INSIGHTS BLOG > What Will Cannabis Deschedulization Look Like?

What Will Cannabis Deschedulization Look Like?

Written on 16 November 2022

by Ruth Fisher, PhD

Current Landscape for Controlled Substances
What Regulators Want
Cannabis Licenses
Alcohol Regulations
Federal Deschedulization

Current Landscape for Controlled Substances

Let’s start by considering the current landscape for government regulation of controlled substances in general and cannabis regulation in particular.

Controlled Substances Generally

The FDA^[1] and DEA^[2] regulate the manufacture and sale of all controlled substances in the US. Controlled substances include not only illegal drugs and prescription drugs, but also dietary supplements.^[3] More specifically, the FDA ensures all (legal) substances available for use are safe and effective. The FDA also prevents manufacturers from making health claims that have not been appropriately established. The DEA enforces drug laws preventing unauthorized manufacture, sale, or use of controlled substances.

Cannabis in Particular

Currently, cannabis is classified under the Controlled Substances Act (CSA) as a Schedule I drug.^[4] Theoretically, as a CSA substance, cannabis is treated like a pharmaceutical, i.e., it’s regulated by the FDA and DEA.

In effect, however, medical cannabis is largely treated somewhere between pharmaceuticals and supplements: General access to medical cannabis requires signoff by a physician – thus making it similar to other pharmaceuticals. At the same time, however, once patients obtain physician approval, patients are free to purchase and consume whichever medical cannabis products they choose – making is similar to over-the-counter supplements.

Recreational (rec) cannabis, on the other hand, is treated more like alcohol and tobacco: Manufacturers must be licensed, and they must establish that products are safe for consumption. Retailers must be licensed to sell cannabis products, but consumers don’t need a prescription or license to purchase or consume.

It thus seems reasonable that medical cannabis would continue to be regulated by the FDA and DEA, while rec cannabis would eventually become regulated with alcohol and tobacco, under the ATF.

What Regulators Want

Let’s take a detour for a moment to consider what regulators – the FDA, DEA, and ATF – seem care about when it comes to cannabis, alcohol, and tobacco.

About the FDA:^[5]

The Food and Drug Administration is responsible for protecting the public health by ensuring the safety, efficacy, and security of human and veterinary drugs, biological products, and medical devices; and by ensuring the safety of our nation's food supply...

FDA also has responsibility for regulating the manufacturing, marketing, and distribution of tobacco products to protect the public health and to reduce tobacco use by minors.

About the DEA:^[6]

The DEA was established in 1973 as the federal organization in charge of enforcing the controlled substances laws of the United States... We are experts in drug law enforcement… we work together as one team to keep Americans safe from dangerous drugs and those that traffic in them.

About the ATF and TTB:^[7]

ATF is a law enforcement agency in the United States’ Department of Justice that protects our communities from violent criminals, criminal organizations … and the illegal diversion of alcohol and tobacco products. We … safeguard the public we serve ...

As of January 24, 2003, the U.S. Department of the Treasury's Alcohol and Tobacco Tax and Trade Bureau (TTB) is responsible for all inquiries in regards to the:

〉 Manufacture, wholesale and importation of alcohol and tobacco;

〉 Regulating the alcohol and tobacco industries and Special Occupational TAX (SOT); and

〉 Collection of the Alcohol, Tobacco, Firearms and Ammunition Excise Taxes imposed on manufactures and importers of these products.

Alcohol and Tobacco Enforcement

Alcohol and tobacco diversion is the trafficking of alcohol and tobacco products in avoidance of Federal, State or foreign taxes or in violation of Federal, State or foreign law.

So, then, the FDA is responsible for ensuring the safety and efficacy of controlled substances people consume (pharmaceuticals, supplements, tobacco, ^[8] and alcohol^[9]), while the DEA and ATF/TTB are responsible for enforcing the laws and regulations surrounding the manufacture, sale, and use of controlled substances.

The differences between the two sets of regulatory regimes are provided in Figure 1.

Figure 1

Based on these statements, together with the nature of cannabis regulations and enforcement, it appears that regulators have three primary concerns when it comes to cannabis:

Ensuring products available for sale are safe for consumption
Preventing unauthorized manufacture and use, particularly use by minors
Ensuring all taxes are paid

Cannabis Licenses

Currently, states have issued licenses mainly for the following types of medical/recreational cannabis activities:

Cultivation
Processing/Manufacturing
Transportation/Distribution
Retail

Different states allow different combinations (stacking) of licenses, which create different industry configurations (i.e., extents of horizontal and vertical integration, within and across medical and recreational sectors). Many states also offer licenses for microbusinesses and for event holders. Of course, all states also issue licenses to testing labs.

