The 2017-18 Budget: The Governor's Cannabis Proposals

The 2017-18 Budget: The Governor’s Cannabis Proposals MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • FEBRUARY 2017 2017-18 BUDGET 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET EXECUTIVE SUMMARY Regulation of Cannabis Has Been Evolving Proposition 215 Legalized Medical Cannabis. In 1996, voters approved Proposition 215, which legalized the use of medical cannabis in California. However, the measure did not create a statutory framework for regulating or taxing it at the state or local level. In 2015, the Legislature passed the Medical Cannabis Regulation and Safety Act (MCRSA) to provide a statutory framework for the state to regulate medical cannabis. MCRSA (as amended by the 2016-17 budget package) requires specified state agencies—including the Department of Consumer Affairs (DCA), Department of Public Health (DPH), and California Department of Food and Agriculture (CDFA)—to regulate and license the medical cannabis industry. Proposition 64 Legalized Nonmedical Cannabis 20 Years Later. In November 2016, voters approved Proposition 64, which legalizes the nonmedical use of cannabis. Proposition 64 also creates a statutory framework for the state to regulate nonmedical cannabis. Specifically, the measure requires state agencies to regulate and license the nonmedical cannabis industry and gives the agencies responsibilities similar to those established under MCRSA for medical cannabis. Proposition 64 also includes taxation provisions for both medical and nonmedical cannabis to be administered by the Board of Equalization (BOE). Governor’s Budget Proposal Budget Includes $51 Million for Implementation Activities in 2017-18. The Governor’s budget proposes a total augmentation of $51.4 million in 2017-18 across four departments (DCA, DPH, CDFA, and BOE) and about 190 positions across these departments to implement MCRSA and Proposition 64. The budget-year funding would mainly support (1) licensing and enforcement programs in DCA and CDFA, (2) development and implementation of licensing and “track and trace” information technology (IT) systems, and (3) tax administration activities in BOE. The budget also proposes a General Fund loan of up to $62.7 million in 2017-18 to help fund these activities. Furthermore, the administration’s budget proposal includes funding and positions in future years, with funding decreasing to $32.1 million and staffing increasing to 219 positions in 2020-21 and ongoing. Governor Will Propose Bill to Align MCRSA and Proposition 64. While there are many similarities between the statutory frameworks of MCRSA and Proposition 64, there are also some key differences between the laws. The administration indicates it plans to propose budget trailer legislation that will align MCRSA and Proposition 64. At the time this analysis was prepared, the administration had not provided the Legislature with a draft of its proposed statutory changes. LAO Assessment The Legislature will face an important policy choice regarding the degree to which it wants to align the statutory frameworks of MCRSA and Proposition 64. We believe that it makes sense to www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET align the state’s regulations. The Legislature’s authority to amend regulatory structures depends on the nature of the changes the Legislature proposes to make. While the Legislature has significant authority to amend the regulatory structures for medical and nonmedical cannabis, its authority to modify MCRSA is broader than for Proposition 64. We note that decisions about this statutory alignment will be important in determining the level of staffing and other resources needed to implement the two measures. We find that there is significant uncertainty regarding the resource needs for departments to regulate and tax medical and nonmedical cannabis. This lack of clarity stems from various factors including uncertainty regarding (1) the specific details of future regulations, (2) the number of applicants that will seek licenses from the state and the associated workload, (3) the ongoing costs for new IT systems, (4) when departments will be able to fully implement licensing programs, and (5) the future federal stance towards states legalizing cannabis use. We also find that the General Fund loan is larger than necessary to cover proposed expenditures and maintain a reasonable fund balance. LAO Recommendations We recommend the Legislature work with the administration to enact legislation to align the regulation of medial and nonmedical cannabis to the maximum extent possible. We further recommend that the Legislature make its decisions on the extent to which it wants to align the regulatory structures for medical and nonmedical cannabis before making its decisions on the Governor’s requested funding and related positions. Doing so could better enable the Legislature to provide funding and staffing levels consistent with the ultimate regulatory structure. In addition, given the high level of uncertainty regarding the resource needs that will be required in the future to regulate cannabis, we recommend taking a more incremental approach to budgeting for departments that are requesting resources in 2017-18. Under our proposed approach, the Legislature would fully fund departments’ budget requests in 2017-18, but in some cases less funding would be provided in subsequent years. This incremental approach would allow the Legislature to re-evaluate resources as part of the 2018-19 budget process when additional information is available on actual workload. (To the extent that the Legislature enacts legislation to align MCRSA and Proposition 64, our recommended funding levels may need to be revised.) Once the Legislature determines its preferred level of funding for 2017-18, we recommend it tailor the size of the General Fund loan to meet those needs, without providing a bigger than necessary loan. We also recommend the Legislature require an annual report on implementation and outcomes. This type of report would both facilitate legislative oversight and help inform subsequent decisions for how best to implement future stages of the cannabis regulatory system. 