down all morning

Washington State voters love initiatives. Some say that it is our socialist roots to thank or blame – depending on your persuasion – that has driven us to lead from the masses, rather than the top. Initiative 3 passed in November 1914, which banned the manufacturing and sale of alcoholic drinks. The initiative passed with 53% of the vote, although it was opposed by many, including like the Seattle Times.[1] The United States entered the Prohibition era in 1920 after ratifying the Eighteenth Amendment. Proponents of Prohibition included Progressives who argued that the presence of liquor unfairly damaged minority communities. Other groups that supported Prohibition included women, rural citizens and the KKK. A common bond among some of these groups was their roots in the temperance movement which advocated for traditional values.

Bootlegging became rampant across Washington State and the whole country. During prohibition, California grape growers increased their land by about 700% because of individual demand to develop their own wines.[2] Grape concentrate became very popular during the era, but forced to include a disclaimer with steps to ensure that the concentrated was not turned into wine. My own well-natured grandfather manufactured his own alcoholic blend in the basement of Bagley Hall at the University of Washington. Growing up, I never once saw him take a drink, but it’s hard to know what you’ll do for something until you’re told you can’t. Opposition to Prohibition largely grew from urban environments where some of the country’s largest illegal alcohol manufacturing and consumption occurred. In 1932, Washington repealed the state Prohibition laws by way of Initiative 61 with 62 percent of the vote, larger than the amount than initially passed Initiative 3.

Prohibition ended nationally in 1933 as the 21^st Amendment was passed, something that Franklin Delano Roosevelt promised while running for President. Before the amendment was passed however, Seattle created an emergency ordinance that banned the sale of alcohol above 3.2 percent within 2 miles of the University of Washington and within 500 feet of any lower education school. The 3.2 percent distinction was created because city officials did not believe that alcohol 3.2 percent or below was actually intoxicating.

It was actually a Senate Bill, not an Initiative that created the Washington State Liquor Control Board (WSLCB) that still regulates the state liquor market. Beyond regulating manufacturing and distribution, the WSLCB also oversees distribution of liquor licenses to establishments that wished to initially, sell beer and wine. Later, laws were passed that permitted serving hard alcohol in establishments, all done of course through initiatives.

In 1948, under Washington State Initiative 13, proponents tried to make beer and wine sales occur solely by government. The initiative was soundly defeated with 74.3% voting against it. On the other side of the coin, in 1972, Initiative 261 was put on the ballot, which would privatize liquor sales in Washington State. It was defeated with 55.1% of the vote. This occurred during a transformational period in the state and country, where alcoholism and alcohol abuse became recognized as an illness rather than a choice.[3] Washington State has continued to sell hard liquor through state run liquor stores, grossing $222 million in fiscal year 2009 through taxes and $101 million through revenue.[4]

Two Initiatives are on the Washington State ballot in 2010 that would privatize liquor sales, Initiative 1100 and Initiative 1105. There are differences between the two in terms of implementation of privatization, which leads to some concern as to the effects if both are passed in November. It’s likely that the proponents of Prohibition in the early 20^th Century would oppose modern privatization efforts for the same reasons they initially fought to outlaw alcohol. The effects of privatization could very well have damaging social costs unless implemented very carefully with a pigovian tax that sets the taxation amount to the marginal social cost. The challenge with doing this of course is estimating these amounts.

However, before diving too far into specific issues being debated within the proposed initiatives, it’s important to first understand the general issues being debated within the argument of liquor privatization.

The Issues

The primary issues being debated when it comes to privatization of liquor are underage drinking, small business effects, state finances and social costs. While the most important issue is in the eye of the beholder, each is worthy of separate analysis to determine the effects of privatization on each.

Underage Drinking

It is difficult for one to research much into policy surrounding alcohol of any sort without quickly finding an argument against privatization because of concerns around underage drinking. The argument is not without merit, 31.31% of people in Washington State between the ages of 12 and 20 reporting to have had at least one alcoholic drink in the past month.[5] This behavior can have a lasting effect on these people’s lives, even heightening the possibility of alcoholism later in their life. The question however, is whether or not underage drinking is positively correlated to the presence of privatized liquor stores in the State of which the person lives.

