As San Diego’s cannabis tax revenue plummets, officials blame illegal market, new competition

Inflation may be driving customers to illegal delivery services, which can charge less because of lower overhead, fewer regulations.

BY DAVID GARRICK FEB. 14, 2023 5 AM PT

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SAN DIEGO —

Revenue from San Diego’s cannabis tax has been dropping sharply in recent months as the city’s two dozen dispensaries face growing competition from delivery services and new dispensaries in other nearby cities.

San Diego officials say they now expect cannabis tax revenue to be 23 percent lower than they had previously expected during the ongoing fiscal year that ends June 30 — $19.8 million versus $25.7 million.

Industry leaders say the primary cause of their “double-digit” drops in sales is illegal delivery services, which they estimate make up about half of the region’s cannabis market.

“The legal industry is facing huge competition from the non-legal industry,” said Phil Rath, executive director of a group of dispensaries called the United Medical Marijuana Coalition. “Delivery services are an ongoing enforcement challenge for the city.”

City officials say another factor is that several other local cities, including Chula Vista and La Mesa, have been starting to allow legal dispensaries after years of banning them.

“Up until recently, we had a monopoly,” said Ricardo Ramos, the city’s deputy director of business operations. “Now we’re competing with all these other jurisdictions.”

Officials have also lowered their long-term projections for cannabis tax revenue, which has been expected to pay for enforcement of dispensaries and a new cannabis equity program that aims to give a leg up in the industry to people of color adversely affected by the war on drugs.

Just over a year ago, long-term estimates for cannabis tax revenue were projected at $31.5 million in fiscal year 2025, $33.3 million in fiscal 2026 and $33.8 million in fiscal 2027.

In November, those were revised down to $26 million in fiscal 2025, $28.4 million in fiscal 2026 and $28.9 million in fiscal 2027. But city finance officials say they aren’t confident even in those revised estimates.

“It is likely that the overall level of revenue from the cannabis business tax is too high,” finance officials said in the city’s five-year financial outlook published in November, citing rising retail competition from other cities.

Other factors could be inflation or too many cannabis businesses for too few customers.

“There’s just a saturation of cannabis products, which has brought down the cost,” Ramos said. “As a result, the tax and gross receipts that are being reported to the city has decreased.”

Rath said lower-priced cannabis products have been selling much better than higher-priced products in recent months, a trend he blames on inflation leaving some customers with less money to spend on cannabis.

“It’s like people buying generic ketchup,” said Rath, adding that he’s unsure if things will bounce back when inflation eases. “Consumers sometimes get accustomed to their purchase patterns.”

Rath said inflation has also likely spurred more customers to shift to illegal delivery services, which he said sell their products for roughly 30 percent less than legal cannabis businesses because they have lower overhead.

“I’m hearing from retailers that sales are down in the double digits,” he said. “It’s got to be the illegal market. People didn’t just stop consuming.”

Customers who buy from legal cannabis businesses can have higher confidence the products are safe and don’t contain mold because state law requires testing, but Rath said inflation may be prompting people to take more risks.

The illegal market within the city of San Diego shifted almost entirely to delivery services more than five years ago when an aggressive city enforcement effort shut down dozens of illegal cannabis dispensaries.

San Diego only allows deliveries from cannabis businesses that also have a storefront. But Rath and Ramos noted that state law allows jurisdictions to approve delivery-only businesses and that those businesses can sell products anywhere in the state.

Rath said some delivery services from Orange County serve San Diego, which he called unfair competition for local dispensaries.

San Diego last year reduced the tax rate from 8 percent to 2 percent for indoor pot farms and factories that make cannabis edibles. But city officials said that is not a big factor in the drop in tax revenue, because 97 percent of that revenue comes from dispensaries.