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET INTRODUCTION While voters legalized the use of medical various agencies charged with regulating and cannabis in California in 1996, the state did not taxing the cannabis industry. create a regulatory framework for medical cannabis This report is intended to help guide the until the Legislature approved the Medical Legislature through these important decisions. Cannabis Regulation and Safety Act (MCRSA) We begin by providing background information in 2015. Prior to the act, most regulation of on MCRSA, Proposition 64, and the funding medical cannabis was left to local governments. In that the Legislature provided in 2016-17 to begin November of 2016, voters approved Proposition 64, implementation of MCRSA. Next, we summarize which legalized and created a regulatory framework the Governor’s 2017-18 budget proposals for for the nonmedical use of cannabis. four regulatory agencies with responsibility In the coming year, the Legislature will face key over cannabis. Finally, we assess the Governor’s choices about whether it wants to make statutory proposals and provide recommendations to the changes to bring the regulatory frameworks of Legislature as it faces these key decisions about MCRSA and Proposition 64 into greater alignment. implementing a regulatory structure for medical Additionally, the Legislature will need to determine and nonmedical cannabis. the staff and other resources to provide to the BACKGROUND Regulation of Medical Cannabis and Chapter 719 [SB 643, McGuire])—known collectively as MCRSA—to provide a statutory Proposition 215 Legalized Medical Cannabis. framework for the state to regulate medical cannabis. In 1996, voters approved Proposition 215, which As shown in Figure 1 (see next page), MCRSA legalized the use of medical cannabis in California. (as amended by the 2016-17 budget package) However, the measure did not create a statutory requires specified state agencies to regulate the framework for regulating or taxing it at the state medical cannabis industry. For example, it gives or local level. For most of the past two decades, the (1) Department of Consumer Affairs (DCA) medical cannabis has mainly been regulated and the authority to license distributors, transporters, taxed by local governments through ordinances dispensaries, and testing laboratories; (2) California and permit requirements. While the state largely Department of Food and Agriculture (CDFA) the did not regulate medical cannabis, it did collect authority to license cultivators; and (3) Department sales tax on these products. Local jurisdictions of Public Health (DPH) the authority to license throughout the state have imposed restrictions on manufacturers of cannabis-related products (such the cultivation and sale of medical cannabis or in as baked goods). (As we discuss later, the 2016-17 some cases banned it entirely. budget package transferred oversight over medical MCRSA Created the Regulatory Framework cannabis testing laboratories from DPH to DCA.) for Medical Cannabis. In 2015, the Legislature MCRSA established a target date of January 1, 2018 passed three state laws (Chapter 688 [AB 243, for accepting license applications. Wood], Chapter 689 [AB 266, Bonta], www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET Figure 1 Medical Cannabis Industry to Be Regulated by Multiple State Agencies Under MCRSA Regulatory Agency Primary Responsibilities Department of Consumer Affairs (DCA) • License distributors, transporters, dispensaries, and testing laboratories.a Department of Food and Agriculture • License cultivators. • Implement track and trace information technology system. Department of Public Health (DPH) • License manufacturers. Department of Fish and Wildlife • Monitor and reduce environmental impacts of cultivation. State Water Resources Control Board • Regulate water-related impacts of cultivation. Department of Pesticide Regulation • Develop pesticide use guidelines for cultivation. a Responsibility for medical cannabis testing laboratories was transferred from DPH to DCA pursuant to Chapter 32 of 2016 (SB 837, Committee on Budget and Fiscal Review). MCRSA = Medical Cannabis Regulation and Safety Act. Regulatory agencies are also required to set development of licensing IT projects and for CDFA’s standards for the labelling, quality testing, and track and trace project. Third, the budget included packaging of medical cannabis products. MCRSA resources for the Department of Fish and Wildlife further requires the establishment of an information and State Water Resources Control Board to reduce technology (IT) system that uniquely identifies the environmental impacts of cannabis cultivation— cannabis plants and enables licensing authorities such as on water quality and instream flows needed to track cannabis through the distribution chain for fish spawning and migration. Fourth, the budget (commonly referred to as “track and trace”). included an additional loan of $19 million (in Additionally, MCRSA authorizes state departments addition to the $10 million authorized in MCRSA) to establish licensing fees to cover regulatory costs. from the General Fund to the MCF to cover costs These fees are to be deposited into a new state associated with implementing MCRSA. (The fund, the Marijuana Control Fund (MCF). MCRSA Governor’s 2017-18 budget assumes an additional authorizes a $10 million loan from the General Fund $11.5 million loan in the current year to implement to the MCF to pay for initial activities associated CDFA’s IT projects.) with implementing the legislation. The 2016-17 budget package also included 2016-17 Budget Provided Resources to legislation—Chapter 32 of 2016 (SB 837, Committee Implement MCRSA. The 2016-17 budget provided on Budget and Fiscal Review)—that made various a total of $33.1 million and 134 positions to six state statutory changes, including shifting authority to departments in 2016-17 to implement MCRSA. license medical cannabis laboratories from DPH to Figure 2 summarizes the various proposals DCA. approved and their out-year effects. First, the Legalization and Regulation of budget included funding—primarily for DCA and Nonmedical Cannabis DPH—to develop and implement regulations for different parts of the medical cannabis industry. Proposition 64 Legalized and Created a Second, the budget included a total of $8 million for Regulatory Framework for Nonmedical Cannabis. DCA ($6 million) and CDFA ($2 million) to begin In November of 2016, voters approved Proposition 64, 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET which legalizes the nonmedical use of cannabis. dispensaries), and a new license category Under Proposition 64, adults 21 years of age or called microbusinesses. (Microbusinesses older can legally grow, possess, and use cannabis for can engage in cultivation of less nonmedical purposes, with certain restrictions. than 10,000 square