Black market marijuana undermines legal businesses

A man smokes marijuana during a hip hop performance at the Bushwick Collective’s 11th Annual Block Party in Brooklyn, New York on June 4, 2022.

Alex Kent | AFP | Getty Images

Thriving, unregulated marijuana companies in the United States are undermining legitimate markets awaiting banking and tax reforms.

While it’s a problem in states like Colorado, Michigan and Washington, it’s a much bigger problem in New York. Unlicensed companies “occupy a fairly high percentage of potential market share,” according to Amanda Reiman, a researcher at cannabis intelligence firm New Frontier Data. None of the 36 newly licensed pharmacies in New York have even started operations.

New York’s licensing program lags years behind the state’s sophisticated black market. New York issued its first batch of dispensary licenses last month, but recreational marijuana has been legal in the state for nearly two years.

“These businesses masquerade as secure, legal entities,” said Trivette Knowles, press secretary for the New York State Office of Cannabis Management, “but there are currently no licensed sales taking place in New York State.”

The problem is particularly troublesome in New York City, Knowles said. Weed can be purchased from brick-and-mortar stores, trucks, pop-up stores, bodegas, and even courier services that deliver directly to consumers. His office has issued cease and desist letters to some of the unlicensed operators in the state, but some trade groups say there are likely tens of thousands of illegal businesses in the city alone.

“It’s almost like a slap on the mole,” said Reiman of New Frontier Data. “If one falls down, another just pops up.”

Reiman said her company doesn’t track data on the many illegal businesses that have sprung up across the country, but she estimates the national market is worth about $60 billion. The legally regulated industry is only half of it, she said.

“When you have pharmacies and distribution systems that mimic regulated markets pretty closely, it can be really difficult to get people to switch,” Reiman said.

Unregulated markets, she said, also pose serious health risks for consumers. A November study commissioned by the New York Medical Cannabis Industry Association found that after screening cannabis products from 20 illegal stores in New York City, about 40% contained harmful contaminants such as E.coli, lead and salmonella.

In addition to cease and desist letters, New York City has also begun to crack down in other ways.

In December, Mayor Eric Adams announced the seizure of more than $4 million worth of illegally sold products. His office also issued over 500 civil and criminal subpoenas as part of a two-week pilot program with various law enforcement agencies.

“We will not allow the economic opportunities offered by legal cannabis to be exploited by unlicensed entities,” the mayor said at a news conference.

Bank reform put on hold

For the third time this year, the Secure and Fair Enforcement Banking Act, also known as SAFE, hit a brick wall in Congress after lawmakers barred it from a $1.7 trillion government-funded bill. The measure would have strengthened the legal cannabis industry by allowing licensed businesses access to traditional banking services.

Under federal law, banks and credit unions are prosecuted and penalized nationwide for providing services to legal cannabis businesses because it is still a Schedule I substance along with heroin and LSD. Schedule I substances are defined by the Federal Drug Enforcement Administration as drugs with no currently accepted medical use and with a high potential for abuse.

Without access to traditional banks, legal marijuana businesses are forced to operate with cash only, and they don’t have access to credit, capital, or even the use of basic bank accounts.

“Unfortunately, this is a win for the illegal market that pays no taxes and has no regulations or audit assurances,” said Boris Jordan, co-founder and chief executive officer of Curaleaf.

Jordan said the “entire industry will suffer.”

The SAFE bill, which has garnered some bipartisan support, must be reintroduced during next year’s session of Congress, when Republicans take control of the House of Representatives.

Executives like Brady Cobb, CEO of Sunburn Cannabis, said the way forward is “a bit murky given the new political makeup of the chambers.”

sticker shock

Consumers often turn to the black market for weed because they can get a better deal there, said cannabis tax attorney Jason Klimek. He has advised various cannabis companies and is currently the Chair of the Tax Committee of the Cannabis Law Department of the New York State Bar Association.

Klimek authored a study of New York’s cannabis taxes that predicts that legal cannabis in the state is likely to double in price due to high state and federal taxes.

He said the high price of legal weed in New York will “cause legal adult cannabis use to be so much more expensive than the illegal market,” leaving consumers with “sticker shock.” He said look no further than California, for example, where high taxes and competition from unlicensed companies are still a problem for the legal industry six years after their inception.

“California is being decimated by its illicit market, which is thriving because legal products are more expensive, more regulated, and taxed more,” he said. “They just couldn’t keep up.”

Some relief came in July when Gov. Gavin Newsom lowered the state crop tax, which offered a lifeline to small farmers. But high taxes are still hampering the introduction of the regulated market. Marijuana sold at California retailers carries an excise tax of 15%, a state sales tax of 7.25%, and local taxes of up to 15%.

Marijuana for sale at the Freedom Festival marijuana fair on Wednesday, April 20, 2022 in Bensenville, Illinois.

Erin Hooley | Tribune News Service | Getty Images

“While tax generation from the legal side is a critical component of the current legal model, we also need to balance this with sensible regulations and realistic tax structures,” said Lindsay Robinson, executive director of the California Cannabis Industry Association.

In 2021, California had more than $1.2 billion in marijuana tax revenue, according to the Motley Fool. 60% of this revenue goes to anti-drug programs for children, 20% to environmental programs and 20% to public safety.

Robinson worries that legal businesses will be “taxed out of existence” with California’s current tax structure.

In New York, legal marijuana will include a 13% retail tax and a tax based on the potency level of tetrahydrocannabinol, or THC, the psychoactive component of marijuana.

Klimek said if New York is to establish the lucrative, equitable legal market, that tax structure may need to be revised so in-store sticker prices don’t turn customers away.

He also said the state should take the step of incorporating illegal operators into its new legal system, something the New York City Bureau of Cannabis Management agrees with.

“We recognize that those who have sold in the past most likely have great business skills that can be applied in our market,” said Knowles, press secretary for OCM. “We have always been committed to ensuring that those who have had to sell illegally in the past continue to have the opportunity to do so in the future.”

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