Whether you realize it or not, you're now a witness to history. On Tuesday, June 19, Canada's Senate passed bill C-45, which is better known as the Cannabis Act, making adult-use marijuana legal throughout the country. According to Prime Minister Justin Trudeau, by Oct. 17, 2018, adults can legally purchase marijuana in Canada.
To be clear, no one is exactly sure what will happen when the proverbial green flag waves. Though we've witnessed a couple of U.S. states legalize recreational marijuana since 2012, no developed country has ever done so. At this point, examining the supply-and-demand outlook is nothing more than a series of educated guesses.
Here's why Canada's legal marijuana sales growth could disappoint
But according to Statistics Canada, Canadians spent a whopping $4.3 billion (5.7 billion Canadian dollars) on marijuana in 2017 -- and it wasn't even legal yet, aside from medical weed, which was given the green light back in 2001. Various estimates have suggested that the legal weed market could be worth $5 billion in added annual sales (that's in U.S. dollars), and these lofty sales figures are a big reason why growers have been actively expanding their capacity as quickly as their wallets will allow.
However -- and stay with me on this one because I'm throwing out an idea that's almost inconceivable given the euphoria that's surrounded legalization -- there's no guarantee that legal-weed stocks and businesses are immediate winners in the post-legalization environment.
Per Statistics Canada, approximately 90% of the aforementioned $4.3 billion in marijuana sales last year were conducted in "non-medical consumption." Since recreational marijuana wasn't legal last year, and technically still isn't until Oct. 17, 2018, non-medical consumption is just a fancy way of saying "black market consumption."
Should this figure surprise anyone? Not really. According to a report published in May by Marijuana Business Daily entitled "Marijuana Business Factbook 2018," aggregate U.S. cannabis demand is a delectable $52.5 billion. Yet, the midpoint of sales from 2017 was just $6.2 billion. This implies that more than $46 billion in black-market sales are currently being made in the United States.
So, what's the problem if marijuana is going to be legal in Canada, you ask? Namely, black market cannabis is still illegal. Any sort of unlicensed production that subverts legal channels, and taxation, will remain illegal.
More so than that, it's a threat to the legal way of growing, processing, distributing, and retailing marijuana. Black market growers have no stores to pay for, no taxes to worry about, and no income-tax statements to provide the government. With no overhead costs and the ability to undercut those who follow the rules in price, it could make unseating the black market much tougher than Wall Street and investors realize.
Will Canada's unique approach to taxation work?
Of course, Canada has a unique approach that it's using to try to lure consumers and businesses into legal channels.
As outlined in October 2017, Canada is setting up an excise tax rate of CA$1 per gram up on cannabis costing up to CA$10, and a flat 10% excise tax rate on pricier cannabis strains. The federal government also devised a two-year tax-sharing agreement with provinces that allow them to reap 75% of excise taxes collected. Should the remaining 25%, which goes to the federal government, exceed CA$100 million annually in these two years, all of the excise tax overage will head to the provinces.
In plainer terms, Trudeau and the federal government aimed to set excise taxes on marijuana as low as is reasonably possible. By keeping excise taxes low, the belief is that the price difference between legal marijuana and black market weed will be minimal, thusly pushing consumers and businesses into legal channels. Though there will be substantial revenue to be made, legalization wasn't a ploy for Canada to generate a new revenue stream.
Comparatively, U.S. states love the idea of using the legalization of marijuana as a means to generate a new channel of revenue. It's not uncommon for a number of states to be struggling with a budget deficit; and while legalizing marijuana may not close the gap, it does provide a new source of revenue that narrows state budget gaps. In essence, the U.S. views marijuana as a revenue generator, and pretty much nothing more. As such, high level of taxation could make it even tougher in U.S. states like Washington and California to compete with black market growers.
If there's an environment where legal cannabis could thrive, it's Canada given its reasonably low excise tax rates. But only time will tell if that's the case.
The Motley Fool has a disclosure policy.