Last week, state officials released the official tally of tax revenue in sales, excise and cultivation taxes in 2018 – the first year recreational cannabis sales were allowed under Proposition 64. The $345.2 million was about a third of what most outside analysts expected. Quarterly tax revenue gained steadily until the last three months of 2018, when it flattened out.

From a basic economics perspective, this is no surprise. Illegal sellers who are often lightly policed can offer marijuana for at least 20 percent less because they don’t have to pay taxes or regulatory fees or state-mandated packaging costs. Many illegal storefront dispensaries and delivery services don’t have to worry about start-up costs. They belong to long-established networks for buying and selling marijuana that emerged after state voters’ 1996 approval of medicinal marijuana use.

But the state’s Cannabis Advisory Committee is growing impatient with the reasons authorities and others give for the enduring strength of black market sales. In the committee’s first annual report, it decried what it called the “fragmented and uncoordinated” law enforcement response to the marijuana black market. The committee’s other big gripe is the slowness of local governments to allow recreational cannabis sales. Only about one-third of cities and counties have approved such sales, according to the Southern California News Group’s database.

While Gov. Gavin Newsom said recently that he will deploy 150 California National Guard troops to eradicate illegal growing in Northern California, he has otherwise long counselled patience. On the campaign trail in 2016 while running for governor, he said he thought it would take “five to seven years” for the legal recreational marijuana industry to settle in and thrive if Proposition 64 passed. This long view is reflected in his proposed 2019-2010 budget. It anticipates $355 million in cannabis tax revenue – only a 3 percent increase from the 2018 calendar year.

Tribes, cartels could pose threat to regulated CA pot

But the industry could have other headaches on the horizon as well. A recent analysis in the San Diego Union-Tribune noted some large marijuana seizures at the border in Imperial and San Diego counties that suggest Mexican drug cartels still see cannabis as lucrative even though in recent years they have largely focused on more easily imported drugs like opioids and methamphetamine.

“We are continuing to see more marijuana production in Mexico than we might expect with [California’s] legalization,” University of San Diego professor David Shirk told the newspaper.

The Mexican government has taken initial steps toward legalizing cannabis. That could have fallout for the Golden State by encouraging more pot farming in Mexico.

But there’s also one emerging wild card facing California’s recreational industry that state regulators don’t appear to have anticipated: That’s the possibility that Native American tribal lands not subject to state or federal laws could emerge as both cannabis cultivation and sales centers. Tribes could potentially enjoy a price advantage over legal shops that illegal sellers now do.

A recent Southern California News Group story noted that 24 state tribes, mostly in Southern California, had taken steps of varying degrees toward getting into the marijuana business. The Santa Ysabel tribe in northeast San Diego County reportedly already employs about 100 people in its cannabis greenhouses.

California’s first year with legal recreational sales of marijuana is wrapping up with a series of downbeat reports on a new industry struggling to find its footing.

An Associated Press analysis posted Sunday said estimated legal sales of cannabis would total just $2.5 billion in 2018 – in a state of 40 million people in which 13 percent of adults admit to use, significantly higher than in most states. State officials will be lucky if they receive half the $630 million in pot taxes anticipated in the 2018 state budget.

When tax revenue goals went unmet early last year, one assumption was that this was primarily the result of resistance to legal cannabis. An estimated 80 percent of local governments have not authorized recreational sales, as is their right under Proposition 64, the 2016 ballot measure that cleared the way for such sales. And in some of the cities that have issued permits, only a handful have been issued.

But as the year wore on – and costly state regulations kicked in mandating careful testing and child-resistant packaging of marijuana and marijuana products, such as edibles – reporting on the California pot beat increasingly focused on the huge price advantage that illegal sellers have.

Medical marijuana law led to sales networks

A recent Southern California News Group article pointed out that with voters’ approval of medicinal marijuana in 1996, growers and sellers had a 20-year head start in establishing sales and distribution networks that were poised to fill demand when cannabis possession and use became legal on Jan. 1, 2018. These networks are able to sell marijuana that is up to 50 percent cheaper than the marijuana available in licensed stores.

These growers and sellers don’t just balk at going the legal route because of fees, regulations and paperwork. They’re emboldened by the weakening of criminal penalties related to marijuana in recent years, according to the Southern California News Group analysis.

A San Francisco Chronicle report published last week quoted Steve DeAngelo, a co-founder of Oakland’s huge Harborside marijuana dispensary, as saying “the unrolling of legal adult-use cannabis has reinvigorated the underground market rather than curtailed it.”

