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Annual Privatization Report

Washington State Approves Privatization of State Liquor Monopoly; Other States May Follow

Washington State to become first state to fully privatize state's wholesale, retail liquor monopoly

Leonard Gilroy
May 31, 2012

In November 2011, Washington State voters approved the privatization of the state’s monopoly on the distribution and sale of distilled spirits, becoming the first state in the nation to fully shift wholesale and retail from public to private sector operation and potentially injecting some momentum into privatization efforts in Virginia, Pennsylvania and other states currently exploring similar proposals.

By an overwhelming 60–40 margin, Evergreen State voters approved Initiative 1183 (I-1183), a ballot measure sponsored by Costco and other major retailers that will fully privatize both wholesale distribution and retail sales of liquor, while removing obstacles to the wholesale distribution of wine. I-1183 was designed to rein in the scope of, and address the perceived deficiencies of, Initiative 1100 (I-1100), a more sweeping Costco-backed privatization measure narrowly defeated at the polls in November 2010. (For more details on I-1100, see Reason Foundation’s Annual Privatization Report 2010

Among its provisions, I-1183 will:

The license fee structure—designed to generate more alcohol-related revenues to the state relative to monopoly operation—was key to the passage of I-1183, as it created a strong argument that state and local governments would see a financial benefit under privatization. According to the state Office of Financial Management’s (OFM) fiscal impact statement for I-1183, the measure would increase revenues to the state by an estimated $216 million to $253 million over six fiscal years, with a similar $186 million to $227 million increase in local government revenues over that same period. Further, the OFM estimated a one-time net state revenue gain of $28.4 million from auctioning off the state liquor distribution center. OFM did not estimate proceeds from the sale of existing state-run liquor stores, so actual one-time revenues from divestiture are likely understated.

I-1100’s opponents had stoked fears that passage would reduce state and local government revenues, which played a key role in voters’ rejection of that measure in 2010. The provisions of I- 1183—in particular, provisions establishing a new license fee structure—were designed to ensure that it can fully replace revenues generated by the current state wholesale markup.

Though it remained neutral on I-1183, the Distilled Spirits Council of the United States (DISCUS) highlighted two key critiques of the measure amid the election campaign that are likely to inform similar debates in other states. First, the minimum retail outlet size of 10,000 square feet effectively excludes a broad range of small- and medium-sized retailers—including gas stations and mom-and-pop specialty spirits stores—from the market, potentially reducing competition and consumer choice. This restriction prompted groups like the Washington Food Industry Association—an organization representing independent grocers that supports the general concept of privatization—to oppose I-1183 on grounds that it gives large retailers an advantage over smaller businesses.

Second, DISCUS raised concerns that I-1183 would create franchise protection for spirits wholesalers, with the practical effect that once a supplier selects a wholesaler for a particular brand, that wholesaler would retain exclusive distribution rights in perpetuity unless it chose to forfeit them. DISCUS noted that in most states, suppliers can choose their wholesale partners and hold them to high standards of performance and service through the ability to open the arrangements to competition in the event of wholesaler underperformance.

As with I-1100, Gov. Chris Gregoire, many state legislators and the Washington State Democratic party opposed I-1183, but unlike in 2010, these political opponents did not reject the concept of privatization. Ironically, in the spring of 2011 Gov. Gregoire signed into law a bill (Senate Bill 5942) passed by the majority Democrat legislature authorizing the state to solicit proposals for a long-term lease of the state’s spirits wholesale monopoly in return for a one-time, lump-sum payment. Though I-1183 proponents complained that the bill was designed to serve as an end-run around the initiative—potentially taking the wholesale component off the table in advance of the November 2011 election—those fears were rendered moot a week before the election when the state announced that it had rejected both bids it received from wholesalers as not being in the financial interests of the state.

S.B. 5942 was not the only legislative action on liquor monopoly privatization in Washington State. Legislators introduced two separate Senate bills (S.B. 5111 and S.B. 5933) that, like I-1183, would have completely privatized the distribution and sale of distilled spirits. However, both bills were referred to the Senate Labor, Commerce & Consumer Protection Committee and failed to receive a hearing in the 2011 legislative session.

With the passage of I-1183, Washington State will join 32 other states that have allowed private firms to distribute and sell distilled spirits since the end of Prohibition. Of the 18 remaining “control” states—a term referring to states that have a government-run monopoly on the sale and/or distribution of distilled spirits—Iowa and West Virginia privatized their spirits retail monopoly in recent decades (while retaining their in-house wholesale operation), and Maine has more recently outsourced the operation of its wholesale monopoly to a private manager. Since the end of Prohibition, major shifts in state alcohol systems have moved in a one-way direction toward privatization; while several “control” states have expanded the role for private enterprise to varying degrees, no state has ever shifted from a private regime to a state-run liquor monopoly.

Pennsylvania appears to be the state best poised to potentially follow in Washington State's footsteps by privatizing its alcohol monopoly. First-year Gov. Tom Corbett announced his support for privatizing the state's alcohol monopoly during his 2010 campaign, and upon taking office in 2011, his administration hired the consulting firm Public Financial Management (PFM) to conduct a valuation study for the potential privatization of the Pennsylvania Liquor Control Board's (PLCB) monopoly on the wholesale and retail sale of wine and distilled spirits.

