The marijuana industry has had an incredible run in a very short amount of time. Having once been an illicit industry worldwide that the public viewed as taboo, it's now a legitimate business model throughout much of North America. Canada lifted the veil of recreational pot prohibition in October 2018, Mexico gave the green light to medical marijuana in June 2017 (and is strongly considering adult-use legalization in 2019), and two-thirds of all U.S. states have approved cannabis in some form as of today.

We've also seen a dramatic shift in how the public views cannabis. In 1995, a mere one out of four respondents were in favor of legalizing weed nationally, according to Gallup. But Gallup found that two out of three respondents favored legalization by October 2018.

This broad-based optimism throughout North America is expected to lead to a rapid rise in legal-channel sales. A recently released report from Arcview Market Research and BDS Analytics projects global sales growth of 38% in 2019 to $16.9 billion, with sales catapulting to $31.3 billion by 2022. Canada alone has a chance at hitting nearly $6 billion in recreational marijuana sales by 2022.

However, even though Canada is the leading cannabis market now, it's not considered to be the pinnacle approval for the weed industry. That title goes to the United States, and more specifically California, which would be the fifth largest economy in the world, based on gross domestic product.

California generated far less pot tax revenue than expected

When residents of the Golden State voted to overwhelmingly approve Prop 64 in November 2016, investors' expectations for pot sales in California went through the roof. Initial projections called for the state to bring in $643 million in tax revenue for the first year of recreational weed sales, with tax revenue eventually topping $1 billion, and sales for the state approaching $11 billion by 2030. Unfortunately, reality hasn't come remotely close to meeting these lofty expectations.

This past Tuesday, Feb. 19, California's Department of Tax and Fee Administration reported tax revenue collection of $345.2 million for the first full year of legalization (sales commenced on Jan. 1, 2018). This was nearly half of the $643 million that was initially expected during the first full year of adult-use sales.

And for those folks who were hoping that California's slow start was being put in the rearview mirror, you may need to revise your optimism. For the fourth quarter, tax revenue totaled $103.3 million, which was a meager 2.5% more than the $100.8 million in tax revenue the state collected during the third quarter. Even though the state looks to be on track to top Gov. Gavin Newsom's dramatically reduced projected marijuana tax overhaul of $355 million for the current fiscal year, which ends June 30, legal-channel cannabis sales and tax collection are nevertheless badly missing the mark.

What's wrong with cannabis in California?

With support for the marijuana industry incredibly strong in the U.S., and Prop 64 passing with ease during the 2016 election, you might be wondering how it's possible for California's weed industry to be struggling so badly. The most likely answer appears to be the state's marijuana taxes.

Legalizing marijuana to generate tax revenue has been either a major or minor catalyst for pretty much every recreationally legal state, with the exception of Vermont, which doesn't allow retail sales. The differentiating factor between states is how they handle the aggregate tax on cannabis. Having a history of large budget deficits and rising state expenditures, California imposed what's arguably the highest aggregate tax on legal cannabis in the country. This includes a 15% excise tax on purchases of cannabis and cannabis products, local taxes that vary but average about 8%, and a wholesale tax of $9.25 for every ounce of cannabis flowers and $2.75 per ounce on cannabis leaves. In total, this can add up to as much as a 45% tax on the consumer.

It's pretty evident that this tax is thwarting the move of consumers into legal channels, and state legislators know it. Just a few weeks ago, the state's legislature introduced Assembly Bill 286, which aims to reduce excise taxes from 15% to 11% for a period of three years, and remove the cultivation tax on growers until 2022. Doing so would certainly push the aggregate tax rate below 40%, but it'd still, arguably, make legal weed considerably pricier than black market marijuana. Black market growers, of course, don't pay federal or state taxes, and they don't have to wait for cultivation licenses or retail permits.

Another issue has been regulatory red tape within the Golden State. Just as Health Canada has dealt with a backlog of cultivation licenses and sales permit applications, resulting in a shortage of weed to our north, California has contended with a slow dispensary license approval process, resulting in rampant oversupply that's struggling to find buyers. It's unclear when sufficient sales channels will be available in California to help reduce the state's oversupply.

Lastly, growers have somewhat struggled with California regulations imposed last summer that require cannabis grown within the state be pesticide-free.

California's pot stocks are no longer surefire winners

Even with California generating significant early cannabis sales figures, Golden State-based pot stocks are no longer the surefire winners that investors once believed they'd be. Thankfully for many of these marijuana stocks, other avenues exist.

For example, vertically integrated dispensary MedMen Enterprises (OTCBB:MMNF.F) has eight prime locations in California. These established locations have been responsible for producing higher sales per square foot than Apple stores. But if California's legal-channel sales have disappointed, it's only logical to assume that retailers like MedMen aren't seeing sales anywhere near their potential, even with its focus on more affluent clientele.

However, MedMen is currently in the process of acquiring privately held PharmaCann for $682 million, which will double the number of states it has a presence in and give the combined company more than six dozen retail licenses. Further, MedMen is really focused on expanding in Florida in 2019, which'll lessen its reliance on California. In other words, this is bad news for MedMen, but it's far from devastating.

Then again, things aren't as rosy for a niche player like Origin House (OTC:ORHO.F), which is considerably more reliant on California than MedMen. Previously an investment-focused cannabis company, Origin House changed tactics two years ago and began gobbling up companies in the distribution space in California. There are likely to be thousands of individual pot products in the Golden State in hundreds of licensed dispensaries, but when it comes to distribution licenses, there are only a small handful -- and Origin House is looking to corner the market as a marijuana middleman. The problem is that if oversupply issues continue and black market cannabis thrives, Origin House won't come anywhere near investors' lofty expectations.

Long story short, a big economy is no guarantee of success when it comes to the marijuana industry, and California has quite a bit of work ahead if it's to resolve its cannabis conundrum.

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