California Gives Up on the Illegal Cannabis Market

California has the biggest legal cannabis market in the world – it’s a larger economy than some small nations. But while the Golden State’s regulated market is massive, it’s illegal market is far bigger.

California has a big illegal cannabis market problem

Back in 2019, I quoted reports that there were 3,000 illegal businesses in the state. Other reporting from last year estimated that the illegal market was only double the size of the legal market. By one more recent estimate, 2/3 of sales are illegal market sales. This is not a good thing. You’d expect a state with such a robust market and appetite for regulation to actually do something about it. But it hasn’t. And it won’t.

Let’s back up and look at why we are in this mess in the first place. Cannabis is federally illegal. California only opened state recreational licensing in 2018. Before that, and with some exceptions for medicinal use, all cannabis was illegal. From the state’s point of view, there are really two big-picture ways to get legacy operators to come into the illegal market.

Option 1: Make the legal cannabis market easy to join

First, the state could have made it very easy to enter the legal market (something I’ve written about since at least 2019). Very clearly that did not happen. It takes hundreds of thousands of dollars in leasing, property improvements, and local and state permitting just to open up shop. That process takes AT LEAST several months, and likely more than a year.

By the time a legal market operator gets to work, they are often six to seven figures in debt, subject to overwhelming state, local, and federal taxes, and facing significant illegal market competition. The state has long known about this problem, but done virtually nothing to make it easier to get into the legal market. If anything, it’s gotten more complicated since 2018, as things like provisional licensing are going away.

Option 2: Disincentivize the illegal cannabis market

That brings us to option two: enforcement. Whether you think enforcement against the illegal market is good or bad, we can all agree that if a state makes participation in the legal market so unattractive, a massive illegal market will persist. And unless that illegal market is taken to task in some way, it will not only grow, but fester. One would expect that a state like California, with its mammoth cannabis tax rates and the ability to assess massive penalties against illegal operators, would be incentivized to jealously protect licensed cannabis operators.

California’s choice: do nothing

Now, if you read tweets or press releases from cannabis regulators, you might be fooled into thinking that the state was actually fighting back hard. After all, the state did get a $128 million civil fine against a former licensee for alleged illegal market activities. But that fine is the exception, not even close to the norm. In fact, if you look closely at the actual stats, you’ll see a very different picture.

For example, here are statistics released by the Department of Cannabis Control just last week:

In other words, in the biggest cannabis market in the world, in a market where illegal sales eclipse legal sales by a margin of perhaps 2:1 or even 3:1, the state served a whopping … 92 search warrants in the matter of three months. Think about this. That is one per day. And this is more that 3x the 21 warrants served in the entire three month period before that.

It shouldn’t be that difficult for the state to actually go after the illegal market. I could probably find 92 illegal dispensaries in big California cities in an afternoon on Google. Why the regulators apparently can’t do this is mystifying.

I should be clear that it’s not just enforcement. The state hasn’t done much of anything else to put a dent in the illegal market. Yes, it has passed laws that give the state severe enforcement powers. But it won’t use them. Beyond that, the only real example that comes to mind is when the regulators required retailers to display QR codes linking to their licenses. Yes, someone high up thought this would actually do something. As expected, it’s done nothing except add yet another requirement to the already byzantine regulations facing licensees.

A simple recommendation

To be clear, I am not a fan of enforcement. I think that incentives work a lot more than disincentives. If the state wanted to eliminate the illegal cannabis market, it should have never required costly licensing or allowed local control. But at this point in time, it’s not really realistic to think that the state will ever do things like eliminate licensing or taxes or do away with local control. Even putting aside the difficulties in changing the law, too many people have spent too much money getting licenses. Can you blame them for wanting to keep the market small?

If the state’s not going to do that, then it needs to embrace enforcement, but with a big caveat. Enforcement on its own didn’t work during prohibition, and it won’t work here. If the state wants to ease up on the illegal market, it will combine incentives and disincentives. In this model, it would eliminate nonsense requirements such as the 6AM to 10PM sales window that the illegal market obviously ignores. It would also be much more aggressive about seizing unlicensed product, even if it didn’t necessarily put people behind bars for decades (which it shouldn’t).

California claims it cares about its cannabis market, but has never seriously tried to combat the illegal market. This is a stain on the state’s regulators. If the state wants to meaningfully help fix the myriad problems that plague its cannabis industry, it should start by figuring out what to do about the illegal market. And fast.