U.S, April 10, 2020 (CANNABISBUSINESSTIMES) California is the largest cannabis market in the U.S., but it also is the state market that arguably has grappled with the greatest challenges since adult-use legalization rolled out there Jan. 1, 2018.
With a many-decades-long history of cannabis cultivation and a largely unregulated medical cannabis market that thrived for nearly a quarter-century since the passage of Proposition 215 (also called the Compassionate Use Act of 1996), California had become home to more than 68,000 cannabis farmers, as Cannabis Business Times reported in 2018. The state’s cannabis market was predominantly comprised of smaller, family-run cannabis farms and dispensaries, and it began crumbling under the weight of the adult-use regulatory structure and accompanying costs (licensing and testing fees, and exorbitant taxes).
Not unrelated, the state’s illicit market continues to dominate cannabis sales by the billions of dollars. In late 2019, The Motley Fool reported on estimates that projected legal cannabis sales would fall $5.6 billion short of illicit-market sales that year.
Now, more than two years into the state’s adult-use program, the struggle continues, and unless things change, the future of the state’s legal market is grim, says Hezekiah Allen, a former cannabis grower who has an extensive history in the California market.
Allen is perhaps most well-known for his work as executive director of the California Growers Association (CGA) from 2015-2018, where he advocated and lobbied for legislation that protected the state’s extensive cannabis heritage, including its smaller, family-run farms. He had formed HDA Public Affairs in 2010 to separate and protect himself and his then-gray-market grow from his lobbying and advocacy work.
Today, in addition to still operating HDA Public Affairs, Allen spends the bulk of his time working with Emerald Grown, a corporation of California cannabis cooperatives whose “goal is to get the farmers’ products to market and maximize the returns to the farmer,” he says. The organization has agreements with about 45 growers, Allen adds.
Here, Cannabis Business Times speaks with Allen about the current outlook of the state’s cannabis businesses, the impacts of the coronavirus pandemic on the already strained legal cannabis market, and what needs to change for the state’s industry, which he says “will fail without government intervention.”
Noelle Skodzinski: What are you seeing as far as the overall outlook of California farmers?
Hezekiah Allen: Before this crisis, the outlook was bad. California has created a regulated market within which it’s very difficult for a small or mid-sized businesses to succeed. And honestly, even the large businesses are finding it very hard to succeed. The current crisis has not made that any better.
I think before this crisis, we probably could have limped along for two or three more years. But most businesses, without some significant change to the regulatory and the taxation scheme, especially small businesses, would have failed in the next few years. I think this is likely to expedite that. I don’t think in and of itself it’s creating that market failure. But I do think it is likely to expedite it.
Skodzinski: What are the biggest impacts the coronavirus pandemic is having on cannabis businesses, aside from the usual challenges of lack of access to small-business loans, tax deductions and any support being offered to non-cannabis businesses by government agencies, such as the Small Business Administration?
Allen: Not a lot of facilities that I know are set up with six feet of distance between workspaces. So retooling workspace and reduced capacity because of reduced workspaces, workers being out, not wanting to come into work, not being able to come to work. So that whole typical scope of problems that everyone’s dealing with.
I think the larger picture though is with unemployment spiking the way it is, I don’t buy into the theory that cannabis is recession-proof. I think that medical is a bit more so, but a lot of patients are income-sensitive, and even if they don’t consider [cannabis] a luxury item, they may not actually have the money to purchase it. That’s why the compassion argument was so important and why we’ve worked so hard to make sure that that medicine can get to the market in the first place.
But I think that over the next several months we are going to see some pretty significant downturns in consumer spending.
I also think one thing that really sets us apart, and it’s what you mentioned—that we’re not eligible for any federal support, and we know that. … We can’t even get just a typical, normal small business loan. These types of events [like the current situation] are when those safety nets can be helpful: a low-cost bridge loan, operating capital loans, the SBA is making grants now for goodness sake, but none of that’s available to us.
