California's medical marijuana regulations may cause some growers pain

As California prepares to bring in the $1 billion medical marijuana industry from the legal shadows, growers and marketers on the pot-rich North Coast are waiting to see how much the massive regulatory structure will cost them and whether to stick instead with the prosperous but risky outlaw status they have lived with for nearly two decades.

The regulatory scheme, which will cost up to $50 million, must be funded entirely by license fees paid by the industry, while new taxes on the cannabis trade - which some advocates say is one of Sonoma County’s major industries - offer the prospect of millions of dollars to help pay for paving roads, hiring police and other public services.

Investors have taken note of the imminent regulation of California’s cannabis industry, which accounts for nearly half of the nation’s booming $2.7 billion market in legal cannabis, according to one report.

But the rosy financial forecasts - along with the prospects of enhanced public safety, cannabis consumer protection and reduced environmental damage seen as the benefits of regulation - may fall short if growers, manufacturers, dispensaries and others engaged in the business decide the costs are prohibitive.

“There will be resistance,” said Tawnie Logan of Santa Rosa, executive director of the 200-member Sonoma County Growers Alliance.

The vast majority of growers, distributors and cannabis manufacturers want to gain the safety and security of licensing, she said, but it’s a “painful transition” for those who’ve been operating by their own rules in an all-cash, bank- and tax-free business for nearly 20 years.

Logan, a cannabis and conventional crop farmer who has two daughters, likened the process to a child raised by permissive parents encountering the structures and demands of college life. “You would expect rebelliousness,” she said.

A $10,000-a-year local permit fee, which Logan said she has seen in proposals, would be reasonable for an established dispensary or a farmer cultivating 5,000 square feet of cannabis, she said. But that fee would be problematic for farmers of 500 to 1,000 square feet, whose revenues are far lower. The lowest-level state licenses cover operations up to 5,000 square feet, and Logan suggested that cities and counties might offer micro-permits for farms below 1,000 square feet.

A legislative analyst’s report, which pegged the state’s regulatory costs at $20 million to $50 million a year, estimated annual license fees of $4,000 to cover the more conservative cost, assuming 5,000 annual applications.

Hezekiah Allen, executive director of the 500-member California Growers Association, estimated the total cost of grower compliance with state and local regulations at $50,000 over three years, which he said was “pretty stiff” for many North Coast growers.

A survey of 200 growers conducted at last year’s Emerald Cup, a public marijuana competition in Santa Rosa, found that 85 percent of growers were cultivating less than 10,000 square feet. A typical 10,000-square-foot operation consists of four greenhouses measuring 30 feet by 80 feet.

Growers overall averaged a net household income of just over $100,000, about 30 percent of gross revenue in a high-cost industry, according to the survey.

“If we overtax this market, it will stimulate unregulated black market activity,” said Allen, an industry advocate who was actively engaged in crafting the new law, called the Medical Marijuana Regulation and Safety Act, signed by Gov. Jerry Brown last month.

State Sen Mike McGuire, D-Healdsburg, who authored one of three bills that were consolidated under the law, said it is “the most comprehensive regulation” on medical marijuana in the nation.

It was also long overdue, he said, noting that medical marijuana - authorized by voters as Proposition 215 in 1996 - had gone largely unregulated since then, while the use of cannabis to relieve illness “exploded across California and throughout the nation.”

Since much of the country’s marijuana is grown in his North Coast district, McGuire said the issue is personal, and he acknowledged the importance of not pricing cannabis businesses out of the regulated market.

“If it’s too expensive, people won’t bother,” he said. “For 20 years, no one has paid a dime for licensing.”

Based on the record of legalizing recreational pot in Colorado and Washington, McGuire said he determined that 35 percent is the “sweet spot” for sales taxes. He plans to introduce a bill next year establishing a 15 percent statewide retail sales tax on medical cannabis, which would yield up to $195 million and be assessed on top of current sales taxes that run about 8 percent.

Dispensary sales are subject to the existing taxes, but go largely unpaid. The state Board of Equalization collected $44 million in sales taxes from dispensaries last year and estimates that only 25 percent to 30 percent of the sellers are making the required payments, said Tim Morland, legislative director for board member Fiona Ma. The overall sales tax compliance rate is 98 percent, he said.

Sales tax revenue goes into state and local government general funds, while permit and license fees can only be used to cover the direct costs of administration, such as issuing licenses. The new law gives local governments the right to assess fees and taxes, and requires that state license applicants must first obtain a city or county permit.