(Abbreviations: B2B: business-to-business, B2C: business-to-consumer)

Let’s take a deeper dive into Transportation/Distribution licenses. Most states have only one type of license in this category; that is, states tend to issue only Transportation or Distributor licenses, and the activities allowed vary tremendously by state. Here are some specific examples:

Michigan Transport License: “In Michigan, a marijuana secure transporter license holder can store and move marijuana plants and marijuana-infused products to and from various marijuana retailers (dispensaries), growers (cultivators), testing facilities, and processors (manufacturers).”^[10]

Colorado Transport License: “A licensed marijuana transporter (transporter) provides logistics, distribution, and storage of marijuana and marijuana products.”^[11]

Massachusetts Transport License: Massachusetts has three separate license types for Transport:
- Transporter provide B2B delivery services
- Couriers provide B2C delivery services.
- Delivery Operators provide the several different B2C services: “Marijuana Delivery Operators allowed to purchase marijuana and marijuana products from licensed Marijuana Cultivators and Marijuana Product Manufacturers and sell and deliver to consumers. They may also securely store on their premises marijuana and marijuana products that have been purchased at wholesale for eventual resale to consumers.”^[12]

Nevada Distributor License: “licensed to transport marijuana from a marijuana establishment to another marijuana establishment.”^[13]

California Distributor License: In California, depending on the fee, Distributors can provide some or all of the following services:^[14]
- Transport cannabis goods
  - They cultivated or manufactured
  - For other businesses
- Store cannabis goods
- Assist in the lab testing process
- Provide quality control services

Florida Distributor License: Only licensed Medical Marijuana Treatment Centers (i.e., Medical Dispensaries) are allowed to apply for Distributor licenses. A Distribution license allows Centers to transport medical cannabis goods to patients, testing labs, or other Centers. However, a Center “is not permitted to distribute marijuana to or make a wholesale purchase of marijuana from another medical marijuana treatment center.”^[15]

Oregon Wholesaler License: “A marijuana wholesaler license permits the licensee to procure marijuana items from Oregon Liquor Control Commission (OLCC)-licensed cultivators, processors, and transfer, deliver, transport, or sell, including sale by auction of the marijuana items to other licensed wholesalers, research certificate holders, retailers, and non-profit dispensaries. The license does not permit holders to sell, transfer, deliver, or transport whole, non-living marijuana plants to retailers and non-profit dispensaries.”^[16]

What’s clear is that states allow only carefully chosen activities in the area of transportation and distribution. Activities generally fall into one of the following categories (see Figure 2):

B2B transportation
B2C transportation
Storing products
Offering certain value-add services
Purchasing products for resale

Figure 2

Alcohol Regulations

Alcohol Prohibition ended with the ratification of the 21^st Amendment in 1933. The Amendment has two main parts:^[17]

Section 1: The repeal of the 18^th Amendment, which had prohibited alcohol.

Section 2: The prohibition of any unlicensed importation of alcohol into a state from another state.

The second section says that it’s up to each state to determine the specific alcohol-related activities it wants to allow.

There are a few federal laws regarding the manufacture, sale, and use of alcohol. However, the vast majority of regulations fall to the states, and states vary tremendously in the alcohol-related activities they allow.

Federal Laws for Alcohol

As discussed earlier, the ATF is the federal agency within the DOJ responsible for enforcing alcohol activities, while the TTB is federal agency within the Department of the Treasury responsible for regulating and taxing activities relate to alcohol production and use.

The federal government established three main national laws with respect to the consumption of alcohol. First, the Federal Uniform Drinking Age Act of 1984 establishes the minimum legal drinking age at 21. While states can alter this, most tend to comply, because otherwise they risk losing federal funds for highways. Second, an alcoholic beverage is defined as any beverage that contains over 0.5% alcohol per volume. Despite the existence of a federal definition, states and local jurisdictions vary somewhat on this threshold.^[18] And finally, in 1988, the legal limit for blood alcohol content (BAC) was established at 0.08% for establishing intoxication when driving a motor vehicle.^[19]

All other laws and regulations on alcohol activity are determined at the state level

State Laws for Alcohol

The states have all adopted a Three Tier System for regulating alcohol activity within the state. Under this system, each state issues separate licenses for the manufacture, distribution, and sale of alcohol. Manufacturers sell to distributors, who sell to retailers.^[20]