feet, distribution, Proposition 64 also creates a statutory manufacturing, and retailing.) framework for the state to regulate nonmedical • Expands CDFA’s track and trace IT system cannabis. Specifically, the measure requires state developed under MCRSA to include agencies to regulate and license the nonmedical cannabis for nonmedical use. cannabis industry and gives them responsibilities similar to those established under MCRSA for • Requires each licensing agency to charge medical cannabis. For example, for nonmedical fees to cover its regulatory costs for cannabis, the measure: nonmedical cannabis. • Authorizes CDFA to license cultivators. • Requires licensing agencies to begin issuing • Charges DPH with licensing testing licenses by January 1, 2018. laboratories and manufacturers, consistent Local Jurisdictions May Pass Ordinances to with MCRSA as originally adopted. Regulate Nonmedical Cannabis. Proposition 64 states that the measure is not intended to limit the • Authorizes DCA to license distributors, authority of local jurisdictions to adopt and enforce retailers (similar to medical cannabis Figure 2 Summary of Previously Authorized Funding and Positions for MCRSA Implementation (Dollars in Millions) Funding Authorized 2018-19 and Department 2015-16 2016-17 2017-18 ongoing Consumer Affairs $1.6 $9.7 $4.0 $0.5 Food and Agriculture 3.3 5.4 3.4 3.4 Public Health 0.5 3.9 2.5 5.7 Fish and Wildlife — 7.7 5.8 5.8 State Water Resources Control Board — 5.7 6.7 5.7 Pesticide Regulation — 0.7 0.7 0.7 Totals $5.3 $33.1 $23.1 $21.7 Positions Authorized Consumer Affairs 9.7 33.0 33.0 33.0 Food and Agriculture 5.5 18.0 18.0 18.0 Public Health 6.0 14.0 16.0 37.0 Fish and Wildlife — 31.0 31.0 31.0 State Water Resources Control Board — 35.0 35.0 35.0 Pesticide Regulation — 3.0 3.0 3.0 Totals 21.2 134.0 136.0 157.0 MCRSA = Medical Cannabis Regulation and Safety Act. www.lao.ca.gov Legislative Analyst’s Office 7 2017-18 BUDGET their own local ordinances to regulate nonmedical MCRSA and Proposition 64 Contain cannabis businesses. This could include through Some Differing Regulatory Requirements local zoning and land use requirements, business Proposition 64 Statutory Framework Mirrors license requirements, and other requirements. MCRSA in Many Areas. In many areas, the Proposition 64 Sets Up Framework for statutory framework established by Proposition 64 Taxation. Proposition 64 includes taxation mirrors the one established by MCRSA to regulate provisions for both medical and nonmedical medical cannabis. For example, as mentioned cannabis to be administered by the Board of above, the measure gives state agencies similar roles Equalization (BOE). Specifically, Proposition 64 to those assigned by MCRSA. Additionally, some imposes new excise taxes on (1) each ounce of the licenses established under Proposition 64— of cannabis grown and (2) the retail price of such as those for small- and medium-size cannabis products sold. Additionally, the sale cultivators—are identical to the licenses established of medical cannabis, which had been subject under MCRSA in terms of size limitations. to sales tax, is specifically exempted from part Some Key Differences Between MCRSA and of that tax under Proposition 64. (Based on an Proposition 64. While there are many similarities alternative interpretation of this provision, BOE between the statutory frameworks of MCRSA has implemented a full sales tax exemption.) The and Proposition 64, there are also some key measure does not change local governments’ differences between the laws. For example, there existing ability to place other taxes on medical are some differences between the types of licenses cannabis. Nor does it restrict their ability to tax they establish. Notably, Proposition 64 allows nonmedical cannabis. cultivation license types that permit cannabis Revenues collected from the new state excise grows (beginning January 1, 2023) larger than is taxes will be deposited in a new state fund, the allowable under MCRSA. As previously mentioned, California Marijuana Tax Fund. Certain fines on Proposition 64 also creates the microbusiness businesses or individuals who violate regulations license type. created under the measure will also be deposited Another key difference is in the degree to into this fund. Monies in the fund will first be which entities can control multiple steps in the used to pay back certain state agencies for any cultivation, distribution, and retail chain. For cannabis regulatory costs not covered by license example, MCRSA generally limits a medical fees. A portion of the monies will then be allocated cannabis licensee to holding state licenses for specified purposes, such as for substance use in no more than two categories. In contrast, disorder treatment and education. Proposition 64 generally allows a licensee to hold Proposition 64 Authorizes Additional General licenses in more categories. Additionally, while Fund Loans. The measure authorizes General Fund both MCRSA and Proposition 64 have distributor loans of (1) up to $30 million to the MCF for initial license categories, distributor licensees under regulatory costs and (2) $5 million in 2016-17 for MCRSA generally are required to be independent the Department of Health Care Services to provide entities that do not hold licenses in other license a public information campaign about the dangers categories. In contrast, under Proposition 64, of driving under the influence of cannabis and distributors generally can hold licenses in other the repercussions of cannabis use by minors and license categories. pregnant women. 8 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Some Changes to Proposition 64 Could recent years, the U.S. Department of Justice has Require Voter Approval. Proposition 64 allows chosen not to prosecute most cannabis users and for modifications to the framework of nonmedical businesses that follow state and local cannabis laws cannabis regulation by a majority vote of the if those laws are consistent with federal priorities, Legislature. (Modifications to Proposition 64’s such as preventing cannabis from being taken to framework for nonregulatory issues, such as other states. However, this federal policy could taxation and criminal offenses, require a two-thirds change in the future, which might affect the state’s vote of the Legislature.) Under the measure, any ability to effectively implement regulations on legislative changes must be consistent with the cannabis. Additionally, because possession or use proposition’s stated intent and further its purposes. of cannabis is