Virginia's inner struggle to get off the scotch tax

By Rosalind S. Helderman
Washington Post Staff Writer
Thursday, August 5, 2010; A01

RICHMOND -- For drinkers, a fifth of Jack Daniel's costs about the same wherever they buy it -- about $25 in Virginia and the District, a couple of bucks less in Maryland. But for the governments that regulate that bottle, the difference is as stark as a sip and a chug.

In the District and most of Maryland, just a dollar or two from a fifth of Jack Daniel's goes to government. But in Virginia, where whiskey and every other kind of liquor is sold in state-run stores, more than $13 of the retail price goes to the state.

As Virginia Gov. Robert F. McDonnell (R) prepares to call the legislature into a special session to consider privatizing the state's 76-year monopoly on the sale of hard alcohol, he faces a hard economic fact: The liquor business has been exceptionally profitable for the commonwealth.

Every shot poured and every cocktail downed is another cha-ching for the state, and that translates into hundreds of millions of dollars a year that are used to fund schools, prisons and mental health facilities.

Even after paying all of the expenses involved -- buying millions of cases from distilleries, paying more than 2,680 employees, keeping the lights on and the rent paid at 332 stores -- Virginia's Alcoholic Beverage Control board deposited $248 million in liquor profits, as well as excise and sales taxes, into state coffers during fiscal 2009. And unlike nearly every other facet of government, the liquor business has proved to be essentially recession-proof, taking in $13.7 million more in fiscal 2009 than in 2008.

Regardless of the profits, McDonnell fundamentally believes that running the liquor business ought not to be a government function. He also believes that selling the system's assets and new liquor licenses could bring in a one-time windfall of $300 million to $500 million, which he would use to improve the state's ailing roads. A private system would also mean better selection and more convenient stores for consumers, he contends.

On Wednesday night, McDonnell held the first of a statewide series of town hall meetings in Roanoke, partly to sell the idea.

Legislative challenge

McDonnell and his aides know that to steer a plan through the General Assembly, where one chamber is controlled by Democrats, he will have to convince legislators in both parties that the state will not lose out financially if the system is privatized.

"We're working on a mechanism that would get us as close as possible to the current revenue that ABC generates for the state right now," said Eric Finkbeiner, a senior policy adviser who is leading the governor's privatization effort and plans to unveil a proposal this month.

An examination of the pricing structure for liquor in Virginia, Maryland and the District demonstrates the difficulties involved with coming up with such a plan.

Take, for instance, that bottle of Jack Daniel's, which is the bestseller in Virginia.

Virginia buys the bottle from the distillery in Tennessee for $11.48. The state adds a $1 warehouse processing fee to every 12-bottle case. It also marks up the price by an amount generally set by the ABC governing board with state budget targets in mind: currently 69 percent. Then comes a 20 percent excise tax, one of the nation's highest. After paying the state's standard sales tax, customers plunk down $24.68 for a bottle, whether they live in Lynchburg or suburban Loudoun County.

In private systems, such as those in the District and most of Maryland, the state collects taxes but leaves pricing and profits to businesses. Store owners buy Jack Daniel's from a wholesaler, not the distillery. The businesses add a markup, resulting in a price comparable to Virginia's. But the government collects only sales taxes and an excise tax that is set at $1.50 per gallon in both jurisdictions.

At the District's largest store, Calvert Woodley Wine and Spirits in Northwest Washington, a fifth of Jack Daniel's has been selling recently for $22.90 -- or $25.06 after sales tax. But the D.C. government will make just $2.37 on excise and sales taxes, less than 10 percent of the total sale. At privately owned Camelot Discount Liquors in Laurel, Maryland will pocket $1.43 on a bottle of Jack Daniel's, which has been going for $20.02 after sales tax.

Instead of hundreds of millions of dollars from the sale of distilled spirits, the District collected $10.82 million in sales and excise taxes last year; Maryland took in an estimated $24.7 million.

Montgomery County, like Virginia and unlike most of the rest of Maryland, controls the sale of distilled spirits within its boundaries, but the county sells Jack Daniel's for less and makes less of the profit than Virginia does. Montgomery applies a 27 percent wholesale markup and an 18 percent retail markup to arrive at a price of $19.09, or $20.24 after sales tax. On a retail sale, Montgomery takes in $6.38 and the state collects $1.45.

Profits vs. taxes

"Virginia is clearly capturing the profits that would otherwise be captured by private industry," said William Kerr, an economist with the Alcohol Research Group at the Institute of Public Health in California. "And there's no way to get that money otherwise except to raise the tax."

Finkbeiner said he thinks Virginia can come up with a taxing structure to largely replace liquor sales profits, in part by creating a tax at the wholesale level. State revenue will also rise, he said, in response to payroll and other taxes paid by an enlarged private liquor industry.

But it won't help customers much. Virginia officials concede that prices of mid- and low-range items probably won't drop. They do think, however, that the prices of high-end items will fall, resulting in additional sales and increased tax revenue.

Plus, McDonnell and his aides think Virginians will buy more liquor overall in a private system. That's partly because they envision more stores -- various privatization models call for 800 or more retail outlets.

Those stores may also be more convenient. Under some plans, distilled spirits would be sold at some drug and grocery stores, a sales model prohibited in Maryland and the District.

McDonnell aides think the state could capture sales to Northern Virginians who today cross the border for liquor. They estimate that the state loses 10 percent of liquor sales to Maryland and the District.

"Maryland and D.C. will likely still have a price advantage, but if people are able to buy when they go to the grocery store, if they don't have to make a separate trip to an ABC store, that will boost sales," Finkbeiner said.

Experts with the Distilled Spirits Council of the United States, one of a number of industry groups that has been advising the governor, are skeptical about the state's ability to match the $248 million revenue stream it gets today. According to an analysis by the council, overall government collections on a gallon of liquor would have to reach $25 in Virginia to match the state's current revenue. That would make taxes in Virginia five times the average in other privatized states.

"If you try to impose that kind of tax, you're never going to get the up-front revenue you need. You're taxing away everybody's potential profit," said David Ozgo, an economist with the council, which is neutral on privatization but generally supports modernization of liquor sales.

Some supporters of privatization say the millions of dollars collected by Virginia on liquor sales are a product of the state's monopolistic control over what should be a private industry.

"There's nothing wrong with reducing our revenues by a couple hundred million if it forces politicians to make long-needed cuts," said Ben Marchi, director of Virginia's chapter of Americans for Prosperity, which lobbies for smaller government.

That argument is unlikely to sway leading members of the legislature, whose approval the plan needs.

"I'm open to being persuaded," said Sen. R. Edward Houck (D-Spotsylvania), setting himself apart from members of his party who have made clear their opposition. But to persuade him, must the plan match the current system's profitability?

"Absolutely," Houck said. "We don't need any less revenue than we have now."

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