There are a few relevant nuances in this system. First, each state differs in the types of relationships members of each tier can enter into with members of other tiers. Second, most states regulate beer and wine differently (more loosely) from liquor. Third, in most states, businesses cannot be involved in more than one of these three activities on a large scale. Finally, in some states, the state controls certain types of operations directly, rather than licensing private businesses. For example, in a good number of states, the state either operates liquor stores itself or contracts agents who operate the stores on the state’s behalf.^[21]

Apart from the Three Tier System, states, and even local jurisdictions, have significant differences regarding who can legally manufacture, import, distribute, sell, and/or consume alcoholic beverages. Specifically, states differ in:

Whether to allow the sale of alcohol in the State^[22]
Whether to allow the importation of alcohol into the State from other states^[23]
How to distribute alcohol throughout the State^[24]
The possession of alcohol in the State^[25]
Whether to allow home brewing in the State^[26]
When, where, and how much alcohol may be sold and consumed by an individual^[27]

Finally, there are substantial differences across states in the regulations for the transportation and shipping of alcohol within and across state lines. About half the states “require a license or permit to transport alcohol into, through, or out of state, [and] there are states (such as certain counties in Texas) that are ‘dry’ and therefore do not allow alcohol transport.”^[28] As for shipping alcohol, the USPS prohibits the shipping alcohol, but both UPS and FedEx will do so, under strict rules.^[29]

Federal Deschedulization

The structure of federal and state laws and regulations for the production, distribution, sale, and use of alcohol appears to be well-suited for managing (rec) cannabis activity, if and when cannabis is descheduled. Furthermore, states that have legalized cannabis activity have already established elaborate structures (license and regulation systems) for managing the production, distribution, sale, and use of cannabis. Finally, the established cannabis regulations tend to be structurally similar to those for alcohol activity. Taken together, this all suggests that the most obvious way for the federal government to deschedule cannabis would be to simply continue to leave it up to the states to decide if and how to allow cannabis activity within state borders, just as they are now doing. The only extension would be for the federal government to allow cannabis activity to cross state lines to the extent that individual states choose to allow it. And of course, the other federal laws and regulations limiting cannabis activity under its Schedule I classification (notably Section 280e and access to traditional banking/payment services) would no longer apply.

This structure of cannabis regulation would generate definite winners and losers. It would also induce two additional phenomena that warrant further discussion: state protectionism and dominant wholesalers.

Winners and Losers

Figure 3 compares the average price per ounce of high-quality cannabis across states. According to this source the current average price per ounce across states is $320. The five states with the lowest prices are OR, WA, CO, CA, and MT. The five states with the highest prices are ND, VA, IA, WV, and MD.

Perhaps the biggest determinants of cannabis prices are:

Growing Conditions: Certain locations present better climate and soil for growing cannabis. These areas will tend to produce lower-cost cannabis. The best climates for growing cannabis are Northern California, Washington, Oregon, Maine, Kentucky, Tennessee, and Florida.^[30]Colorado serves as a hub for seeds banks, genetics, and cultivation know-how, making it a powerhouse for high quality indoor-grown cannabis.^[31]

Legal Status and Enforcement: States with greater restrictions on and enforcement of cannabis cultivation and use will tend to have higher prices.

Supply and Demand: States with greater demand relative to supply will tend to have higher prices.

Figure 3

Currently, many high-cost cannabis producers are able to profitably serve their local markets, since lower cost suppliers from other states are not allowed to compete in those local markets. However, if products are allowed to flow across state lines, then higher cost producers will no longer be insulated from competition by out-of-state suppliers with lower-priced products.

If and when products can “freely” (i.e., with the appropriate licenses) cross state borders, producers of low-cost products will enter states with high-cost – and thus high-priced – products. As products flow from low-cost states into high-cost states, many high-cost suppliers will be forced out of the market if they cannot compete with out-of-state producers offering lower-priced products

As seen in Figure 3, cannabis from Western states will tend to flow into Northern and Eastern states, which may drive suppliers in those states out of the market. More generally, suppliers with more efficient (lower cost) operations will win, while suppliers with less efficient (higher cost) operations will lose.

With cannabis deschedulization Section 280e will no longer apply, thereby eliminating the excessive federal income tax burden associated with cannabis activity. Cannabis deschedulization will also enable cannabis operators to use traditional payment systems (e.g., banking and credit cards), which will reduce many of the excessive security costs to businesses because they will no longer be forced to run cash operations.