Since underage drinking is a large part of the social issue that privatized liquor presents, I decided to conduct my own multi-variable analysis on the issue across all 50 states and Washington D.C. The reason is that the argument of underage drinking being affected by privatized liquor doesn’t seem to have been explicitly studies across all states. Rather, statistics utilized by anti-privatization advocates include compliance with alcohol in privatized vs. non-privatized states, which favor non-privatized states as compliance tends to be more stringent in government run stores. Holding underage drinking held as the dependent variable, I included the following as independent variables:

• Percent having 5 or more drinks in the past month (binge drinking)[6]
• Gallons of Liquor Drank Per Resident Per Year[7]
• Presence of Privatized Liquor Sales
• High School Graduation rate[8]
• State Median Income[9]
• Single Parent Households for Children Under 18[10]

The analysis is by no means scientific as the sources are disparate, but my hope was to analyze what precisely affects levels of underage drinking. Below is the output stemming from my analysis, which includes an acceptable R Square of .68 which implies that the variables analyze explain a large portion of the variability between underage drinking levels across states.

What surprises me most from the analysis is that the presence of privatized liquor sales across states is actually negatively correlated with underage drinking. The larger factors that appear to be related to underage drinking are binge drinking levels and also single parent household levels. Based on this analysis advocates for lowering underage drinking might best focus their efforts on reducing the amount of alcohol consumed in one setting, or the consumption patterns by alcohol consumers.

Additionally, continued support for services in areas that have high proportions of single parent households may also achieve better results than simply stopping privatization of liquor. The laws of supply and demand state that when quantity supplied of any good increases with a relative price decrease, the quantity consumed will increase. However, this does not necessarily mean that underage residents will increase consumption even if relative access is higher. This research shows that underage drinking may be more of a factor of environment and choice rather than access.

Small Businesses

Small businesses are split over whether they should support privatization of liquor. Grocers and other convenience stores that would benefit on the bottom line from privatization are generally in favor of privatization. However, the Washington Brewers Guild is adamantly opposed to privatization because of the impact they believe it will have on their members.[11] The guild claims that by privatizing liquor, prices will be driven down by large retailers like Costco, who will then ask for large price discounts. The argument goes that brewers will need to sacrifice revenue in order to compete on shelves now crowded with other liquor. This means that large liquor producers would beat out smaller producers because of their ability to scale at low prices over high volume.

 If we presume that competition is always good, then the Washington Brewers Guild’s argument makes sense for some of their members’ self-preservation, but nonsense from the perspective of individual consumers and the market as a whole. By allowing more enterprises to enter the market, consumers are better off, and innovation is likely to occur through natural creative destruction. If a new enterprise is able to provide a better product or the same product through lower costs, then they will naturally win in the market. It is up to governments and communities at that point to create ordinances that manage social costs and cap ability for enterprises to freely operate as they would without any regulation.

Small grocers and convenience stores have mixed feelings about privatization because through privatization, a proposed license costs $1000 annually meaning that they simply cover that fixed cost, and any profit above that is theirs to keep. However, there are other costs to grocers and other small businesses that may be affected by privatization. For instance, big box retailers like Costco would likely be able to set prices much lower than smaller stores, and even create private label versions of liquor for even deeper discounts.

Chris Gregoire said in January 2010 that if Washington State goes the way of auctioning off liquor licenses like West Virginia, [12] “You'll have what they have, which is Rite Aid sells all liquor, is that what you want in Washington state?” However, she later said, “Do you want liquor sold at street corner stores all across the state of Washington?"[13] These contradicting arguments go at the core of the business issue as politicians are concerned about large businesses running the liquor business, but are uncertain if they prefer a potentially higher social cost should small businesses operate in the industry. While these concerns are often brought up by small business consortiums, it is no different than competition within other goods.

