Federal inaction spells bad news for marijuana business

March 21, 2014, 9:36 PM UTC

FORTUNE — The extremely slow pace at which the federal government is moving toward its inevitable legalization of marijuana is creating two major problems, one short-term and one long-term.

In the short term, an industry that most Americans want to see legitimized is severely hampered by the fact that what it does is a still serious federal crime. In the long term, the lack of federal oversight now, in the industry’s nascent stages, will almost certainly end up with the pot business consolidated in the hands of a few big companies with enormous political and economic power, to the detriment of its own customers, people who work in the business, the environment, and our social well-being.

This week, we learned just how unlikely it is that our moribund Congress will take the steps necessary to create an environment for a healthy, thriving, relatively harmless marijuana industry to take root. The Denver Post reported on Thursday that a bill that would allow banks to serve marijuana companies that are legal under state laws is being met with silence by nearly all 99 members of the two House committees that could get it passed. Marijuana businesses can’t use credit cards, get loans, or receive any of the other banking services that are routine for most companies.

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Bill sponsor Denny Heck, a Democrat of Washington (which along with Colorado is one of two states that have legalized marijuana for recreational use) said that when he approaches his fellow members to discuss the bill, they have nothing to say. “The almost universal response is the rolling of one’s eyes,” he told the Post.

So operators of legitimate businesses in Colorado and Washington, plus the 18 other states and Washington, D.C. that allow sales of medical marijuana, are still hauling giant wads of cash around with them and — along with their customers — must be constantly on guard against robbers and thieves. And they’ll be doing so until at least next year.

The industry’s main lobbyist, the National Cannabis Industry Association, remains optimistic, and even understanding, to some degree, of the intractable Congress. “A few years ago, there would have been no such bill,” says Taylor West, the group’s deputy director. The “dramatic change in public opinion over the past few years” will simply take time to have its effect on Congress.

Despite the swell of public support for legitimizing the pot business (more than half the country is now in favor, according to most polls), many members of Congress are hesitant in part because their own states haven’t yet legalized marijuana for either medicinal or recreational use. It so happens that most of the members of the two committees — Financial Services and Judiciary — that could push the banking bill to the House floor represent districts in states where marijuana remains entirely illegal.

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The Justice Department last month approved rules for prosecuting marijuana crimes that explicitly excluded banks from being prosecuted for doing business with the pot industry. But those rules don’t amount to a guarantee, and they aren’t nearly good enough for the banks, most of which will likely continue to steer clear of the industry until stronger protections are in place. Ironically, the Justice Department’s move seems to be helping to keep the banking bill stuck in committee. The Post reports that some members questioned the need for the bill given the administration’s order to federal prosecutors to stand down.

It likely that action on the bills will come only after several more states legalize either medical or recreational marijuana, which would create legitimate pot-industry constituencies in states where there currently are none. The Marijuana Policy Project estimates that five more states will legalize pot in one way or another over the next year, which would put the number over half.

Will that be enough for Congress? “It’s hard to predict anything with this Congress,” says West. And it doesn’t seem likely that the next Congress will be any more predictable or reliable.

Even if the banking bill were passed, and even if most or all states were to legalize pot in some form, there would still be the enormous problem of the federal government’s classification of marijuana as a Schedule 1 narcotic, which puts it on a par with heroin in terms of the criminal penalties for possession and sale. The NCIA for now isn’t even really trying to get marijuana rescheduled to (at the very least) make it a lesser offense.

“It’s just less than feasible right now,” West says. So the NCIA is taking an incremental approach with Congress, trying for now just to get the banking bill passed and to get IRS rules changed so that state-sanctioned pot businesses can take what are for other businesses legitimate tax deductions. A provision of the Internal Revenue Code still considers marijuana sales to be “drug trafficking,” and bars such deductions. This puts a serious crimp in earnings. “In fact, some medical cannabis operations could be driven out of business on account of this provision,” according to the NCIA.

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As the years wear on and the federal government continues to take tiny steps toward legitimizing the industry, a hodgepodge of incompatible state laws will be enacted, which not only will burden the industry, but will destroy any chance of the federal government getting a handle on rationally taxing and regulating it. This could lead to all kinds of problems, such as pot businesses marketing to children, inadequate labeling, and environmental problems. (Without smart regulation, pot cultivation can ravage the environment.) Further, taxing marijuana sales only at the state level could lead to rampant smuggling between states with different tax rates, as we see now with tobacco.

It could also lead, eventually, to massive industry consolidation, as happened with the beer business in the years and decades after prohibition was lifted in 1933, when regulation was (and still is) left almost entirely to the states. Rather than thriving, open marketplaces filled with lots of small, competing players, the pot industry could end up being a corporate-controlled oligopoly that resists competition and enjoys massive lobbying power to keep itself in place.

Already, the main pot lobby doesn’t have a problem with this. In fact, it uses “federalism” as an argument to get more-conservative members of Congress on board with its agenda. “For some members,” West says, “it’s productive for us to argue that we should allow the states to regulate this,” which the NCIA believes will make passing legislation like the banking bill more palatable for them.

That’s probably true, and helpful in the short run. In the long run, not so much.

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