“Because we are up against high taxes and the proliferation of illegal shops, it is difficult right now,” pot shop owner Javier Montes told the Los Angeles Times last week. “We expected lines out of our doors, but unfortunately the underground market was already conducting commercial cannabis activity and are continuing to do so.”

Shop owners in the Los Angeles and Bay areas have urged authorities to crack down on illegal storefront and delivery sellers. But while state regulators say that is a priority in 2019, it’s unclear how much of a priority it will be for local law enforcement agencies who are strapped by pension costs and often have difficulty maintaining police staffing because of recruiting woes.

Among those who anticipated that legal California sellers were going to be seriously undercut by illegal sellers is Gov.-elect Gavin Newsom, who led the Proposition 64 push.

Newsom: Addressing black market to take ‘5 to 7 years’

While on the campaign trail in May, Newsom said he thought it would take “five to seven years to substantively address the black market” issue.

As governor, Newsom could order stepped-up efforts to target growers and sellers, as well as seek new funding for such enforcement.

But the legal marijuana industry also wants help on another front. The Chronicle reported there is a huge backlog at the state office processing permits to legally grow marijuana, with no action yet on about 90 percent of applicants.

U.S. Attorney General Jeff Sessions’ Jan. 4

While none of the four U.S. attorneys’ offices in California have taken high-profile enforcement steps to date, at least two may be inclined to take on legal marijuana in some way – especially given that Sessions has already complained that pot being grown in the state is being trafficked in other states where it remains illegal.

In the California Eastern District based in Sacramento, President Donald Trump nominated McGregor “Greg” Scott to serve as U.S. attorney, returning to a job he held under President George W. Bush. He was sworn in Dec. 29. His large district is mostly inland California, from the Oregon border to the Inland Empire, including Humboldt County, ground zero for the Golden State’s pot culture.

Cannabis advocates worry about Sacramento U.S. attorney

While the Sacramento Bee editorial page hailed Scott’s selection, the Bee’s newsroom reported earlier this month that marijuana advocates are on edge because of Scott’s history of aggressively targeting medical marijuana in his first stint on the job. Scott’s office received national attention in 2008 when it secured 20-year and 21-year sentences for two Modesto men whom Scott said were running a criminal empire – not a clinic.

The Cal NORML marijuana advocacy group blasted Scott for urging local prosecutors to refer medical marijuana cases to his office, calling it “particularly notorious for harsh sentences against medical marijuana defendants.”

“He used to be a hardcore, anti-cannabis drug warrior,” Sebastopol criminal defense attorney Omar Figueroa told the Bee. “I hope he has evolved.”

Scott offered no overview of his intentions beyond issuing a statement saying he would review marijuana cases “in accordance with our district’s federal law enforcement priorities and resources.”

Cartel prosecutor takes reins in San Diego with tough statement

The other California U.S. attorney who might be inclined to take a hard line on pot is Adam Braverman in the San Diego-based Southern district. Braverman was sworn in Nov. 16 after years as a hard-charging prosecutor in the San Diego office targeting drug cartels which operate on both sides of the U.S-Mexico border. His statement echoed Sessions’ remarks that individual states should have no expectations that federal drug laws would go unenforced just because their voters or legislators had approved legal use of pot.

“The Department of Justice is committed to reducing violent crime and enforcing the laws as enacted by Congress. The cultivation, distribution and possession of marijuana has long been and remains a violation of federal law,” Braverman’s statement said. “We will continue to utilize long-established prosecutorial priorities to carry out our mission to combat violent crime, disrupt and dismantle transnational criminal organizations, and stem the rising tide of the drug crisis.”

Earlier this month, former prosecutor and criminal defense lawyer Nicola Hanna was named interim U.S. attorney for the Central District, based in Los Angeles. Hanna, who is expected to get the job on a permanent basis, has kept quiet on Sessions’ announcement. His office refers questions to Justice Department headquarters in Washington.

Any crackdown on cannabis might be difficult just from a resources perspective for Hanna. His office serves an area with 18 million residents in Los Angeles and Orange counties and five adjacent counties – by far the most heavily populated of any office. It is often responsible for complex cases involving not just drugs and white-collar crime but also national security.

Views of acting U.S. attorney in San Francisco unclear

In the Northern District based in San Francisco, U.S. Attorney Brian Stretch resigned within days after Sessions’ policy change, though he said the decision was unrelated.

Alex G. Tse is serving as the acting U.S. attorney after being Stretch’s second-in-command. Tse has kept a low profile to date on Sessions’ policy reversal.

