In the marijuana business? It’s complicated

Medical marijuana grower Brendan Howley inspects marijuana hung to dry at a facility he operates with his business partners. 1/2013 Credit: Tom James/Crosscut

Dean and Marsha don't look like your average criminals.

Both in their sixties, the pair is warm and genuine, reminiscing over their younger days and telling stories of their grown children. In their well-kept, modest rural home near Gig Harbor, Marsha's framed cubist paintings cover every wall. With Dean's round face and long white hair, and Marsha's deep laugh lines and penchant for hugs, the two seem more like a pair of content grandparents.

But in the eyes of the state — despite their two medical marijuana licenses, entitling them to 30 plants, a number they're careful not to exceed — criminals is exactly what Dean and Marsha are. Because of the fact, both spoke on the condition that their whole names not be used.

"We're part of the evil armed cartels," Marsha said, with a chuckle and a smile in her living room late last month.

What puts the couple outside the bounds of the law is what they do with the marijuana they harvest. About two-thirds of it goes legally to dispensaries, destined for prescription-holding medical marijuana patients. But the other third goes to the black market, into the hands of people without prescriptions.

For the Washington State Liquor Control Board, the agency charged by Initiative 502 with creating a legal market for marijuana in the state, that makes them part of a major emerging problem: What to do about black market overflow from the state's medical marijuana market.

Initiative 502, which legalizes the production and use of marijuana, was intended to eliminate the demand for black market weed, but a surplus grown under the legal umbrella of the medical marijuana industry is making that a challenge.

A simple equation

For longtime Skagit County medical marijuana grower Brendan Howley, the arithmetic is simple. Current state law allows a grower to keep 15 plants and 24 ounces of dried marijuana on hand. Skilled growers though, with high-tech setups, can get more than 24 ounces out of just a single plant. If a grower grows all of his legal plants, Brendan explains, he will inevitably end up well over the legal limit.

"I don't think an expert grower can conform to the law the way it’s written," Howley says. "An expert grower can break the law with one plant."

The fact that Brendan is able and willing to move all of his product through legal channels puts him in the vast minority. Most growers, he says, operate with one foot in the black market, selling part of their product to legal dispensaries, and part to middlemen or dealers, who then sell to recreational users.

Currently, if growers hold onto excess product after harvest, taking the time to move it themselves to a dispensary, they can be arrested for having too much on hand. On the other hand, the black market pays from 25 to 50 percent more than dispensaries, which buy at wholesale rates low enough to tack on their own premiums afterward.

Since growers are breaking the law whether they keep extra product or not, Howley says the extra cash is just enough to sway most people toward pushing their extra legally-grown marijuana into street supplies.

One way the plant moves from growers to the street is through people like Harvey, a "middleman," though not a dealer. Harvey usually works with three to five growers at any one time, buying or accepting marijuana deliveries on trust and then selling to dealers. Like Dean and Marsha, he asked to be identified by first name.

A former employee at a medical marijuana dispensary, Harvey has known many of his growers for years, even decades. Although his work has eventually become something he's known for, he says he still only moves a few pounds a year; the equivalent a part-time job.

Even after the liquor control board brings most of the market into the open, Harvey thinks there will still be a place for people to sell the plant illegally.

Under I-502, marijuana will be taxed 25 percent each time it changes hands. The law also prohibits growers from owning stores or store-owners from growing, meaning that by the time legal pot reaches the consumer, it will have been sold — and taxed — at least twice. Potentially driving the cost up even further, I-502 also requires independent testing of each type of marijuana a producer sells.

"It seems like there’s a lot of hands for it to pass through,” Harvey says. “In the black market world, there’s usually the grower, the middleman, the seller and the user. If the taxation is high enough, it will drive it back toward the streets."

The lessons of history

The parallel between the passage of Initiative 502 and the end of the prohibition on alcohol is striking.

In 1933, like today, the country was in the depths of a financial crisis — the Great Depression. An abrupt change in public opinion about alcohol and a tax-strapped government jumped on the new revenue — especially since, like today, the law was already being widely ignored.

"One reason prohibition was repealed was so the federal government could get tax money, too," said Bill Rorabaugh, a University of Washington history professor and author of “The Alcoholic Republic,” a book on America's temperance era.

"Roosevelt wasn't dumb. Why should we have all these people drinking untaxed beer?"

While other states saw serious problems with organized crime and corruption after prohibition, Rorabaugh says Washington's Liquor Control Board was uniquely successful in regulating the state's alcohol market due to a few key factors.

First, there was a unity of leadership. The first chair of Washington's Liquor Control Board was a World War I Admiral named Luther E. Gregory, who was determined to root out corruption and straighten out the state’s liquor market.

Second, the board used a carrot-and-stick approach with bootleggers, licensing all the businesses it could — but striking those who violated its rules with lifetime bans from the industry. Over half a decade, the number of liquor licenses in the state decreased by half as the board weeded out violators, simultaneously setting a dramatic example and rewarding those who remained with steadily increasing slices of the market.

Third, Gregory had a strong understanding of economics, and made low taxes on the new market a key priority. Low taxes allowed newly-opened, state-run liquor stores to keep their prices low in order to compete with bootleggers and their cheap homebrew.

The Legislature at the time pressured Gregory to raise taxes on the market right away, in order to get revenue flowing. But Washington’s governor at the time stood by Gregory, promising to veto any legislation that ran contrary to the Liquor Control Board's agenda.

Years later, the Liquor Control Board would jack up liquor taxes significantly, until they were among the highest in the nation. Still, Gregory waited six years to do it. Just long enough to break the back of the bootlegging industry.

