannabis operations in Santa Cruz County.

Still, Berryessa doesnt regret his decision to trade the stress of worrying about getting booted by his landlord, or having his door kicked in by law enforcement, for the stress of trying to generate cash flow or pass stringent testing requirements.

“I believe that what I do is a legitimate way to make a living and Im proud of what I do.”

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