illegal under federal law, cannabis In some cases, it may be unclear whether a future cultivators, manufacturers, and retailers and change to Proposition 64 would meet this criterion dispensaries typically do not have the same access and, therefore, could be enacted by the Legislature to federally regulated financial services, such as or would require voter approval. banking, that other businesses have. Accordingly, cannabis businesses often rely heavily on cash Cannabis Continues to Be transactions for their operations. Illegal Under Federal Law Under federal law, it is illegal to possess or use cannabis, including for medical use. In GOVERNOR’S PROPOSALS Proposes $51 Million in Figure 3 2017-18 for Four Summary of Governor’s 2017-18 Budget Proposals for Departments Cannabis Implementation As shown in Figure 3, (Dollars in Millions) the Governor’s budget 2020-21 and proposes a total of Department 2017-18 2018-19 2019-20 After $51.4 million from MCF Consumer Affairs $22.5 $30.9 $30.4 $30.2 Food and Agriculture 22.4 16.1 16.1 0.0 in 2017-18 across four Board of Equalizationa 5.4 2.7 2.1 2.0 departments: DCA, DPH, Public Health 1.0 0.1 -0.2 -0.2 CDFA, and BOE. The Totals $51.4 $49.8 $48.4 $32.1 budget also requests about Positions 190 positions in 2017-18 2020-21 and across these departments. Department 2017-18 2018-19 2019-20 After Figure 3 also shows how Consumer Affairs 120.0 188.0 205.0 205.0 Food and Agriculture 50.8 60.0 60.0 0.0 these funding and position Board of Equalizationa 22.0 21.3 17.4 16.9 levels are proposed to Public Health -3.0 -3.0 -3.0 -3.0 change over the next Totals 189.8 266.3 279.4 218.9 couple of years. We discuss a Budget proposal also identified $1.1 million and 1.9 positions for the Board of Equalization in 2016-17. www.lao.ca.gov Legislative Analyst’s Office 9 2017-18 BUDGET the proposals for each of these four departments in continue to implement statutory requirements for more detail below. cannabis cultivation licensing. This amount would DCA’s Proposal Funds Licensing, decrease to $16.1 million in 2018-19 and expire after Enforcement, and IT ($22.5 Million). As shown 2019-20. The funding would support the following: in Figure 3, the Governor’s budget proposes a total • IT Implementation and Ongoing of $22.5 million for DCA in 2017-18, an amount Maintenance ($16.9 Million). The budget that would grow to roughly $30 million in out requests $16.9 million and 13 positions years. The budget year funding would support the in 2017-18, decreasing to $10.5 million in following: 2018-19 (expiring after 2019-20) to develop • Licensing and Enforcement and support the cultivator licensing and ($17.4 Million). DCA requests additional track and trace IT projects. (Funding resources for licensing and enforcement includes $15.1 million in 2017-18 and of medical and nonmedical cannabis $8.7 million in 2018-19 and 2019-20 for businesses, including dispensaries/ contracted services for the cultivator retailers, microbusinesses, distributors, licensing and track and trace systems.) transporters, and testing laboratories. • Licensing and Enforcement ($5.5 Million). Specifically, the request would support The budget requests three-year 120 staff, relocation to a new headquarters limited-term funding of $5.5 million and office for DCA’s Bureau of Marijuana 34.3 permanent positions (growing to Control (BMC), laboratory testing, and 40 positions in 2018-19) for license and vehicles and equipment. Of these proposed enforcement activities related to cultivators, positions, 50 are for enforcement, 35 are for as well as one human resources support licensing, and 35 are for various support position. functions. Out-year funding includes the establishment of a total of five field offices • Measurement Standards. The budget by 2019-20. requests 3.5 permanent positions in 2017-18, growing to 7 permanent positions • IT Implementation and Ongoing in 2018-19, to enforce standards established Maintenance ($5.1 Million). DCA also by CDFA to ensure the accuracy of all requests funding to continue to implement weighing and measuring devices (such a licensing and enforcement IT project as scales) used in connection with the for medical cannabis that was initially sale or distribution of cannabis. No approved in 2016-17, as well as expand the funding is requested because revenues project to cover its nonmedical cannabis received from weighmaster license and licensees. Funding is proposed to decrease registration fees are deposited into a to $3.6 million beginning in 2018-19 continuously appropriated account within to cover the ongoing operations and the Agriculture Fund to support these maintenance costs of the project. activities. CDFA’s Proposal Funds Licensing and Track BOE’s Proposal Funds Tax Administration and Trace ($22.4 Million). The Governor’s budget Activities ($5.4 Million). The Governor’s budget proposes $22.4 million for CDFA in 2017-18 to 10 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET proposes $5.4 million for BOE in 2017-18, Other Provisions of the Administration’s decreasing to $2 million annually beginning Cannabis Proposal in 2020-21, to administer the new excise taxes Anticipate Trailer Bill Language Will Be required under Proposition 64. (The budget also Forthcoming. The administration indicates it assumes BOE spends $1.1 million in the current plans to propose 2017-18 budget trailer legislation year.) The funding would support drafting that will align MCRSA and Proposition 64. regulations; conducting outreach and education; However, at the time this analysis was prepared, the registering taxpayers; and processing payments, administration had not provided the Legislature returns, collections, and appeals. This proposal with a draft of its proposed statutory changes. Nor does not include funding for audits or enforcement, has the administration indicated what specific so it does not reflect the full ongoing cost of changes it proposes to make to bring the two pieces administering the new tax program. of law into greater conformity. One exception to DPH’s Proposal Funds IT and Redirects this is that the administration has indicated that Positions to BMC for Licensing of Testing Labs it expects to propose moving the oversight of ($1 Million). The Governor’s budget proposes a nonmedical testing laboratories from DPH to DCA, net increase of $1 million for DPH in 2017-18, an so that DCA has exclusive authority over testing amount that would decrease in future years and be laboratories. (This is consistent with the budget a net reduction to its budget of $172,000 beginning