California Gov. Jerry Brown's new budget says pot revenue is 'slower than anticipated'

Robert Gauthier | Los Angeles Times | Getty Images

A cannabis farmer applies fertilizer to a crop of plants in Humboldt County, California.

• California Gov. Jerry Brown released forecasts Friday that trimmed the state's cannabis excise tax revenues projections for next year.
• It follows an independent state budget watchdog earlier this week disclosing that California's pot tax collections are off to a slow start in the first quarter.

Rich Pedroncelli | AP

Gov. Jerry Brown on May 10, 2018, in Sacramento, Calif.

California Gov. Jerry Brown on Friday released a revised state budget plan, which showed a slower pick-up in tax revenue from the legal cannabis industry than expected and a weakening in revenue projections for next year.

"While the forecast assumes revenues will be phased in over time, preliminary data indicates revenue receipts are slower than anticipated," the budget said. "Cannabis revenue projections are subject to great uncertainty."

The new budget bumps the current fiscal year's outlook up $10 million, estimating the combined medical and adult use industry would generate $185 million in 2017 to 2018. For 2018 to 2019, or the first full year under California's Proposition 64 that legalized adult recreational use, the state lowered its outlook by about $13 million to $630 million in excise tax revenues.

The budget revision also disclosed that the first quarterly deposit, due at the end of April, came to $33.6 million in excise taxes — about on par with projections a watchdog organization on Monday said could impact the current year's revenues.

Brown included in the May revision an additional $133.3 million for cannabis-related activities, including license and permit processing, enforcement, laboratory services, information technology, quality assurance and environmental protection.

An independent state budget watchdog on Monday disclosed that marijuana tax collections are off to a slow start.

The state's independent Legislative Analyst's Office anticipated marijuana excise taxes in the first quarter of 2018, or the first three months since recreational marijuana sales started, would come in around $34 million and would likely miss the $175 billion goal for the first year's tax revenues.

"Based on this quarterly tally, we think that 2017-18 revenue likely will be somewhat lower than the administration's January estimate," the LAO said in a blog post Monday.

But the revised budget actually strengthen's the current fiscal year's outlook by about $10 million, from $175 million to $185 million. It's the next fiscal year, which starts July 1, for which the state mitigated its expectations, if only by $13 million.

"I would suspect they are anticipating a ramp up in entities being licensed, and that the increased access in the market will significantly accelerate growth and revenues," said Greg Shoenfeld, BDS Analytics' vice president of operations.

Industry experts say the slow start is not unexpected because other states such as Colorado and Washington also experienced hiccups in the early period of legal recreational marijuana sales. In the case of California, though, they say the situation was made worse due to problems with marijuana businesses getting licenses, local pushback and outright confusion.

"It's not a surprise that the state overestimated because they were probably using an ideal scenario to come up with these forecasts," said Chris Walsh, vice president of editorial and strategic development at Denver-based Marijuana Business Daily, which tracks the cannabis industry across the nation. "It's just getting off to an extremely rocky start."

Added Walsh: "There's going to be much fewer sales than expected until all that is ironed out. It might take a couple months, or it could take a year or more."

Josh Edelson | AFP | Getty Images

Industry observers say the state's recreational marijuana industry is experiencing a choppy start due in part to licensing issues. Some legal pot shops are complaining their business is suffering due to competition from illegal black market dispensaries.

"A lot of the illegal dispensaries are putting prices so low out the door because they are not paying taxes," said Sica Sohn, the assistant manager at Hollyweed Dispensary in Los Angeles. "There are over 10 illegal dispensaries within a mile radius of my location."

In March, California's Bureau of Cannabis Control, or BCC, warned 900 unlicensed pot shops that they needed to stop operating.

"The state can't issue licenses without local approval and the locals have taken some time to come online," BCC spokesman Alex Traverso told CNBC. "We have about 400 licenses shops now."

Even though Proposition 64 was approved in 2016 by about 57 percent of the state's electorate, there are local jurisdictions in California that still refuse to permit marijuana businesses. The proposition gave local governments the authority to decide whether or not they wanted pot shops, cultivation and how to regulate sales of marijuana.

About 85 percent of cities in the state have banned adult-use retailers, whether storefront or deliveries, according to Chris Beals, president of Weedmaps – a cannabis technology platform.

"There are a lot of cities and counties that don't have the sort of courage or temerity to license retail but want the tax revenue and jobs from marijuana," he said. "The situation is bonkers – probably the largest ban rate of any legalized state in the country."

Beals said there are wide stretches of the state still without licensed dispensaries. "From L.A. heading north there's roughly a 200-mile stretch before you get the next dispensary. Until you don't have these vast empty spaces with no retail, you're not going to be able to effectively tamp down the illegal market."

For local cities embracing the new law, retail marijuana can bring in many millions of dollars in tax revenues, as has been the case already with Oakland and San Jose. The city of Los Angeles projects pot revenues will reach $3.5 million in the first half of 2018.

"For some smaller local governments, a relatively small amount of marijuana-related revenue can prove to be a larger credit positive because of the smaller size of annual fund revenue," Moody's Investor Service said in report Tuesday. But it added that some jurisdictions "opted out of licensing retail outlets, partly because of a potential increase in law enforcement costs."

Customers buying legal marijuana in California face state and local taxes, and in some cases when all the taxes for growers and sellers are added up it can be as much as 45 percent, according to Fitch Ratings.

The state imposes a 15 percent excise tax and then there's regular state and local sales taxes that vary from 8 percent to 10 percent. Also, businesses pay local taxes that can range from one to 20 percent of gross receipts. Cannabis farmers also have various taxes on dry flowers and leaves.

"We have no choice but to charge tax on top of the prices, or even sometimes to pay it out of our pockets in order to compete with a lot of the illegal dispensaries," said Sica Sohn, an assistant manager at Hollyweed Dispensary. "The illegal locations can market a lot of their products at a lower price, and we (as legal shops) cannot rival it because of the really high tax that's imposed on the marijuana industry."

There's a proposal in the state legislature, Assembly Bill 3157, that would lower the state's excise tax imposed on purchasers of cannabis from 15 percent to 11 percent for about three years. It also would suspend the cultivation tax until June 1, 2021.

The bill's analysis from the Assembly's Revenue and Taxation Committee points out that California's marijuana industry essentially went two decades without any statewide regulatory system and needs a helping hand now in order to thrive in future years and compete against the state's illegal cannabis market.

"Legal cannabis businesses are facing financial challenges due to sticker shock from increased prices and competition from black market operators that are not subjected to taxes or the cost of complying with regulations," according to the committee's analysis.

The analysis also quotes from New Frontier Data estimates that marijuana prices jumped 44 percent after Jan. 1, when the new taxes and regulations went into effect. It also said there have been layoffs in licensed cannabis businesses in the state and some longtime operators are worried about going bankrupt.

"You've got these businesses that are still operating in an unregulated environment because they don't have a license and they are getting competitive advantages," said Walsh. "I don't think state lawmakers took into account the local issues to the degree they should have."