Other Social Costs

Privatization of liquor without a proportionate tax increase would almost guarantee increased consumption of liquor through competition and lower prices. Financially, this can be a positive thing for the collecting body, but socially it can be damaging.

In a state like Washington that relies on a Sales Tax for the majority of its revenue, a recession like the most recent one is devastating to the budget. Social services are cut and employee levels are leaner than normal lean amounts. Governor Chris Gregoire has even suggested selling naming rights to highways and rest stops as a way to decrease the budget gap with what services require and what the state has.[14]  With potential increased alcohol consumption, so too would increase needs for services like alcohol counseling and treatment programs that are continually being trimmed. Law enforcement would likely need to increase for alcohol related crimes. The only way to mitigate these issues would to pass a Privatization law that includes a large amount of funds for social services.

Additionally, sales taxes are called “regressive taxes” because they disproportionally tax less advantaged individuals. Alcohol sales taxes are exactly the same, and increasing consumption would continue to disproportionally tax the less advantaged, which also hurts people that need help the most. This is part of the greater social cost that needs to be considered, and can potentially be combatted through city ordinances as found in Seattle’s Pioneer Square neighborhood.

Finances

In theory, finances should be able to be constructed in favor of the highest gross margin for government when privatized. Since privatization would allow businesses to compete on price, consumption will increase, and even at the current tax amount, come close to the same revenue as with state operated stores. In addition, with state stores closing, there would be an enormous reduction in fixed costs. If the government prefers the current consumption rate of liquor, there could be taxes imposed high enough that prices would drive consumers to consume less than they normally would under privatization.

At the current consumption rate, with zero selling and marketing related fixed costs, government gross margin with higher taxes would be much higher with liquor privatization. There would need to be some account for the fact that sales tax revenue will be lower per bottle as large retailers like Costco would undoubtedly begin carrying private label brands for the fraction of what name brands cost to the consumer today. This would create an interesting economics decision to be made by the WSLCB in order to predict consumer behavior based on quantity and price.

The primary fixed costs associated with privatization for the government would be the WSLCB’s overhead from distributing licenses to retailers. Some proposed ways of doing this include cap and trade, so that there would be limitations on the number of stores that could appear. Additionally, in certain initiatives, the WSLCB would be involved with setting taxation amounts based on desired revenue and consumption amounts.

In terms of costs, I looked at positions that would likely be eliminated from government payrolls, which ends up being about $31.5 million per year.[15] About $14 million of the change is from retail workers and $12 million is from retail managers. These costs do not include health benefits, pension or any other government expenses from employing them. Additionally, transitioning them should privatization occur would also not come without cost. Options would likely include retraining and/or unemployment income, but considering them one-time costs, they are not included as part of this analysis. However, based on looking at the WSLCB’s current budget allocation against 2009 salaries, employee salaries are about 21% of the entire operational budget.[16] While this percentage is likely low as the result of large purchasing, if we extrapolate the retail employee salaries at the same percentage, there is a potential cost savings of $150 million per year for salaries and other operating expenses.

One major gap in financial plans within arguments for and against privatization is the description of liquor within the general market. In fact, liquor is a substitute good for other alcohol beverages, so calculating revenue for liquor only is a significant mistake. The ability for liquor to generate revenue in the market depends on it price within the greater alcohol beverage market. As a result, a proper implementation would need to walk the line with keeping taxes low enough that enough people purchase liquor when faced with the option of purchasing other alcohol beverages but high enough to generate to tax revenue worth the implementation.

Lastly, it is important to understand the timing of revenue and cost with a new privatization program. There would be significant one-time costs as previously discussed with closing retail stores and transitioning its retail workers to other careers. Additionally, the work of projecting new taxes would not come without great expense. Recognition of tax revenue from private retailers that begin to sell as a result of privatization would take at least one full calendar year from the time a law is enacted, which means there would be a period in which revenue is down by large margins while costs are extremely high. This likely means that the WSLCB would run at a net deficit for the transition period.