proposals discussed above.) in 2019-20. This includes the following changes: Budget Assumes Licensing Revenue but Not • IT Implementation and Ongoing Excise Tax Revenue in 2017-18. The Governor Maintenance ($1.4 Million). The projects a total of $11.5 million in revenues to Governor’s budget requests funding to the MCF from various license fees in 2017-18. In design, configure, and maintain an IT contrast, the Governor’s budget does not project application to process medical cannabis that the state will receive any excise tax revenue manufacturers’ licenses. Although DPH in 2017-18. (The administration projects excise will also be responsible for licensing tax revenues to be over $550 million in 2018-19, nonmedical manufacturers, it has not growing to over $950 million in 2021-22.) requested funding to incorporate this Governor Proposes General Fund Loan in responsibility into its IT application at this 2017-18. The Governor’s budget includes a General time. Fund loan to the MCF of up to $62.7 million in 2017-18. (The administration’s fund condition • Transfer of Testing Laboratories statement for MCF actually shows a higher (-$0.4 Million). DPH also proposes to budget-year loan amount of $78.3 million.) redirect three positions (and $410,000) This amount would be in addition to a total of from DPH to DCA for licensing medical $45.5 million projected to be loaned from the cannabis testing laboratories, consistent General Fund in 2015-16 and 2016-17, including with the transfer of authority over these the loans authorized under MCRSA ($10 million), laboratories made in the 2016-17 budget the 2016-17 Budget Act ($30.5 million), and package. Proposition 64 ($5 million). www.lao.ca.gov Legislative Analyst’s Office 11 2017-18 BUDGET LAO ASSESSMENT The Legislature will face an important result in state agencies providing more efficient policy choice regarding the degree to which services to licensees by reducing complexity. Even it wants to align the statutory frameworks of with a unified regulatory structure, the Legislature MCRSA and Proposition 64. Decisions about this could still maintain some differences between the statutory alignment will further be important regulation of medical and nonmedical cannabis in determining the level of staffing and other where doing so makes sense. For example, the resources needed to implement the two measures. Legislature could consider whether it wants to However, determining the level of resources allow higher potency limits for medical cannabis. needed in 2017-18 and beyond is complicated by Legislature’s Authority to Amend Regulatory the significant uncertainty caused by other issues, Structures Depends on Nature of Changes. As such as the future size of the cannabis industry and described above, the Governor indicates that he potential federal actions. In addition, we find that will propose changes to the regulatory structures the proposed General Fund loan that would be used for MCRSA and Proposition 64 to better align the to fund the initial implementation costs is oversized two systems. Under the California Constitution, based on the current cost estimates proposed by the the Legislature is prohibited from making changes administration. to statutes added by a voter-approved initiative (such as Propositions 215 and 64) unless the Aligning MCRSA and initiative includes provisions specifically allowing Proposition 64 Makes Sense legislative changes. Otherwise, those changes In the 2017-18 budget summary, the Governor would need to be submitted to voters. indicated that as the state moves forward with While both measures provide the Legislature the regulation of both medical and nonmedical with significant authority to amend the regulatory cannabis, one regulatory structure of cannabis structures for medical and nonmedical cannabis, activities across California is needed. Therefore, the its authority to modify MCRSA is broader than administration will provide trailer bill language to for Proposition 64. Because Proposition 215 did align the state’s cannabis regulations. The concept not establish a regulatory structure for medical of aligning the state’s regulations where feasible cannabis, the Legislature has broad latitude to makes sense. The extent to which the regulatory decide all aspects of how medical cannabis will be structures for medical and nonmedical cannabis regulated without having to submit those changes are aligned would affect the resources necessary for to voters. Thus, the Legislature is not limited by state departments to regulate the cannabis industry. Proposition 215 in enacting changes to MCRSA’s Alignment would likely eliminate some duplicative regulatory structure to align it with the provisions regulatory functions, thereby reducing government of Proposition 64. costs to implement and operate the program. In contrast to Proposition 215, Proposition 64 Alignment would also affect the regulated establishes a regulatory structure for nonmedical community. For example, a single regulatory cannabis. However, Proposition 64 also explicitly system could reduce confusion amongst licensees allows the Legislature to amend the measure. regarding regulatory requirements, and it could Under the measure’s provisions, changes would 12 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET require a majority vote, a two-thirds vote, or voter to regulate and tax medical and nonmedical approval depending on the nature of the changes. cannabis. This lack of clarity stems from various For example, legislative changes to the regulatory factors, including uncertainty in the (1) regulatory structure for nonmedical cannabis are permitted decisions regarding medical and nonmedical with a majority vote as long as they conform cannabis, (2) number of licensees and associated with the stated intent of the measure. Changes workload related to this market that has not been to the regulatory structure not deemed to be in previously regulated by the state, (3) ongoing conformance with the measure’s intent would have needs for funding new IT systems, (4) timing of to be approved by voters. implementation, and (5) federal stance on cannabis. Legislature’s Decisions About Aligning Regulatory Decisions Likely to Affect Proposition 64 and MCRSA Will Affect Resource Resource Needs. Various departments—including Needs. The Legislature’s ultimate decisions about DCA, DPH, and CDFA—are in the process of aligning the regulatory structures for medical drafting regulations to implement MCRSA and and nonmedical cannabis will affect the level of Proposition 64. These