However, his office was known for its aggressive targeting of Oakland’s Harborside Health Center, which the Feedly marijuana news website says is “perhaps the state’s best-known dispensary.”

The 9th U.S. Circuit Court of Appeals, based in San Francisco, threw out prosecutors’ case against Harborside in 2016, saying they had ignored Congress’ direction that medical-marijuana dispensaries operating within state laws should be left alone.

Under current law, the possession of small amounts of marijuana (less than one ounce) is punishable only by a fine, whereas those who grow or sell marijuana can face stiff criminal penalties, according to an analysis from the California Secretary of State. In 1996, California voters approved Proposition 215, which legalized medical uses of marijuana for people of all ages who receive a doctor’s recommendation.

Beginning in 2003, the state legalized nonprofit groups known as collectives that are allowed to grow and sell marijuana to their members. Under recently passed laws, those collectives will be phased out and replaced with state-licensed medical-marijuana businesses. Meanwhile, local governments often strictly regulate or ban medical-marijuana businesses. And the federal government still considers marijuana a “Section I” drug, which means that federal enforcement agencies still claim the right to crack down on any sales. Indeed, U.S. Attorney General Jeff Sessions has reportedly been eyeing a crackdown on states that allow recreational sales.

Against that backdrop, California’s Prop. 64 legalizes the use of marijuana, for any reason, for adults only, creates a complex state system for regulating nonmedical marijuana businesses, imposes a wide array of taxes on marijuana and changes the penalties for marijuana crimes, notes that Secretary of State analysis. Specifically, adults may possess around an ounce of pot, smoke it in their own home or private business, give some of it away and may grow up to six plants in their own residence.

Six state agencies – including a relatively new Bureau of Medical Cannabis Regulation – will regulate different aspects of the marijuana pipeline (sales, testing, transportation, growing). The industry will be required to pay a state tax on growing marijuana and a state retail excise tax plus any local sales taxes. Localities are free to tax, regulate and even ban recreational marijuana sales. Because of federal restrictions, marijuana businesses may not have bank accounts – an unresolved issue as the state steps up its tax-collection requirements.

The arguments over the measure’s plusses and minuses are largely over, but it will take a while before everyone is clear on what’s allowed and what isn’t in any particular jurisdiction. There’s broad agreement on some basics: No smoking marijuana in public, adults only, and it’s OK to possess small amounts of weed. But it will take some time for Californians serving prison sentences for marijuana-related offenses to petition the court to have those convictions tossed out.

And it will take some time for cities and the state cannabis agency to approve the first round of stores that sell recreational products. Chalk it up to bureaucratic morass, perhaps. “Los Angeles and San Francisco are among many municipalities that won’t have their licenses ready by the time marijuana sales become legal on New Year’s Day,” according to Fortune. The magazine notes that the state has issued 69 licenses for medical marijuana clinics, which must receive new state approvals under the new law. But it only has issued 44 licenses for nonmedical stores. Per the article, Sacramento, San Diego and Berkeley have approved licenses for stores in their cities, but consumers in San Francisco and Los Angeles and other cities will have no place to legally shop for weed as of the new year.

And National Public Radio reports that the local pot scene will vary greatly. The League of California Cities told the news service that “communities are all over the map when it comes to dealing with recreational marijuana. Some allow cultivation but not retail. Others will allow delivery but no storefronts.” It will take time for all of that to play out.

There’s still a debate over the process of legally growing marijuana for recreational users. Small growers for the medical-marijuana market are worried that Proposition 64 will allow big, corporate farms to take over the emerging recreational market. In fact, many pro-pot activists had actually opposed the legalization initiative out of concern over what it would mean for small businesses and fears that the new regulatory system would be too heavy-handed.

There are other gray areas. A CNBC article explores what it will mean for Californians who attempt to catch a flight across the state. “That is a conundrum for the state’s airports, which are locally owned and operated but are subject to federal law, under which marijuana is an illegal substance. Areas beyond security checkpoints are under federal control,” it reported. A Los Angeles airline security official is quoted saying that this will be a gray area.

Furthermore, the state still is trying to figure out how to combat driving under the influence. As the “Pathways Report” from the state’s Blue Ribbon Commission on Marijuana Policy acknowledged, marijuana stays in a user’s system for several weeks. That’s long after the high has gone away. Police agencies need to determine if someone is driving stoned without slapping fines on a driver who may have smoked a joint a week ago. Of course, that’s an issue whether or not marijuana is legalized.

