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

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:

  • Dismantle the state’s existing wholesale and retail monopoly by authorizing private distribution and sales of distilled spirits. I-1183 limits spirits sales to stores of over 10,000 square feet (with certain exceptions), which the state expects could increase the number of spirits retailers to 1,428, relative to 328 outlets under state operation. By contrast, I-1100 had no such limitation on store size and was estimated to result in over 3,000 potential new retail outlets. An analysis by the Washington Policy Center reviewed liquor retail outlet density in 11 western states and found that under I-1183, Washington State “would still rank among the top five states for restrictive access to liquor sales [...] and would be the most restrictive non-monopoly-control state in the West.”[1]
  • Authorize the sale of the state’s liquor distribution and liquor store facilities and equipment, including the state’s distribution warehouse.
  • Allow retailers to buy spirits and wine directly from manufacturers, while preserving the existing mandate that retailers purchase beer from wholesalers. While retailers may still choose to purchase spirits or wine from wholesalers, the initiative’s direct sale provisions mark a significant step away from the mandated use of the “three tier” system—where retailers are only allowed to purchase alcohol products from wholesalers, who in turn are required to purchase their products from manufacturers—prevalent across states today. By contrast, I-1100 would have gone further by eliminating the mandatory use of wholesalers for spirits, wine and beer, which generated significant opposition from existing beer and wine wholesalers in the state.
  • Allow spirits and wine manufacturers to offer quantity discounts to retailers.
  • Leave existing taxes on spirits, wine and beer unchanged. I-1183 would also eliminate the state’s current 52% wholesale markup, creating the opportunity for retailers to compete on the level of private markup applied.
  • Create a new retail license issuance fee of 17% of all spirits sales revenue (with payments required quarterly in arrears), as well as an annual license renewal fee of $166.
  • Create a new distributor license fee of 10% of total annual revenue from spirits for the first two years of licensure—which drops to 5% of spirits sales revenue in subsequent years—as well as an annual renewal fee of $1,320 per license. The initiative also authorizes the state’s liquor control board to issue an additional, one-time fee on distributors in 2013 if total distributor fees collected by the state have not generated an aggregate $150 million by March 31, 2013.
  • Give local governments the ability to object to or prevent the issuance of local liquor licenses.
  • Require retailers to train all liquor sales staff on compliance with liquor laws and regulation. Additionally, I-1183 limits the issuance of retail licenses to those outlets that adequately demonstrate effective safety, management and training protocols to prevent sales to minors and inebriated persons.

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:

  • Full wholesale and retail privatization, with limits around the number or types of both licenses. In the “limited retail license” scenario, PFM found that approximately 1,500 retail licenses would be a reasonable accommodation of consumer convenience and license scarcity, and the model could be implemented through an auction process.
  • Full privatization with limited licensing of wholesale, open licensing of retail. Under the “open market retail” approach, PFM estimates there would likely be 3,000 to 4,000 retail licenses issued, and any qualified applicant would have an opportunity to apply for a license.

Among the key findings of the PFM report:

  • The “limited retail license” option would generate more upfront revenue, for which PFM estimated a valuation of retail licenses under this scenario in the range of $730 million and a valuation of wholesale licenses in the range of $575 million, for a total estimated valuation of between $1.1 billion to $1.6 billion.
  • The “open market retail” option would generate less upfront revenue but has the advantage of fewer market restrictions around retail licenses and reduced risk of sub-optimal license auction results. Further, this scenario would generate more ongoing revenue from licensing, so other alcohol taxes would not need to be as high to generate the same level of alcohol revenues to the state relative to the current monopoly system.
  • Upfront revenues from the auction of wholesale licenses would be generated in both retail scenarios. PFM determined that auctioning wholesale licenses by brand was the best option, which would lead to between 10 and 30 primary wholesalers serving the state. Wholesale licensees would pay an initial franchise fee along with annual license fees that support the cost of regulation.
  • PFM estimates that additional sales from the repatriation of sales currently lost to other states (e.g., “border bleed”) will be approximately $100 million under privatization. A September 2011 study by the Commonwealth Foundation found that bootlegging across state lines—in part driven by lower wine and spirits prices in some surrounding states— has cost the state billions in lost sales and tax revenue.
  • PFM recommends that one-time proceeds to the state from privatization could be used to reduce the state’s unfunded pension liability, invested in infrastructure, or used as incentives for economic development.
  • PLCB’s licensing and enforcement responsibility under privatization would remain and likely require increased staffing to accommodate additional licensing activities. Overall, after privatization PFM estimated that the PLCB would likely consist of approximately 290 full-time equivalent positions after the departure of approximately 3,200 retail, distribution and central office staff.
  • With regard to product pricing, PFM estimates price neutrality under the “open market retail” approach and some potential, minor price increases under the auction retail approach. However, the analysis uses a conservative pricing model, and with the expected amount of competition in retail pricing, PFM estimates that “for the majority of sales in Pennsylvania, the product prices will be at or slightly lower” than its model suggests.[2]