The PFM report found that the current monopoly system provides the state with an average of $97 million in net revenues annually, but that the system's overall profitability has been on the decline as the growth in expenses has outpaced revenues. In fact, the analysis found that if the state fully accounted for indirect costs and other factors, then nearly all PLCB stores would be unprofitable today.

The PFM analysis identified two viable privatization approaches:

Among the key findings of the PFM report:

In a press release announcing the receipt of the PFM report, Corbett noted, “Pennsylvania should not be in the business of selling alcohol. It's time to get state government out of the retail trade business and instead focus on essential public services—that's what taxpayers expect of us.” He added that he would likely sign into law a bill offering a viable privatization alternative to the current system, if it were to reach his desk.

Corbett may get that opportunity in 2012 when state legislators turn attention to House Bill 11 (HB 11), legislation introduced in September 2011 by House Majority Leader Mike Turzai. HB 11 would privatize the state’s wholesale and retail monopoly, creating a limited number of retail and wholesale liquor licenses and auctioning them to the highest bidders under a model consistent with PFM’s “limited retail license” scenario (HB 11 contemplates the auction of 1,250 retail licenses, up from the current 613 state stores). HB 11 would allocate 750 retail licenses to large retailers with stores over 15,000 square feet, with the remaining 500 licenses granted to smaller retailers with a set number in each county. Also, HB 11 would replace current alcohol taxes—including the 18% Johnstown Flood Tax, the state’s retail markup, and the per-bottle handling fee—with a gallonage tax of between $8 and $9 per gallon of wine and $11 and $12 per gallon of spirits, varying based on alcohol content.

At press time, the outlook for HB 11 was unclear. The bill had not yet been heard in legislative committee, and although a range of legislators have already signaled their support, it also faces stiff opposition from the United Food and Commercial Workers Local 1776, which represents approximately 2,500 state store clerks. However, numerous opinion polls demonstrate strong public support for privatization among Commonwealth residents. For example, a September 2011 Quinnipiac University poll found that Pennsylvania voters support privatizing liquor stores by a 62% to 31% margin, with support among all demographic groups.

Virginia is another state with an ongoing policy discussion on privatizing the state’s spirits monopoly. Privatization of the Commonwealth’s liquor retail and wholesale operations was a central pillar of Governor McDonnell’s larger fiscal agenda upon entering office in January 2010, but his first privatization proposal that year—which would have privatized wholesale and retail functions to generate approximately $400-500 million for the state to invest in transportation infrastructure—failed to garner enough legislative support to advance, largely due to concerns that privatization would reduce alcohol-related revenues to the state. (For more details, see discussion in Reason Foundation’s Annual Privatization Report 2010.)

The McDonnell administration made a second attempt in 2011, offering a more limited proposal that would have privatized retail operations—closing the 332 state-run liquor stores and authorizing the issuance of 1,000 private retail licenses—while leaving wholesale functions under state operation. The McDonnell administration hired PFM to analyze the privatization proposal, and the consultant’s January 2011 report found that retail license auctions would net the state an estimated $200–400 million (which McDonnell proposed to invest in transportation) and an additional $13 million in alcohol-related revenues on an annual basis, even with the proposed reduction in the state’s markup from 69% to 50%. Despite a proposal that addressed lawmakers’ previous concerns over ongoing revenues, the administration’s accompanying legislation never received a legislative committee hearing and failed to advance.

Despite the second legislative defeat, Governor McDonnell has indicated his interest in another privatization push in 2012, an effort that could be aided by a transition of the state Senate to Republican control in the wake of the November 2011 election.

In other news on the privatization of state alcohol monopolies:

Leonard Gilroy is director of government reform at Reason Foundation. A version of this article originally appeared in Reason Foundation's Annual Privatization Report 2011, released in April 2012.


Notes

[1] Jason Mercier, Citizens’ Guide to Initiative 1183: To End Washington’s Liquor Store Monopoly, Washington Policy Center, September 2011, p. 4, http://goo.gl/2OQ5f (accessed November 9, 2011).

[2] PFM Group, Liquor Privatization Analysis: Final Report, Commonwealth of Pennsylvania, Office of the Budget, October 2011, p.101, http://goo.gl/aIzN0 (accessed November 17, 2011).

[3] Sebastian Kitchen, “ABC leaders: Privatizing state liquor sales a hard sell,” The Montgomery Advertiser, February 16, 2011.

[4] Idaho State Legislature, Office of Performance Evaluation, Distribution and Sale of Liquor in Idaho, Report No. 11-01, January 2011, http://goo.gl/MDCqb (accessed 10/6/2011).

[5] Associated Press, "Gov. Otter: Don't Privatize Idaho liquor stores,” February 1, 2011, http://goo.gl/bG1Nl (accessed 10/6/2011).

[6] Dawn House, “Push to privatize Utah liquor sales is growing,” The Salt Lake Tribune, April 8, 2011.


Leonard Gilroy is Director of Government Reform


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