three departments have resources state agencies need to implement their indicated that they anticipate that they will programs. For example, DCA indicates that its IT complete their medical cannabis regulations in the proposal cost estimates are based on current law spring and their nonmedical cannabis regulations with two regulatory systems. It further indicates later in the year. that IT costs could decline if changes in the law Some of the decisions that are made in resulted in a consolidated regulatory framework. the regulations could have implications on Additionally, we expect that the number of entities the level of funding and positions needed to that seek licenses and therefore licensing workload implement the regulations in the future. This is could be affected by the specifics of the regulatory because the regulations will specify what types structure that is ultimately selected. For instance, of information—such as information related to the number of entities seeking distributor licenses criminal history, ownership, or residency—have would likely be affected by whether the regulatory to be provided, reviewed, and verified by the structure generally allows these licenses to be regulating agencies. The more information that is held along with other license types or not. The required will probably result in a greater level of resulting number of licensees would, in turn, have licensing staff needed for these reviews. effects on the level of resources required to regulate Licensing Workload Uncertain Given New those licensees. Once the Legislature makes key Regulatory Program. The state has not regulated decisions about which requirements of MCRSA the medical cannabis industry in the past, and and Proposition 64 to align, it will be in a better nonmedical cannabis has operated on the black position to assess the resource needs of the state market. Therefore, there is a lack of reliable agencies that will be implementing the regulatory information on the current size of the cannabis scheme. industry in California, and tremendous uncertainty about the number of licensees that will seek to be Significant Uncertainty regulated by state agencies in the future. Given Regarding Resource Needs and Timing this uncertainty, implementing agencies have We find that there is significant uncertainty taken different approaches to estimating the size regarding the resources that will be needed of the cannabis industry, resulting in workload www.lao.ca.gov Legislative Analyst’s Office 13 2017-18 BUDGET projections based on notably different estimates not account for this likely change. Accordingly, we of the licensee population. For example, BOE’s find that there is even greater uncertainty regarding budget request assumes that there will be 1,700 the DCA’s anticipated resource needs in future dispensaries/retailers remitting taxes (based years. on a study performed in 2014), while DCA’s Amount of Resources Necessary for IT Systems request assumes there will be 6,000 dispensaries/ Uncertain Given Early Project Stage. There are retailers (based on extrapolations from Colorado’s also uncertainties regarding the costs associated experience with cannabis legalization). While with creating the IT systems to regulate this new there could be different reasonable approaches to industry. Implementing departments are still in estimating the licensee population given the lack the relatively early stages of IT project development of reliable information, ideally all implementing and implementation. For example, DCA has departments should be operating under similar not yet provided the California Department of assumptions for the purposes of crafting the Technology or the Legislature with the alternatives budget. analysis—including cost-benefit analyses—of their Furthermore, the assumptions about project, information that is critical in informing licensee populations used by departments has a the Legislature on the merits of the proposed large effect on the licensing, enforcement, and approach. Additionally, DCA and CDFA have not tax administration resources requested. Thus, yet completed the selection of vendors to customize if departments’ estimates of future licensee their software solutions (known as a “Systems populations turn out to be incorrect, there could be Integrators”). We expect that future-year funding a significant impact on their resource needs. needs for the projects will become more certain as There is also uncertainty about other aspects of they proceed. the workload costs associated with each licensee. We further note that the specific ongoing For example, DCA estimates it will conduct resources requested by DCA for its IT system enforcement-related investigations on 10 percent appear inflated. For example, the department of its licensees that require testing of cannabis has identified $1.8 million in ongoing costs for products. The request assumes that it will cost system integration. However, we would expect $1,000 to test each cannabis sample. This cost that these expenses should decline after the initial estimate for testing is based on information from development is complete. the University of California, Davis. However, Timing of Expenditures Uncertain Given private testing labs reportedly charge much less Ambitious Timeline. January 1, 2018 is an than this—often less than a couple hundred ambitious timeline to begin accepting and issuing dollars—so it is unclear what the costs will be for licenses because departments must conduct this testing. environmental reviews, finalize regulations and The uncertainties about the number of guidelines, have staff in place, and set up IT systems licensees and associated workload become even in a shorter period of time than is normal for such greater in out years as the share of new versus a large and complex new regulatory program. If renewal applications would likely change compared there are delays, for example, with environmental to the initial years of regulation. We would reviews, it could make it very difficult to meet the expect renewal workload to be lower than for new January 1, 2018 implementation date. Moreover, if applications. However, DCA’s budget request does the Legislature chooses to modify the regulatory 14 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET requirements under MCRSA or Proposition 64, on an ongoing basis. In contrast, CDFA and BOE this could require departments to restart some have generally taken more modest approaches to regulatory development activities, thereby affecting requesting resources. Specifically, CDFA