Couple all of that with the reality that we’re also the only business that can’t deduct our operating costs, and it’s going to be pretty bad if things don’t give. Between 280E, the lack of access to banking, … to federal relief tools, it’s amazing we can keep operating. I think it represents a major turning point in the national dialogue.
Underneath that “essential” categorization, there’s a much more concerning reality that we’re going to do everything we can to get ahead of. We were born fighters, and that’s what it is.
Skodzinski: Governor Gavin Newsom announced in January plans to consolidate by July 2021 the state’s three cannabis licensing authorities (the Bureau of Cannabis Control, the Department of Food and Agriculture, and the Department of Public Health) into a single Department of Cannabis Control, and as part of that, a proposal to “[simplify] cannabis tax administration by changing the point of collection.” In your opinion, what needs to be done aside from obviously providing cannabis businesses the benefits that non-cannabis businesses get?
Allen: The cannabis business community has some real difficult questions we need to answer. From my perspective, what needs to change is the taxes. And since 2017, we’ve known with certainty what the guidelines of those changes are. There are enough stakeholders in Sacramento that have no interest in cannabis whatsoever other than an interest in the revenue that we generate, who have made very clear what they will and won’t vote for. Tax measures take a two-thirds vote; we need to get a lot of votes. So there are a lot of things I wish we could do that … just aren’t on the table, unfortunately.
We need to decide whether or not we’re willing to live with the options that are on the table.
The options that are on the table are to suspend the cultivation tax and increase the excise tax. Suspending the cultivation tax results in a loss of revenue; increase the excise tax to make up for that revenue. Or create a tiered cultivation tax where the first X amount of pounds are tax exempt and any pounds above 10,000 are taxed at a higher rate, and shift that burden to the folks with larger harvests.
There isn’t a pathway to the votes needed to pass a tax reduction, and I think that’s something that we need to come face to face with. And so … I’m okay with either of those options. If somebody is growing 50,000 pounds, I’m significantly less concerned about their tax burden than somebody who’s trying to survive growing a few hundred. That’s just my bias. Not everyone shares that bias, but I’m okay with that.
I’m also okay with getting rid of the cultivation tax entirely and shifting it to the excise tax. We know beyond a shadow of a doubt, at least I do, that we have the votes to pass that option. As of yet, the industry has not backed anything that would be revenue-neutral, and that’s the key. We can pass revenue-neutral tax reform, we can’t pass revenue-negative tax reform. And that’s been true for several years now, and I think it’s on us.
What I think we need to do is decide whether or not that’s going to work for us.
I don’t think consolidating the agencies makes a lot of sense. … Our bottom line is that we’re farmers, we want to be regulated like agriculture. Moving us out of the Department of Food and Agriculture seems like a step in the wrong direction.
If we want to talk big-picture policy changes that could make a massive impact, we could recognize cannabis cultivation as agriculture and cannabis flower as an agricultural product. That would be a game changer—probably such a game changer that it’s impractical at this point. For example, if that were to happen, we would then become a right-to-farm crop, which would essentially overrule local bans, which I just don’t think is viable at the moment. I think that’s why the Secretary of Agriculture hasn’t taken that step.
But that needs to remain the longer-term goal—full recognition as agriculture—and anything that moves us away from that, I will be very cautious of, if not openly opposed to.
Beyond that, I think we need to talk more about this idea that if a farm is not damaging natural resources, then there shouldn’t be as many compliance and regulatory costs. … We need to operate our farms with balance within that natural system. But if we can demonstrate through third-party certified best practices that we’re achieving those resource-conservation goals, then we need to reduce the costs, extend the timelines, and reduce the rigor of the compliance tasks.
“I think that we have every reason to believe that the experiment of regulated cannabis in California will fail without government intervention.”
