BUSINESS MAVERICK

SA and legal cannabis: profits should be reaped, but like any industry, there are also risks

By Ed Stoddard 21 January 2020
Caption
The banking sector in general should not have a problem providing services to a South African cannabis industry if it is formalised by Parliament and taxed by the Treasury, says the writer. (Photo: Unsplash / Esteban Lopez)

South Africa’s cannabis conversation is shifting into a new gear, with Finance Minister Tito Mboweni on the record as pushing for full legalisation. Such a move will be welcome, with plenty of economic potential to unlock. But other experiments with legal, regulated pot usage, and uniquely South African circumstances, highlight the potential risks as well.

Colorado, a mountainous US state better known for skiing and trout fishing, has been a trailblazer in pot policy. In a Rocky Mountain high, it was the first US state to “go legal”, allowing the production and sale of marijuana for recreational and medical use.

That seems to be paying dividends. State coffers, for a start, have had an additional source of revenue. Total sales since legalisation in 2014 have amounted to $7.6-billion, according to the Colorado Department of Revenue. From that, more than $1.2-billion in tax and licensing revenue has been collected — and counting. In the 2019 fiscal year, the cannabis industry generated $302-million for the state, more than the sums garnered from either alcohol or tobacco sales.

A South African audience might look at that and think, wow — that works out to roughly R5-billion. That’s 25 Nkandla upgrades complete with fire pools, or a whole lot of schools or social grants. It might even keep SAA flying for a few more months.

But by Colorado state revenue standards, it is fairly small change. In fiscal 2019, the state raised $16-billion from taxes and other sources, so pot’s contribution was just shy of 2% of the total. Sin taxes, even in jurisdictions with lots of sinners, typically don’t make or break budgets. In the case of South Africa — and here there be sinners galore — excise revenue gleaned from the sale of smokes and booze, and excise duties on imports of such products, but excluding VAT, amounted to 3.5% of the total raised in the 2018/19 fiscal year, according to National Treasury data.

Still, as Finance Minister Tito Mboweni struggles to plug widening fiscal deficits in the face of looming rating downgrades, internal ANC squabbles, and an economy that is on life support, any additional revenue stream will clearly be welcome. When Mboweni recently tweeted that he would push for cannabis legalisation at an upcoming Cabinet lekgotla, he pointedly mentioned taxes — but he has since been told by the ANC to stop tweeting about policy, so it is hard to see where this will go.

But Parliament has to craft legislation that complies with a Constitutional Court ruling that the prohibitions on dagga use for adults do not pass constitutional muster, so something has to change. So it is instructive to see how this has played out elsewhere and consider how it might yet unfold in South Africa.

Direct tax revenue is only part of the wider economic picture — and we will return to the challenges there in the South African context. Taxes are generated from private sector activity, and in Colorado’s case, the industry’s sales are approaching $8-billion since day one of legalisation. That doesn’t include investments, and there are other spin-offs. A study by the Reserve Bank of Kansas City found that as of March 2018, the industry employed 17,821 full-time positions, an almost 18% increase on the previous year. That represented 0.7% of Colorado’s workforce, and of course many, if not most, of those employees are also paying income tax. And there were 1,637 business owners operating in that space.

It has not all been smooth sailing. In the United States, draconian cannabis prohibitions persist at the federal level, and the Trump administration, with Republicans whose views on pot are like something out of Reefer Madness, is not about to change that. That initially made it hard for the industry to access banking in states where cannabis use has been legalised, but that has been quietly changing. In Colorado, Associated Press reported in October that as many as 35 state banks and credit unions were providing the sector with financial services.

Then there is the example of Canada, the second country after Uruguay to embrace full-scale legalisation. Canada’s cannabis Day Zero was in October 2018, but the profits that many private sector investors hoped to reap have not materialised, and this has played out in the share price of listed companies.

The cannabis industry in Canada has been literally whacked,” a person who was formerly employed in the sector told Business Maverick.

Costs have been miscalculated, and so has demand, as many users stick to their tried and tested dealers who can undercut the regulated market in pricing. The roll-out of state-sanctioned retail outlets — a provincial government issue — has also been uneven. Canopy Growth, the biggest player in the market, saw its share price fall by more than 20% in 2019, the first full year of legalisation in Canada.

Industry players also complain that they cannot effectively market their product because of rules requiring plain packaging and advertising bans and restrictions. But any newly legal industry is bound to have growing pains.

What could go right, and wrong, in SA?

The policy debate in South Africa seems to be leaning towards some form of legalisation, so what could go right here and what could go wrong, based on the examples outlined above and applied to local circumstances?

Taxes seem a good place to start. With dop and smokes already contributing about 3.5% to the national budget, a thumbsuck might be that an additional 2% could be added by taxing pot sales. That may not seem like a lot, but Mboweni at the moment needs every cent he can lay his hands on, and why not get it from a new industry rather than raising the tax burden on existing ones?