does not their timelines for finalizing regulations. Thus, propose significant additional resources in 2018-19 there is some uncertainty as to the extent to which beyond what it requests for 2017-18, and it requests departments will be able to begin issuing all new that all of its funding be approved on a three-year licenses by January 1, 2018. (This uncertainty is limited-term basis. Additionally, BOE’s request reflected in the administration’s estimate that there (1) assumes relatively modest workload (assuming will be no excise tax revenue from cannabis in a retailer population of only 1,700, as discussed 2017-18.) The timing of issuing new licenses will, in above), (2) seeks less funding than its workload turn, affect the amount of resources needed in the justifications would support in many cases, budget year. For example, if licensing entities are and (3) proposes limited-term funding for over significantly delayed in issuing new licenses, there 20 percent of its positions and almost two-thirds may be limited tax collections and reduced need for of its overall request. In our view, the more BOE tax administration staff in the budget year. conservative and incremental approaches taken by Federal Enforcement of Cannabis Laws CDFA and BOE are reasonable given the significant Uncertain. Existing federal policy could change uncertainty surrounding future resource needs. in the future. If the federal government decides General Fund Loan Amount Needed Will to begin enforcing federal law more stringently, Depend on Amount of Funding Approved this could affect the state’s ability to effectively implement regulations on cannabis. If operation of The administration proposes a General Fund medical and/or nonmedical cannabis businesses loan to the MCF of up to $62.7 million in 2017-18. were no longer allowed by the federal government, As shown in Figure 4, once the starting fund this would decrease the level of resources needed balance and anticipated expenditures and licensing by all of the state licensing agencies involved. The revenues are taken into account, this General Fund coming months may bring some additional clarity loan would result in an estimated fund balance at regarding whether recent leadership changes at the the end of the fiscal year of $29 million, which is federal level will bring any modifications to federal likely to be higher than necessary. Even if the state policies regarding cannabis enforcement. did not generate any license revenues in 2017-18, Departments Have Taken Various Approaches to Requests Given Uncertainty. Figure 4 Notably, departments have taken different Marijuana Control Fund (MCF) Fund Condition approaches to crafting their budget proposals (In Millions) in light of uncertainty about future workloads. 2016-17 2017-18 Some departments used more conservative Resources estimates of licensee populations and the resulting Beginning balance $6.9 $17.5 workload, and in some cases, departments took License revenues — 11.5 General Fund loans 35.5 62.7a an incremental approach of phasing in funding Expenditures -24.8 -62.7 over a couple of years. For example, DCA phased Fund Balance $17.5 $29.0 in its funding request over a three-year period. a Based on budget bill. Administration’s fund condition statement for MCF shows a higher loan amount of $78.3 million. DCA further requests the majority of its resources www.lao.ca.gov Legislative Analyst’s Office 15 2017-18 BUDGET the MCF would have a projected balance in the the future (such as for increased IT costs). In our fund of $17.5 million, almost 30 percent higher view, it is reasonable for the General Fund loan to than total estimated expenditures in 2017-18. The be of an amount that provides sufficient funding for administration indicates that the high loan amount proposals in the event that revenues are lower than was to provide financial flexibility in the event that anticipated. Beyond that, a large fund balance is not it decided to propose additional expenditures in likely to be needed. LAO RECOMMENDATIONS Create One Regulatory over the next few months, the Legislature could Structure of Cannabis Activities get more information that will assist it in making its budgeting decisions, such as progress in We recommend the Legislature work with the implementing regulations and IT systems, as well administration to enact legislation to align the as potentially some additional clarity on the federal regulation of medical and nonmedical cannabis to government’s approach to cannabis. the maximum extent possible. The administration’s approach of creating one regulatory structure of Limit Funding Provided for Out-Years cannabis activities makes sense because it would Given the high level of uncertainty regarding likely eliminate some duplicative regulatory the resource needs that will be required in the functions and reduce confusion among licensees. future to regulate cannabis, we recommend taking For example, there are currently two departments a more incremental approach to budgeting for (DCA and DPH) charged with regulating testing these departments by authorizing certain budget laboratories. In our view, it makes more sense requests on a limited-term basis. This approach for a single department to perform this licensing is reflected in Figure 5, which compares the function. In addition, licensees that want to Governor’s proposed funding amounts to our participate in both medical and nonmedical recommended funding amounts. (In some cases, activities could face confusion in an unaligned our recommended funding amounts reflect our system because they would face different rules estimates based on available information.) Under under the two sets of regulations. our proposed approach, departments would be Make These Policy Choices Before Making budgeted as proposed in 2017-18, but in some cases Budget Decisions. To the extent possible, before receive less funding than requested in subsequent making its decisions on the Governor’s requested years. This incremental approach would allow funding and related positions, we recommend that the Legislature to re-evaluate resources as part the Legislature make its decisions on the extent to of the 2018-19 budget process when additional which it wants to modify the provisions of MCRSA information is available on actual workload. In a and Proposition 64 to better align the regulatory few cases—such as for BOE and CDFA’s non-IT- structures for medical and nonmedical cannabis. related request—we recommend providing the Doing so could better enable the Legislature to