In an almost eerie parallel, Rep. Chris Hurst, D-Enumclaw, led a group of lawmakers last month in the very first legislative response to I-502: a letter to the Liquor Control Board, suggesting, among other things, an increase in licensing fees.

The major difference between 1933 and today though, Rorabaugh says, is the existence of a legal medical marijuana market. "This problem between medical dispensaries and recreational outlets is crucial. That's a complication that was not there in 1933 and 1934."

Still, Rorabaugh believes that there's one major factor that gives the legal market an edge. The black market, he says, has a built-in tax of its own: risk. Every person involved in the supply chain knows they could be put out of business at any moment, or even go to jail. So each one raises his prices to make the risk worth it, pushing the street price up significantly.

The size of that "risk premium" sets the minimum price for the black market and the maximum price for the legal market, Rorabaugh explains. If the price of legal pot is much higher than that, bootleggers will be able to undercut legal stores and still make enough to stay in business.

If the state clears the way for legal pot to stay below that price though, they won't.

Modern Questions

Allison Holcomb, the original author of I-502, thinks keeping prices low won't be an issue. Growing pot is so cheap, she said Monday in Olympia, that licensed growers and sellers will easily absorb the taxes.

Citing a 2010 paper in which Carnegie Mellon University professor Jonathan Caulkins did extensive price estimation, Holcomb said the price per pound to produce the plant in the open, legal market could be below $250. That’s close to the current price of a single ounce on the black market.

Not even the hefty taxes imposed under I-502 and the potential for other costs imposed by the Liquor Control Board would surpass that margin. She also believes customers will be willing to pay more for safety.

Guardedly, Skagit grower Brendan agrees. Most growers today, he says, operate facilities that meet few, if any safety or health codes. Although some produce high-quality marijuana, many depend on blatantly unsafe systems, including overloaded circuit-breakers and jerry-rigged electrical setups with cords running through pools of water.

As various state departments bring their oversight to bear on the marijuana industry, Brendan thinks many growers will simply fold in the face of the massive costs associated with essentially rebuilding their facilities from scratch.

"I think it's kind of going to be a come-to-Jesus kind of moment for a lot of growers," he says. "It's going to separate the men from the boys."

This isn’t just posturing. Brendan figures he and his business partners will be priced or regulated out of the industry within two years of full legalization. At that point, he says, operating profitably will require such large economies of scale that his operation simply won't have the capital to keep up.

Government weighs in

On Monday, the Senate health care committee opened public discussion on the first bill to touch the issue, however lightly. Sponsored by Seattle Democrat Sen. Jeanne Kohl-Welles, among other things the bill (SB 5528) orders the liquor control board to study the legality of selling medical marijuana through the same stores as recreational marijuana, along with the possibility of creating a medical marijuana patient ID card.

If passed, the law would require the Liquor Control Board and health department to study the legality of selling medical marijuana through the board, and of creating a state identification card for medical marijuana users. Kohl-Welles said repeatedly Monday that the bill is not intended as a first step toward integrating the medical and recreational markets.

Nevertheless, testimony Monday revolved as much around that idea — that medical marijuana should be protected — as it did around any specific part of the committee’s agenda.

So far though, the Liquor Control Board has been basically mute on how it will deal with the coexistence of the two markets. Hurst, the Representative who suggested the fee hike, met with the board last week, partly to ask if the board had any specific requests for bills that would address the marijuana legality gap.

After the meeting, liquor board chair Sharon Foster said she had not made any specific requests, but had told Hurst that without some sort of regulation, the existing medical marijuana market would make the board's job harder.

"It's in their lap now, not ours."

Another option for clamping down on the medical marijuana market would be to simply enforce the medical law as it stands. Currently, dispensaries operate in a gray area. If law enforcement pressured the storefront face of medical marijuana out of existence, ostensibly at the request of the liquor board, the market might be significantly dampened.

Asked if the board would consider asking for such an action, Foster only repeated, "That's not our role." Leakage from the medical marijuana market, she says, is an issue the board will deal with only if it proves to be a problem further down the road.

The long wait

While the liquor board may choose to wait, for Dean and Marsha there's not really any other choice. The process of legalization has been a tremendous relief already, Marsha says. Visiting the first Tacoma cannabis farmers' market was when it really began to sink in.

"Going into a public place, where people were smoking dope, and saying 'Here, have some of this' and some of that — it was very emotional, in a very fantastic way." Dean, Marsha remembers, cried at the sight.

Marsha's face creased into a smile at the recollection, while Dean furrowed his brow slightly and pursed his lips for a moment. "We had been so closeted, for forty years. So, so closeted."

Although the couple has been growing the plant to sell since the late eighties, the Tacoma experience inspired Dean to start growing for the medical market. After experimenting in soil, he switched over to a hydroponic system, generally considered the norm in indoor marijuana growing.

That switch, which Dean said cost between $8,000 and $10,000, pushed him to refine his practice. Now, with 28 plants, the two produce about four pounds a year — about 1/3 of their total income.

Dean is interested in getting a license to grow for the recreational market too. Ideally, he said, he'd like to apply what he's learned to running a large warehouse grow. "As big as I could scale comfortably," Dean said, "without major problems."

But he is quick to add that the way they operate now works. It wouldn't make sense for them to abandon the distribution network they already have — both legal and illegal — for a market they would have to struggle to survive in.

Speaking on the phone, Marsha picked up when Dean set the phone down to kiss their grown son goodbye. "If there's a decent market for it, we'll go with it," Martha said. "If there's not, we'll probably slip back into the black market."

Of course both scenarios are still in the future. Until that future — and the rules of the market — grow a little clearer, for Dean and Marsha and all the marijuana growers in the state, there's not much to do but wait.

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