Yet, there are plenty of other regulatory burdens on cannabis activity that cannabis deschedulization will not eliminate (e.g., license fees, excise taxes, tracking and reporting requirements, etc.). The large regulatory costs associated with operating cannabis businesses favor larger operations. [When there are large fixed costs of operation, then average costs per unit decrease as the number of units sold increases; that is, the fixed costs can be spread over a larger volume of sales.]

Notably, cannabis deschedulization will transform the cannabis industry from being a large collection of separate, smaller, state markets to being a single, united, national market. A national market provides much larger market potential for any given cannabis business, and many businesses will rapidly scale in size to meet the demands of the newly created national market.

If regulatory costs continue to be substantial, then the larger national companies will have substantial cost advantages over smaller companies. Smaller companies thus stand to lose under deschedulization because they will be forced to compete with lower-cost competitors, some of whom benefit from lower costs due to more favorable supply conditions (e.g., a better climate), while others benefit from lower costs due to larger sizes of operation.

Some of the competitive disadvantages smaller growers and brands will face, especially those due to less visibility in a more crowded market, may be mitigated by enabling direct-to-consumer sales. Enabling smaller operators to communicate with and sell directly to consumers will greatly improve access to customers and enable suppliers to better meet customer needs.

State Protectionism

Once cannabis has been descheduled, states will have the ability to grant licenses for the import and export of cannabis products across state lines. As just described, with no restrictions on product flows across states, products will flow from low-priced states to high-priced states. Suppliers in states with higher prices will face intense competition from out-of-state low-cost suppliers, and many of the in-state high-cost suppliers will be forced out of the market.

It is unlikely that state governments in states with higher-priced cannabis will simply sit by and watch their constituent businesses be driven out of the market. In markets that have legalized cannabis activity, billions of dollars have been invested by suppliers in cultivation and processing operations, and state governments have collected hundreds of millions, if not billions, in taxes on sales and income from these cannabis businesses. It’s a pretty good bet that in high-cost states, state governments will either refuse to issue import licenses for out-of-state cannabis products, or they will severely restrict imports by imposing prohibitive fees or taxes on import activity.

Dominant Wholesalers

States that allow imports of cannabis products from other states will need licensed Distributors/Wholesalers to manage storage and distribution of imports into the state. Just as states differ with regard to the specific types of licenses and activities they allow for alcohol imports, so too will states differ on all this for cannabis.

Distributors and Wholesalers (D/W) create efficiencies (cost savings) by serving as middlemen between suppliers (Cultivators and Brands – jointly referred to as Brands) and Retailers. For example, D/W can buy product in bulk from a variety of suppliers and subdivide those large quantities into smaller batches, which they then package and resell to Retailers.

Brands benefit from selling their products in larger volumes and from only having to deal with a few D/W, rather than with hundreds of Retailers. Likewise, Retailers benefit from only having to deal with a few D/W, rather than with hundreds of Brands. Retailers perhaps also benefit from lower prices due to purchasing in larger volumes (or varieties) from a single seller (the D/W).

While this type of system creates cost savings for Brands, it does have disadvantages. For example, Brands lose the direct relationship with Retailers, which distances them even more from their ultimate customers, Consumers, making Brands less responsive to Consumers’ needs. A second disadvantage is that Brands may lose the ability to choose which Retailers carry the Brands’ products, since D/W may sell to whichever Retailers it can. A third disadvantage is that Brands may lose the ability to have specific Retailers carry their products, if those Retailers only buy from select D/W that don’t carry the Brands’ products.

The last two problems may reflect a more worrying outcome: In markets with many different products, the middleman role of D/W (i.e., the efficiencies D/W creates from aggregating the supply of many different Brands) may become so important to Retailers that most of the leverage that Brands may have had might become usurped by D/W. In other words, D/W may become the gatekeepers that determine which Brands are able to access Retailers. At the same time, Retailers may also end up at the mercy of D/W regarding the Brands that Retailers can access.

States that want to prevent D/W from becoming industry gatekeepers could limit the size/scope of D/W operations, perhaps by limiting the number of Brands D/W can represent. (This would create an interesting game: If D/W are limited in numbers of Brands they can represent, D/W would want to carry only the most popular Brands. However, the most popular Brands would not necessarily want to cede their leverage to D/W. Alternatively, a good D/W could turn smaller Brands into larger ones and extract much of the value it creates for those Brands.)