On top of taxes and fees, cannabis businesses also must shoulder typical business costs, such as workers’ compensation and payroll taxes.

Robert Jacob, owner of the Peace in Medicine dispensaries in Santa Rosa and Sebastopol, said he operates at a competitive disadvantage to businesses that are not meeting all their financial obligations. But it’s worthwhile, he said, because obeying all the rules allows him to serve on the Sebastopol City Council and openly represent his industry.

Medical cannabis advocates say most operators are eager to gain the security and safety afforded by state licensing, including immunity from local prosecution. Since the law was enacted, local law enforcement is already shifting away from a “raid first and ask questions later” approach to marijuana cultivation, said Logan, of the growers alliance.

There is, of course, no absolute guarantee against prosecution as long as marijuana remains prohibited under federal law. The Obama administration has said that states with “strict regulatory schemes” will not face federal action, but Allen noted that a new president will take office while California is implementing its cannabis regulations.

Advocates also are urging local officials to take advantage of licensing marijuana businesses and reaping the cash rewards.

“I really believe we have an economic emergency,” Jacob said, asserting that cannabis is Sonoma County’s major agricultural product, exceeding wine grapes.

Should they decline to allow the cultivation, manufacture and sales of marijuana, the county and cities would jeopardize the contribution of a strong but largely silent economic sector, Jacob said.

It’s time for cannabis businesses to “come out of the closet” and make their presence known, he argued.

Sonoma County is a “hub of innovation” in the cannabis industry, which has been “part of this county for decades,” said Joe Rogoway, a Santa Rosa attorney who specializes in marijuana law. Banning commercial marijuana cultivation would be “saying no to millions of dollars” that could pour into local government coffers, he said.

There’s more to the market than neatly trimmed flowers. Edibles, oils and compounds now make up nearly one third of medical cannabis consumption, and some patients say that smoking is passe, advocates said.

Under the new law, local governments can either permit cannabis businesses or ban them, which would preclude state licensing. If cities and counties adopt no regulations, they lose control and the authority for permitting reverts to the state.

Dispensaries are currently allowed in Santa Rosa, Sebastopol and Cotati, as well as the unincorporated area governed by the Board of Supervisors. An online search reveals six dispensaries listed in the county - four in Santa Rosa and one each in Sebastopol and Cotati.

No local jurisdiction allows commercial cultivation of marijuana. The new state law establishes 17 license types, including 10 for cultivation (subdivided by size of the plot and the means of lighting), as well as manufacturing, testing, dispensing and transporting cannabis.

Board of Supervisors Chairwoman Susan Gorin was noncommittal about the county’s intentions under the new regulations.

“Now, it’s a question of where we want to go,” she said. “I see this as an appropriate avenue for discussion.”

While some county officials already are talking about ways to spend a possible tax windfall, Gorin said the board needs to address concerns such as the prospect of pungent marijuana plants blooming in neighborhoods.

Santa Rosa City Attorney Caroline Fowler said she intends to start discussing marijuana issues, including commercial cultivation and manufacturing, at the council’s Dec. 1 meeting.

Meanwhile, capitalists are well aware of what’s transpiring here.

A glossy, full-color brochure by ArcView Market Research says the legal cannabis industry grew by 74 percent to reach $2.7 billion in sales nationwide in 2014, with California accounting for 49 percent of a market that is expected to continue growing as more states legalize medical and recreational marijuana.

“These are exciting times, and new millionaires and possibly billionaires are about to be made, while simultaneously society will become safer and freer,” Troy Dayton, ArcView Group CEO, said in the report. ArcView’s website declares that cannabis is “the next great American industry.”

State officials will begin work Jan. 1 on a two-year effort to develop the regulations outlined in the new law, including a “seed to sale” system for tracking cannabis production, mandatory testing and labeling for consumer safety and health inspections of cannabis bakeries.

“This is going to be a herculean task,” said Morland of the sales tax board, admitting that state regulators have “no idea how this industry works.”

Ultimately, cannabis growers need to decide where to stand.

Many are “tired of living in fear” and will seek the shelter and certainty of regulation, said Ruby Steinbrecher, a Sebastopol attorney and a cannabis farmer, like her parents.

Others will remain in the black market.

“There are folks out there who do this because they like that outlaw lifestyle,” Steinbrecher said. “They don’t trust the government; they want to stay out of the system.

“It’s a big cultural shift right now.”

You can reach Staff Writer Guy Kovner at 521-5457 or guy.kovner@pressdemocrat.com. On Twitter @guykovner.