San Jose cannabis tax revenue is poised to drop by millions this year, as black market competition and delivery services chip away at the willingness of consumers to pay more.

According to projections in the city’s recently approved budget, recreational cannabis sold at one of San Jose’s 16 licensed dispensaries is set to generate about $15.8 million in tax revenue this year. That’s down nearly 13% from the 2022-23 fiscal year.

It’s a notable decline, given the city’s budget is in the green overall, with a current surplus of $35 million. But with a budget shortfall of nearly $19 million predicted for next year, encouraging the local cannabis industry’s expansion could be a key way for the San Jose City Council to beef up its tax revenue.

City leaders have expressed an interest in lightening the regulatory burden on cannabis businesses. At a meeting on June 13, the council voted to loosen rules governing where dispensaries can set up shop, and asked city staff to look into the appropriateness of fines leveled against legal businesses, such as a penalty for an employee not wearing an ID badge.

“As we see the economic forecasts in our city budget, it’s clear that cannabis is underperforming,” said Councilmember Peter Ortiz at the meeting.

Sean Kali-rai, a lobbyist and founder of the Silicon Valley Cannabis Alliance, attributed the new drop in tax revenue to a number of factors. But he singled out the region’s unauthorized dealers, from whom the city cannot collect cannabis taxes, and expressed frustration that the city’s Division of Cannabis Regulation hasn’t prevented them from operating.

“What the war on drugs couldn’t do, legalization is doing,” he told San José Spotlight. “It’s just handing the legal market over to the illegal.”

The Division of Cannabis Regulation deferred to the city’s finance department on questions about declining revenues. A division spokesperson said complaints about illegal cannabis operations are passed to the city’s code enforcement department and the California Department of Cannabis Control (DCC).

Under Prop. 64, the 2016 ballot measure that legalized cannabis in California, city and county governments have broad authority to decide whether and where pot can be grown and sold.

San Jose councilmembers voted to double the number of cannabis business licenses last year. But in Santa Clara County, only one other city, Mountain View, permits legal cannabis businesses of any kind.

Cities and counties across the state have opted to ban cannabis entirely, confining the legal industry to the few jurisdictions that allow it and ceding the rest to under-the-radar operations.

In the context of San Jose, Kali-rai said, unauthorized sellers aren’t necessarily “somebody standing in a hoodie” on a street corner. Many operate as legal delivery services and sell the same brand name products customers might find in a dispensary display case—without generating tax revenue for the city.

Weedmaps, a popular cannabis delivery app, lists several delivery services operating within San Jose that aren’t among the city’s 16 licensed dispensaries. Some are registered in Alameda County as legal, non-storefront retailers with the DCC. But they appear side-by-side with the city-licensed dispensaries that are allowed to deliver products in San Jose, like Caliva and Purple Lotus.

In a statement, Weedmaps told San José Spotlight it “does not allow retailers without the required state license information to advertise on our platform.”

DCC spokesperson David Hafner told San José Spotlight that state cannabis licenses allow dispensaries to deliver anywhere in California.

“However, local jurisdictions have the authority to regulate commercial cannabis activity, including delivery, within their jurisdiction,” Hafner said.

Competition with these out-of-town delivery services contributes to the higher sticker price of cannabis when bought from San Jose’s legal dispensaries, Kali-rai said. And that, along with state and city taxes and fees and amid a broader economic crunch, has nudged price-sensitive customers to the illegal market.

California as a whole has also reported a drop in cannabis-related tax revenues this quarter, taking in 13 percent less in overall tax compared to the last quarter of 2022.

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