Here’s the uncomfortable math facing licensed operators: when a large share of consumer demand is still met by the illicit market, every untaxed, untested sale is revenue—and often margin—lost to the regulated channel. California’s own Department of Cannabis Control (DCC) estimates the licensed market captured only ~38% of statewide consumption in 2024; the remainder—roughly 62%—was met by unlicensed supply. At the same time, DCC data show $2.39 billion in legal retail sales in the first half of 2024, even as unit volumes rose but prices fell. At that capture rate, H1 2024 implies roughly $3.9 billion in consumer spending flowed to the illicit market in California alone—money that otherwise could have supported compliant retailers, brands, and farms.
Price is the first-order driver. Legal operators carry excise taxes, sales taxes, and local levies that illicit sellers do not. In California, local costs and restrictions can push the effective local tax burden north of 30% for licensed businesses, a structural headwind that narrows or erases the shelf-price advantage needed to convert legacy buyers. Empirical research is clear that consumers tend to switch back to illegal channels if legal prices rise relative to illicit options. In other words, over-taxation effectively “subsidizes” the unregulated competitor by making legal products comparatively expensive.
Tax design matters. As of 2025, states layer very different excise regimes on top of general sales taxes; these range from price-based ad valorem to weight- or potency-based systems, with significant implications for retail pricing and cross-border arbitrage. Analysts at the Tax Foundation have repeatedly warned that keeping legal prices above illicit levels discourages migration into the tested market—undercutting both public health goals and tax collections the industry was meant to generate.
The profit drain is not only about missed top line—illicit competition also compresses legal margins. California’s wholesale prices have fallen dramatically since 2020 (indoor down ~46%, outdoor ~74% in real terms), stressing cultivators and prompting consolidation and license attrition. Retail revenues declined primarily because prices fell faster than volumes grew. This “race to the bottom” is fueled, in part, by illicit supply that is insulated from compliance costs (testing, packaging, track-and-trace, labor standards) yet directly influences consumer reference prices. Margin compression ripples upstream: retailers negotiate harder, brands cut marketing and R&D, and farms delay capital investments—slowing product innovation that could otherwise differentiate legal shelves.
Market structure amplifies the effect. In newer or slow-rolling states, sluggish licensing and uneven enforcement leave illicit storefronts and delivery services entrenched near demand centers, siphoning away early-stage demand that legal operators count on to reach scale. New York’s 2024 market report underscores that most legal demand growth must come from converting consumers away from unregulated sellers, especially in dense downstate regions—meaning every month of weak enforcement or constrained store counts prolongs revenue leakage.
Quantifying “profits lost” will vary by state, but the contours are consistent: (1) foregone revenue equal to the illicit share of total demand; (2) lower legal prices and higher discounts to compete with untaxed rivals; and (3) elevated compliance costs that illicit operators avoid. Nationally, legal sales were about $31.4 billion in 2024; if even one-third of total U.S. demand remained illicit, that implies tens of billions in spend—and the associated gross margin—that never touches licensed P&Ls. That gap widens in jurisdictions where tax shocks (or potency taxes) push shelf prices up faster than consumers’ willingness to pay.
The playbook to reclaim profits is equally clear in the data: right-size tax burdens (and avoid mid-stream hikes), expand local retail access, target illicit storefronts and online gray markets, and improve price transparency so consumers can see the value of tested products. Where those levers are pulled, legal capture rises over time; where they aren’t, the illicit market remains a persistent, profit-draining competitor.
Read more on what cannabis companies are facing in a shifting economy.