multiyear funding requested because we either find provide the funding and staffing levels consistent it to be critical or the department’s estimates are with the ultimate regulatory structure. In addition, 16 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET clearly based on conservative assumptions. (We • Share of DCA’s 2017-18 Licensing and note that these recommendations assume that the Testing Costs. We recommend approving a current statutory framework remains in place and portion of the funding requested by DCA might need to be revised if the Legislature enacts in 2017-18 on a two-year limited-term legislation to align MCRSA and Proposition 64.) basis. Given DCA’s relatively high The specific proposals that we recommend assumption about the number of licensees modifying to be limited term are described below. in 2017-18, we recommend making a • All IT-Related Funding. We recommend share—20 percent—of its licensing and support staff funding limited term. This approving all of the IT funding requests would be consistent with the share of its for 2017-18, but reject proposed funding enforcement staff that DCA proposes to in the out years. Next year, we anticipate fund on a limited-term basis. Furthermore, that better information will be available to while DCA will very likely have ongoing assess future IT costs because departments enforcement-related testing costs, we will have selected systems integrators, recommend funding these costs on a and the new IT systems should be largely two-year limited-term basis rather than an complete. At that point, departments will ongoing basis at this time given the level of have a better sense of additional work uncertainty regarding future-year costs. needed to ensure the IT systems have the desired functionality, as well as the • None of DCA’s Licensing and Enforcement necessary costs to operate and maintain Out-Year Requests. We also recommend their IT systems. This approach would denying requests for future increases in provide the additional benefit of giving the DCA’s licensing and enforcement request Legislature an opportunity to use future at this time. While the department budget hearings to oversee the projects and might need to increase its licensing and ensure that they remain on-track. We note enforcement activities over time (for that this oversight is particularly important example, to staff the new proposed field for DCA given its recent challenges with offices), it is too early to tell what DCA’s successfully managing the BreEZe IT ongoing level of resource needs will be. project. Figure 5 Summary of Governor’s and LAO’s Recommendations for Funding Cannabis Implementation (In Millions) 2017-18 2018-19 2019-20 2020-21 and After Department Governor LAO Governor LAO Governor LAO Governor LAO Consumer Affairs $22.5 $22.5 $30.9 $18.6 $30.4 $13.3 $30.2 $13.3 Food and Agriculture 22.4 22.4 16.1 5.5 16.1 5.5 — — Board of Equalization 5.4 5.4 2.7 2.7 2.1 2.1 2.0 2.0 Public Health 1.0 1.0 0.1 -0.4 -0.2 -0.4 -0.2 -0.4 Totals $51.4 $51.4 $49.8 $26.4 $48.4 $20.5 $32.1 $14.9 www.lao.ca.gov Legislative Analyst’s Office 17 2017-18 BUDGET Reduce General Fund Loan to data to indicate how well programs are functioning. Reflect Actual Budget Actions This might include, for example, the average amount of time to process licenses and to complete Once the Legislature determines its preferred formal discipline actions against licensees. In our level of funding for 2017-18, we recommend it view, this requirement would not constitute much tailor the size of the General Fund loan provided of an administrative burden for administering to the MCF to meet those needs, without providing departments because the information contained in a bigger than necessary loan. For example, if the the report would be data that departments should Legislature were to approve the Governor’s current be collecting anyway. requests for 2017-18, we would recommend that We recommend that this report be required the Legislature reduce the Governor’s proposed for each of the next five years, at which time General Fund loan by $17.5 million—from we would expect that the programs would be $62.7 million to $45.2 million. This would leave fully implemented. Until that time, however, an estimated reserve in the MCF of $11.5 million, such a report would provide the Legislature and which would provide sufficient funds to cover all stakeholders with a consolidated, single source of projected costs even if the state collected lower information on the implementation of MCRSA license revenues than projected in 2017-18. and Proposition 64. This type of report would Require Additional Reporting on both facilitate legislative oversight and help inform Implementation of subsequent decisions for how best to implement Cannabis Regulatory Programs future stages of the cannabis regulatory system. Moreover, such information could help shape Annual Report on Implementation and future cannabis policy by providing information Outcomes. We recommend the Legislature that would illuminate how well different aspects of enact legislation to require the administration the programs are working. to submit a report by April 1 of each year on the Quarterly Briefings on IT Projects. We implementation of MCRSA and Proposition 64. recommend the Legislature adopt budget bill This report should summarize department language to require the departments implementing activities and program outcomes. Specifically, we new cannabis-related IT projects—DCA, CDFA, recommend that this report include data on (1) the and DPH—to provide legislative staff with activities each regulatory department expects to quarterly briefings on the status of these projects. complete in the coming year, such as the number It is important for the Legislature to have the of licenses that will be issued and the number information necessary to monitor the projects of inspections that will be performed; (2) the given the implementation challenges inherent in actual number of these activities completed in the developing and implementing large new IT projects past year; and (3) program outcomes. Outcomes in an expedited time frame. reporting should include measurable performance 18 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET www.lao.ca.gov Legislative Analyst’s Office 19 2017-18 BUDGET LAO Publications This report was prepared by Helen Kerstein and Shawn Martin—with assistance from Seth Kerstein and Sonja Petek— and reviewed by Brian Brown. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 20 Legislative Analyst’s Office www.lao.ca.gov