Privatizing Virginia liquor stores makes sense

By Steven Pearlstein
Wednesday, August 18, 2010

When I first heard Virginia Gov. Bob McDonnell boast that by privatizing the state's liquor system he could generate the same amount of revenue and raise $500 million from auctioning off liquor licenses while holding liquor prices where they are now, I assumed this was just a free-market conservative peddling another cockamamie scheme for spinning straw into gold.

It's not that I have great affection for state-run liquor monopolies. Seventy-seven years after the repeal of Prohibition, you'd think we regard the sale of liquor to consenting adults no differently than the sale of any other good. And if Virginians want to discourage liquor consumption while raising money for governmental purposes, there's this thing called the excise tax that would do the trick without forcing on law-abiding consumers the limited variety, service and convenience of a state-run operation.

But having spent some time this week playing with the numbers, I've come around to the idea that privatization offers Virginians the rare opportunity of a free lunch. The logic goes like this:

Last year, Virginia's 332 state stores sold $675 million of liquor to consumers and restaurants, for which it paid $330 million to distillers. It spent around $130 million running the stores, earned a little extra selling lottery tickets and sundries and at the end of the year delivered about $230 million to the state treasury -- $110 million in excise taxes and $120 million in profits. Because of those monopoly-size profits, along with a higher-than-average excise tax and the lack of retail competition, Virginia liquor prices are somewhat higher than those in the District and Maryland, where there are private markets, but about the same as in neighboring North Carolina, where liquor is also state-controlled.

So how can it be that moving to a private system will make everyone better off -- taxpayers, consumers, and a new crop of retailers and wholesalers that will need to earn a reasonable profit? How is it possible that an anticipated network of multiple distributors and 800 retail outlets operate at a lower overall cost than a monopoly system with one distributor and 332 outlets?

To begin with, it turns out that the larger network of private outlets will be able to operate more cheaply, because most of the liquor will be sold through grocery stores, convenience stores, and private wine and beer stores that are already in operation. They already have most of the infrastructure needed to sell liquor, from stores to cash registers to back-office operations, and can handle the new liquor sales with a relatively modest increase in operating costs. Overall, however, there are potential efficiency savings of $60 million a year over the current system, according to industry executives. Rather than allow those savings to flow to consumers, in the form of lower prices, or to retailers and distributors, in the form of higher profits, the state could capture them by increasing the current excise tax.

There's also no question that Virginia could recapture some of the liquor sales it is now losing to Maryland and the District by offering more stores in Northern Virginia where you can buy beer, wine and liquor under the same roof. The Distilled Spirits Council of the United States estimates that Virginia loses as much as 20 percent of its liquor business to neighboring states because of inconvenience and higher prices, particularly for more-profitable premium brands. By recapturing some of that -- and increasing sales through marketing and promotion -- a privatized system could boost sales by 10 percent and generate an additional $25 million in additional profits and tax revenue.

It's true that those retailers and distributors will expect to earn profits, but thanks to the corporate income tax, they will have to share a portion of those gains with taxpayers. If those firms earn a pretax profit of $110 million -- a fairly standard 15 percent of sales -- that's an extra $5 million that can be thrown into the pot.

Right now in Virginia, restaurants and bars buy their liquor the same way consumers do, by driving to the nearest state liquor store. They not only pay retail prices but also have to deliver it themselves. In a privatized market, they could expect to buy directly from wholesalers and distributors who charge 25 percent less and deliver to boot. The state could capture some of those savings with a sales tax surcharge on restaurant liquor sales, which could generate as much as $20 million in added revenue.

Finally, the state could structure its distribution and retail licenses so that they must be renewed every 10 years, rather than the current plan to have them stay valid in perpetuity. That would give consumers and regulators a chance to challenge renewals and give the state a chance to impose a fee based on the current market value of the license on the open market. A 10 percent tax could eventually raise an extra $5 million per year.

Add it all up -- the operating efficiencies, the increased sales, the additional tax revenue -- and it's not hard to construct a scenario in which sales increase to $740 million, the state gets its $230 million, and the retailers and distributors earn $75 million to $100 million in after-tax profits. And for the right to earn that recession-proof stream of profits, or sell the license to someone else, a well-run auction should be able to generate bids of somewhere between $400 million and $500 million -- money that the governor plans to earmark for badly needed transportation projects, particularly in Northern Virginia.

I admit this may not be the fiscal slam-dunk the retailers and liquor interests claim it to be, and there are lots of non-economic issues to be hashed out. But until there is a definitive plan and a credible economic analysis, Democratic skeptics would do well to keep their minds open and their mouths shut lest they find themselves on the wrong side of Virginia consumers and commuters.

© 2010 The Washington Post Company