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:

  • Alabama: The former state legislator tapped by Gov. Robert Bentley to serve as the Alabama Alcoholic Beverage Control Board’s chief administrator, Mac Gipson, told a February 2011 gathering of state ABC agents that he had reversed his former support for privatization of the state’s spirits monopoly since taking over leadership of the Board, according to The Montgomery Advertiser.[3] Gipson’s change of heart came amid rumors the new Republican legislative majority in Alabama may be interested in exploring privatization, and he warned of potential negative fiscal and law enforcement consequences.
  • Idaho: A January 2011 report commissioned by Idaho's Joint Legislative Oversight Committee found that privatization of the state's liquor enterprise is feasible and outlined several potential approaches.[4] Completely converting to a privatized wholesale and retail system and establishing a liquor tax to replace the current state markup could generate approximately the same amount of revenue as the state receives today. Alternatively, the state could retain the wholesale enterprise and convert all stores to private operation if it continued using a wholesale markup to maintain current revenues. Last, contracting out the operations of the 13 state-operated stores with the lowest sales was estimated to offer $700,000 in potential annual cost savings. The report was met with a cold reception by Gov. C.L. “Butch” Otter, who told the Associated Press in February 2011 that alcoholic beverage control and promoting temperance are proper functions of government under Idaho's Constitution.[5]
  • North Carolina: In January 2011, North Carolina Gov. Beverly Perdue announced that her administration would not pursue privatization of the state's alcohol monopoly. Like Pennsylvania and Virginia, the state hired PFM to conduct a privatization analysis, which found that the state could reap approximately $300 million upfront from retail license auctions and divestiture of the wholesale operation. However, this estimate was based on issuing the same number of retail licenses to match the current number of state-run stores; PFM estimated that one-time revenues could exceed $500 million if additional retail licenses and other systemic changes were approved. In announcing her opposition to privatization, Perdue noted her belief that the current system works well and that she was unwilling to loosen current restrictions on the number and type of retail outlets, operating hours and marketing. Despite the governor's opposition, several state legislators announced that they were still interested in exploring privatization as part of a larger government streamlining push.
  • Ohio: Ohio Gov. John Kasich’s plan to transfer ownership of the state’s wholesale liquor monopoly to JobsOhio—a new nonprofit organization created by privatizing economic development functions formerly performed by the Ohio Department of Development—was approved as part of the 2012–2013 budget. Under the plan, JobsOhio will gain control of the liquor system’s annual net revenues for 25 years in return for a $1.2 billion upfront payment. Approximately $700 million of the proceeds would be used to defease existing state debt, while roughly $500 million would be deposited in the state’s general fund for short-to-near term uses.
  • Utah: The Utah legislature appears poised to take on the issue of alcohol monopoly privatization in the 2012 legislative session, with State Rep. Ryan Wilcox announcing plans to introduce a bill to privatize the state's retail ABC monopoly. The proposal came amid widespread legislator frustration with recent management scandals at the Utah Department of Alcoholic Beverage Control, as well as the agency’s proposed closure of 10 profitable state-run stores in response to a $2.2 million legislative cut to the agency's budget, an outcome temporarily averted when Gov. Gary Herbert later transferred $1.4 million in savings from capital projects to the agency.

    The privatization concept was endorsed by the state Privatization Policy Board, a legislative advisory body on privatization issues that issued a letter to Gov. Gary Herbert in May 2011 supporting retail privatization. “We believe that, although there are difficult political issues, the state should carefully consider the reasons for [...] being in the alcohol business and evaluate ways to move this activity to the private sector,” according to the Board’s letter.

    “It should not be a function of government to sell alcohol,” Wilcox told The Salt Lake Tribune in April 2011. “When the state gets into the retail sales, customer service and performance suffer.”[6] At press time, Gov. Herbert had not taken a formal position but had publicly expressed openness to considering Wilcox’s privatization proposal. More impetus for privatization may come from a November 2011 business plan for the Department commissioned by the state legislature, which recommended an expansion in the use of privately operated liquor retail outlets (known as “package stores”) to generate savings and increase system profits without increasing sales.

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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