By Anita Kumar
Saturday, September 4, 2010; A1
RICHMOND - Gov. Robert F. McDonnell (R), scrambling to make ends meet in his plan to privatize Virginia's 332 state-run liquor stores, is considering adding a fee on alcoholic drinks sold in restaurants and bars to help make up the $250 million in annual taxes and profits that state stores currently generate, according to Richmond sources familiar with the still-evolving plan.
Under the version of the proposal discussed with industry officials Friday, the drinks surcharge, which would be imposed either as a tax on customers or on restaurants' liquor receipts, would be part of a package of new fees including a per-gallon charge to wholesalers.
Democrats and restaurateurs immediately pounced on the proposal as a tax "on people drinking alcohol," as Senate Majority Leader Richard L. Saslaw (Fairfax) put it.
McDonnell pledged in his 2009 campaign to turn over the state's retail liquor business to private operators as a way to produce a windfall of as much as $500 million to fix roads. And the governor has said that his plan would achieve privatization without depriving Virginia of the nearly $250 million in profit that state-run stores generate.
A Washington Post survey of other states that have reduced the government's role in alcohol sales and distribution indicates that state revenues have often fallen short of politicians' projections. In Iowa in the late 1980s, for example, as a financial crisis brought about the collapse of dozens of farms and banks, officials frantically searching for new revenue shuttered the state's 207 liquor stores and allowed private companies to buy liquor licenses.
The result was not quite what politicians had promised. Private stores opened in new places and kept longer hours, but prices increased by 8 percent so retailers could take a profit, and selection narrowed as the state's free-standing stores were replaced by grocery or convenience stores that often limited their stock to bestselling brands. In 1987, the first year of privatization, the state took in about half of the bounty it had anticipated, according to interviews and news reports.
McDonnell would not comment Friday on the latest reports about his privatization plan, but earlier he said that it will fare better than other states' because they did not privatize correctly, failing to learn lessons from the 32 states that have had privately run liquor sales since Prohibition ended.
"We think they didn't do it right,'' he said. "We think the competition that will be generated for licenses will be significant. . . . Thirty-two states do it. They think the free market works."
McDonnell is considering auctioning up to 1,000 licenses to the highest bidders. The proposal, which would privatize alcohol sales from wholesale to distribution to retail, would allow Virginians to buy liquor at private liquor stores, grocery and convenience stores, and big-box stores such as Wal-Mart and Costco. McDonnell expects Virginia will collect a one-time windfall from a variety of sources after privatization: $34 million from selling off properties such as a state liquor warehouse in Richmond, $160 million from wholesale license fees and several hundred million from auctioning off retail licenses, according to the sources.
The governor has cited research concluding that giving up state control of liquor sales would have no impact on drunken driving or other alcohol-related problems, but several other studies have found an increase in consumption in states where private operators take over from a state monopoly.
McDonnell's government reform commission will get his full proposal Wednesday, after which the governor expects to call legislators back to Richmond for a special session on privatization and other cost-cutting ideas.
As word of the latest proposal reached bars around the state, reaction was critical. Kenny Mitchell, who has managed Murphy's Grand Irish Pub in Old Town Alexandria for nine years, said he welcomes a privatized system if it brings cheaper prices and makes it easier to buy liquor. But not if it brings new taxes.
"More taxes. Where does it end?" he said. "Restaurants are already struggling. Small businesses run this country.''
But sources say McDonnell is expected to argue that any new fees on restaurants would be a wash, because they would be spending less to buy alcoholic beverages from private wholesalers than they did from the state, which charged bars and restaurants the same prices paid by people buying a single bottle.
The governor's plan would go much farther than privatization schemes have in other states, but the mechanics of achieving that goal remain unclear.
Iowa and West Virginia, the only two states that have privatized their retail stores in the past two decades, each made less in license fees and sales of assets upfront than they had anticipated. Maine, which leased out its wholesale operation to one consortium, got an initial revenue boost from its privatization, but continues to collect less money each year than when it ran its liquor system.
Officials in Iowa and West Virginia say the change helped them become more efficient and saved overhead costs. In Iowa, 16 years went by before tax and fee receipts from liquor sales - which fund substance abuse treatment and prevention, aid to localities and the state's general fund - reached the level that alcohol had brought in when Iowa ran its own stores, according to the state's Alcoholic Beverages Division.
Four other states - Pennsylvania, North Carolina, New Hampshire and Washington- are considering privatizing liquor sales. Voters in Washington will choose from a pair of privatization plans later this year, but a recent study concludes that the state and localities stand to lose hundreds of millions if either proposal passes.
Nearly all of the 18 states that retained control over alcohol sales after Prohibition have considered some kind of privatization over the last 76 years, but not all have succeeded.
"It takes a huge effort to try to get the political capital together to change the system,'' said Garrett Peck of Arlington County, author of "The Prohibition Hangover: Alcohol in America from Demon Rum to Cult Cabernet."
The 18 states that stayed in the alcohol business after Prohibition set up vastly different systems. Some managed beer, wine and liquor sales; others, just liquor. A couple had private retail stores from the start. All controlled wholesale and pricing.
Privatization proposals started popping up over the past couple of decades, often meeting opposition from labor unions, businesses or those concerned about higher alcoholism rates or lower state revenues.
Alabama added 425 private stores to its 160 state stores after a 1981 court settlement. In 1991, Ohio saved $25 million by allowing companies to run its 453 stores. Michigan leased out its three large warehouses and shut down 62 smaller ones in 1998.
"Nearly every state has looked at privatizing,'' said James Sgueo, president of the National Alcohol Beverage Control Association. "But no state has totally privatized."
In West Virginia, which lets companies bid for licenses a decade at a time, the cost of operating retail outlets dropped by nearly two-thirds after privatization, but state receipts from taxes and fees also dropped, by about a third, according to the state revenue department.
Maine gradually eliminated state stores and, in 2004, leased its wholesale operation to help close a budget shortfall. The state received a $125 million windfall from the conversion, but now collects less than a quarter of the annual revenue it got from liquor sales before privatization.
"There are individuals who believe the state didn't get the value of a growing business,'' said Dan Gwadosky, director of the Bureau of Alcoholic Beverages and Lottery Operations in Maine.
In Iowa, privatization was "a business decision,'' said Terry Branstad, a Republican who served as governor in the 1980s and 1990s and is running for the office again. "We saved a tremendous amount of money."
Former legislator Rod Halvorson led the opposition to privatization, worrying that it would increase access to alcohol and result in the loss of good-paying, full-time jobs. He also didn't think the state should give up its profits from liquor sales.
"Whenever you can hold onto an income-generating asset, you should,'' he said. "It's common sense."
In Virginia, some lawmakers on both sides of the aisle are skeptical of McDonnell's claim that he can maintain the revenue from alcohol that has been built into state budgets. Sen. Emmett Hanger (R-Augusta) said the Commonwealth Competition Council he chairs concluded that selling off the system likely wouldn't be a moneymaker.
"Government is capable of doing a good job in some areas - and this is an area that I think we have a vital state interest in," Hanger said.
U.S. Sen. Mark Warner, a Democrat who considered privatizing liquor stores when he was governor, supports the concept, but warns that "some of the numbers that I've heard bandied around are wildly optimistic.''
McDonnell says he's confident his plan will be a plus for the state: "I'm going to do what's right for Virginia: Take the best practices of 32 other states and look at what on the one hand maximizes the revenues that I can use for transportation and on the other hand preserves public safety.''
Staff writer Rosalind S. Helderman and researcher Meg Smith contributed to this report.