Of course, marijuana use has long been a gray area in California. Even many supporters of Prop. 215, the medical-marijuana law, admit that the ensuing medical marketplace has been fraught with gray areas and enforcement questions. It took nearly two decades after its passage before the Legislature passed a thorough set of medical-marijuana regulations. And they did so largely because of the coming recreational market. Officials viewed the new medical marijuana rules as the foundation for regulating recreational-marijuana sales.

Many observers fear that if state and local governments don’t quickly get pot shops licensed that the black market will continue to flourish, which would defeat the main reason for legalizing the drug in the first place. Supporters of the legalization initiative had argued that in the current black market there’s no one regulating the product’s safety, or overseeing environmental aspects of large-scale marijuana grows or assuring that weed isn’t sold to minors.

The bottom line is pot smokers shouldn’t expect marijuana to be available at many legal stores on January 1 – and it will take many months before the state government, police agencies and localities are working from the same page. The voters may have spoken clearly, but it’s not as easy for government bureaucracies to get their act together.

Steven Greenhut is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

Competing alternatives

Legislators have advanced two different proposals, differing largely in how much regulatory control they leave to local government. The plan put forward by Assemblyman Ken Cooley, D-Rancho Cordova, would task both state and city governments with licensing dispensaries and marijuana farms, the Los Angeles Times noted. Another bill, authored by Assemblyman Rob Bonta, D-Oakland, “would divide regulation tasks among multiple state agencies.”

Different constituencies have begun to line up in favor of one or the other option. “Law enforcement officials prefer the Cooley bill because it gives local governments more control,” reported the Times, while the California Cannabis Industry Association has come down against Cooley’s bill.

Mainstreaming marijuana

Despite the disagreement and broader regulatory confusion — federal law banning the sale of marijuana has not changed — Californians have continued to press ahead for looser rules. Public opinion and public policy have converged steadily toward a greater normalization of marijuana users, if not always marijuana itself. This month, for instance, an overwhelming majority of Assembly lawmakers passed AB 258, The Medical Cannabis Organ Transplant Act, introduced by Marc Levine, D-San Rafael.

According to the bill’s language, “[a] hospital, physician and surgeon, procurement organization, or other person shall not determine the ultimate recipient of an anatomical gift based solely upon a potential recipient’s status as a qualified patient…or based solely on a positive test for the use of medical marijuana by a potential recipient who is a qualified patient.”

In the Senate, meanwhile, state Sen. Mike McGuire, D-Healdsburg, has introduced SB 643, the Medical Marijuana Public Safety and Environmental Protection Act. That bill would use a mix of state and local regulation to address the environmental impact of marijuana cultivation.

As the Guardian observed, McGuire “says illegal grows are deforesting government lands, polluting waterways and affecting the health of those who use medical marijuana. One provision of his bill requires all cannabis to be certified organic by 2022, to eliminate polluted runoff into state waterways and make marijuana safer to use,” while another would crack down on “the illegal use of water to irrigate cannabis crops.”

Industry investment

Underscoring the economic interest at stake in statewide legalization, one popular dispensary app recently spent $1 million on its own initiative-driven organization. As the Sacramento Bee reported, “Irvine-based Weedmaps Media, LLC, which runs Weedmaps.com, put the money into the company-sponsored ‘Californians for Sensible Reform’ to support a possible 2016 initiative.”

Although details on that proposed measure have yet to emerge, the Bee noted, two others have advanced on the strength of more concrete reforms.

One, the California Craft Cannabis Act, “would create a California Cannabis Commission to regulate the industry. Marijuana sales would be subject to all applicable taxes, with additional taxes allowed up to 30 percent. Larger-scale, commercial grows would be subject to additional rules and tax regulation. The law also would preempt any local marijuana restrictions.”

Another, put forward by Californians for Compassionate and Sensible Access, focused more narrowly on local preemption.

Local schemes

With the path to reform in 2016 still so unclear, cities with a marijuana agenda of their own have forged ahead with ideas confined to the municipal level. In San Francisco, Supervisor Scott Wiener and Terrance Alan, the Entertainment Commissioner turned marijuana activist, have joined to propose that the Board of Supervisors create a city-specific Cannabis State Legalization Task Force.

“There’s a reasonable chance that next November the voters will legalize recreational cannabis use in California. The last thing we need in San Francisco is to have a chaotic fire drill about local implementation and so forth,” Weiner told Smell the Truth. For the foreseeable future, San Franciscans won’t be alone in that regard.