– Hezekiah Allen
So that’s sort of my suite of three: We really need to come up with something realistic on taxes. I know we have the votes to pass it, if we meet that revenue, net-neutral threshold. We need to keep moving toward recognition as ag. And we need to focus on the impacts to natural resources, not checking the boxes on regulatory worksheets.
Skodzinski: The illicit market has continued to thrive in California. Do you think it is going to become further invigorated if changes are not made to the existing regulatory and tax structure?
Allen: That’s been my concern all along. … Folks were treating this as though it were a new market. … [That] was very damaging. The strength and entrenched nature of the existing marketplace was hugely underestimated. It’s already, even before this crisis, outperforming the regulated market by maybe 300%.
Most of the product grown and sold in the state is still unregulated and untaxed. This [current economic situation] isn’t going to improve that for sure.
And I don’t think that the regulated market, with all of its additional costs and taxes, is going to stand a chance. It wasn’t able to compete with the unregulated market pricing before, and it’s going to be less able to do so now.
As consumers become more cost-sensitive, they’re going to look at products that are priced better. And at face value, not paying the taxes saves you money, and that that savings is passed on to the consumer. I think we have every reason to believe that the experiment of regulated cannabis in California will fail without government intervention.
Skodzinski: What about rural farmers right now? Are they having a harder time due to impacts from the COVID-19 pandemic?
Allen: You know, the timing of this isn’t so bad. Most of those rural farmers are single-season, outdoor, maybe two-season, mixed-light folks there. This isn’t harvest season. This is when those folks are usually spending a bunch of money with no revenue anyway. Anyone who’s been succeeding in that space knows how to budget. When this could become really acute for them is if sales haven’t picked up by the time there’s harvest. There is a very thin margin and a very thin window where those growers need to generate some revenue pretty quickly after harvest or they miss their next planting season. And so far, we haven’t crossed any of those thresholds. It’s planting season, which nobody’s expecting to do many sales at this time of year anyway.
Honestly, if anything, I think the indoor growers that are paying a power bill every month have a much higher need for constant revenue, and they get behind a lot faster. So a two-month slow down on sales is probably going to hurt them more than it hurts somebody who’s accustomed to budgeting for several months between revenue.
We do work with a handful of indoor growers …, and the feedback I’m getting from them is that … the indoor growers are going to have to turn the lights off if we don’t see something [change]—which I think is probably going to happen in the next five years anyway. A lot of these things, like I said, I don’t think are new circumstances. I think [the current situation] is expediting some of the failures that already existed in the marketplace.
Skodzinski: Is there anything you suggest that cannabis businesses everywhere do as far as pushing to gain federal support, whether on a regular basis or during the current crisis?
Allen: For folks in states with Republican senators, it has never been more important to establish a relationship with those senators. Obviously, it’s always important to have strong relationships with your elected officials, 100%, but when we get down to the meat of the matter, Republican senators, the federal Senate, those are the folks that are going to block our progress.
I think we have the votes to add cannabis to the SBA programs in the House of Representatives. I expect that we will hear from Speaker Pelosi in the next few days to that effect. But we don’t have the votes in the Senate, hands down, and the more inroads we can make with those Republican senators the better. Constituents in those States are absolutely the best people to build those relationships.
I think it’s a great opportunity for the cannabis business community to, to reassess some of the divisions, to try to think more like a community and less like factions. I really do think we’re going to need each other more than we ever have before on other side of this. And we’ve got some time now to try to ease into that.
So if there’s any grudges folks are holding, let go of them, … find common ground. Don’t focus on the differences, … focus on what brings us together. And we’ll see what we get.
Skodzinski: What else?
Allen: Gosh, I mean, we’re essential! (laughs) … I just wish everyone the best possible outcomes. I encourage everyone to take a deep breath, and stay grounded and focused. I do think we’re going to need some external support, some government intervention, but I think if we stay grounded and we stay focused that we’ll get it, frankly. I think it’s a good time to figure out how to best get organized. We’ve got a lot of work to do together in the next several months to make sure we recover.