Of course, many South Africans — just like Canadians — might just keep relying on their trusted dealers, which would deprive the state of some of the taxes it would feel was its due. As Sam Sole, Jacques Pauw and others have reported, cigarette smuggling in South Africa has been a booming business, driven by the taxes on the legal product, which account for most of the price paid. If you don’t pay the taxes, you get a bargain.

The point here is that the government should refrain from imposing exorbitant taxes on cannabis products if it wants to encourage users to purchase the legal product.

Job creation — which the government claims is at the top of its agenda — certainly looks promising.

The number of jobs in the Colorado sector grew by almost 18% between 2017 and 2018. If the point of production is not heavily mechanised, the sector could be labour-intensive. A lot of jobs would be low-paid agricultural work, but South Africa needs every job it can get right now. And of course, there are opportunities for entrepreneurship — provided they don’t get strangled in red tape. Allowing industry players some space to market their products would also help boost employment, as well as hopefully profits.

Then there is the question of emerging or small-scale farmers, which the South African government would clearly hope could find opportunities in a formal dagga economy. Neither Colorado nor Canada have millions of subsistence farmers tilling tiny plots in impoverished rural areas such as the former homelands — but even in affluent jurisdictions where pot is legal, smaller producers are finding the costs of entry prohibitive.

Still, there is plenty of evidence that peasant farmers in South Africa are indeed into weed.

There is anecdotal evidence that in parts of the Transkei small-scale farmers grow both maize and cannabis. It is a form of inter-cropping,” Wandile Sihlobo, head of agribusiness research at the Agricultural Business Chamber, told Business Maverick. Maize in such cases is often for consumption, while the cannabis is for cash because it offers a much better return.

If South Africa could to some extent legalise cannabis cultivation, then small growers in places such as the Transkei and KZN would have a competitive advantage in terms of know-how,” Sihlobo said. “But if licensing fees are too high, that alone would be a significant deterrent to small-scale farmers.”

Compared to larger producers, they would also be at a disadvantage in all of the ways they are being left behind when it comes to other crops: input costs, linkages to markets, the sheer scale, and getting access to capital, among other constraints. This is especially the case in the old Bantustans, where, as is well known, rural dwellers lack title deeds and security of tenure, so they are unable to use the land they work as collateral for credit.

But the banking sector, in general, should not have a problem providing services to the industry if it is formalised by Parliament and taxed by the Treasury. This removes the uncertainty that exists in the US, where state and federal laws can come into conflict.

South Africa has at least two other major challenges when it comes to marijuana production and retailing. One is water: cannabis is a thirsty plant, and in an age of climate change and increasing drought, concerns could be raised about food security if cannabis is grown in place of staple grain crops. Such concerns have been raised in the past in countries such as eSwatini in relation to sugar cultivation. And growers themselves would have to contend with harsh weather patterns. Having access to credit is crucial in such situations to cushion against bad harvests or low prices.

Cannabis in transit heists?

The other major concern, of course, is crime and security. Farmers Weekly earlier in January reported on a phenomenon that would be startling almost anywhere else, but comes as no surprise to a South African audience. It reported that during the past season, the theft had inflicted the macadamia and avocado industries with losses of more than R160-million and R24-million respectively.

It would appear that syndicates are working together, and crime that starts at the farm gate travels all the way up the value chain, aiding a broader crime industry,” it quoted Lizel Pretorius, CEO of Macadamias South Africa, as saying. Macadamias and avocados are, of course, high-value products, with growing demand and robust profit margins — not unlike the future that many see for cannabis.

And if avocados are being looted by criminals, imagine the temptations offered by licensed cannabis operations! Small growers could hardly afford the costs of protecting their buds, but even operations that can foot the bill will have to pass that on to consumers. Even within the current illicit market, one imagines that there are hidden security costs built into the street price.

In Lesotho, where production of pot for medical purposes is a legal and growing business, the operations are pointedly generally in remote areas, which are not hard to find in rugged and relatively sparsely populated Lesotho.

But also imagine the distribution network that gets the product from the point of production to retailers. Cash-in-transit heists are among the many violent crimes that plague South Africa. Cannabis-in-transit heists are entirely conceivable. Preventing such theft will add to costs, as will securing the produce on display at dagga retail shops.

This is all, ultimately, food for thought in anticipation of some kind of formalisation of the cannabis economy in South Africa. There will be challenges as well as opportunities, but ultimately the move is sensible social policy — let consenting adults toke. Cannabis has been used here for a long time and while estimates are surely thumbsucks, it is probably safe to say that the number of pot smokers in South Africa is in the millions.

In 1926, the writer Herman Charles Bosman was jailed for four years for an incident in which his step-brother was killed. In his often hilarious yet poignant prison memoir Cold Stone Jug, he recounts the astonishing amounts of dagga smoked within the confines of the Swartklei Great Prison. He even had a few tokes himself, and unlike Bill Clinton, he inhaled. Prisoners even then were waxing lyrical about the stuff grown in Swaziland.

The popular attitude towards dagga smoking, making of it something mysteriously sinful and raising it to the level of a secret vice indulged in only by the most abandoned mortals, served as a challenge to me,” he wrote.

Times and attitudes have changed. It’s high time the law played catch-up. BM

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