2010 Privatization Initiatives

This paper is not necessarily based on whether the aforementioned 2010 Privatization Initiatives (Initiative 1100 and Initiative 1105) should be passed or failed, but rather if privatization of liquor should occur at all in Washington State. However, it would be irresponsible to ignore these two initiatives which have potentially large implications across several issues.

A primary difference of distinction is that I-1100 prescribes a new tax structure of 10% sales tax on alcohol sold to restaurants while I-1105 prescribes a new tax of 1% and 6% of gross liquor sales to distributors and retailers. I-1100 would keep existing taxes on liquor while I-1105 would repeal taxes applied to liquor and would task the WSLCB with proposing a new taxation system that would match current liquor revenue plus $20 million for each of the next five years. The challenge with any taxes mandated by non-experts is that they are based on the information and research they’ve reviewed. Based on my experiences researching for this paper, I would deem most of the Initiatives’ estimates as just that, which makes their financial directives very dangerous.

One thing noticeably absent from most financial analysis of the two initiatives is mention of cost, as privatization of liquor would significantly decrease financial cost as the result of closing down stores. It is dangerous to include analysis of revenue without costs, but for the purpose of simple explanations, the table below is included from the Washington State Budget & Policy center which summarizes the key differences on proposed key changes to Washington State’s liquor laws.

Source: Washington State Budget & Policy Center[17]

One significant concern for the 2010 election in regards to I-1105 as previously mentioned is that it would repeal sales taxes entirely, with the WSLCB tasked with deciding on a new taxation rate to apply in order to ensure the proper amount of revenue. The challenge is that another initiative on the 2010 Washington State ballot courtesy of Tim Eyman, Initiative 1053, would require a 2/3 vote in order to raise taxes.[18] This means that the Initiative could repeal the taxes, and then have the uphill battle of trying to raise taxes in a legislature of mixed political agendas. The potential loss on this is the current $101 million from taxes, although that number should be lower as state stores would also be lower, reducing overhead.

It is additionally possible that both initiatives would pass, which would create opposing directives that would need to get sorted through at the legislative level.

There is a philosophical question in whether one should vote for an initiative based on the threat of another initiative passing, but that is an individual decision to vote based on belief and let the cards land where they may.

Conclusion

Should liquor be privatized in Washington State? Probably.

If done properly, state revenue can be increased through sin taxes while keeping consumption at acceptable levels. This would need to be done hand in hand with law enforcement and public safety officials to assure that proper budget is then allocated to social services should consumption increase. However, the period in which it is enacted needs to be one where the State of Washington can allow the WSLCB to run at a deficit based on extraordinary one-time costs that will occur as the result of needing to shut stores and plan processes and tax structures for licensing retailers and collecting taxes.

Should Washington State pass the two initiatives in 2010? Maybe, but if one is passed, it should probably be Initiative 1105.

Changing taxes is a very delicate subject. Once a tax is established, any deviation feels significant, and Initiative 1100 would set taxes, making it very difficult to change later. Initiative 1105 would task a worth group, the WSLCB, with setting a proper taxation amount in order to maximize revenue and also based on an acceptable social level of consumption. While dangerous in a year that Tim Eyman’s Initiative 1053 could essentially block any tax increases, it is also dangerous to arbitrarily set a tax amount without a deep exploration of its costs and benefits.

The implementation period will incur extraordinary one-time and likely cause the WSLCB to run at a deficit when budgets are already very tight. A primary reason for current popularity of the two initiatives is using privatized liquor as a way to decrease the gap in the State’s budget. Initiative 1100 would have the best chance of doing that because new taxes would instantly be enacted, but might be harmful in the long-term due to prescriptive taxes by non-experts. While Initiative 1105 would be the best long-term solution, its exploration process would be damaging in a fragile budgetary environment.

However, I do not believe that either of these initiatives can stringently draw a line from revenue to social services that will be needed at least in the short term as a result of privatization, which makes them risky. Given the shaky ground that most services stand on today as a result of slashing major budgets might push them even further should their demand increase.

Philosophically, privatization should occur because there is no sensible reason for the government to need to be in charge of distributing liquor based on the way that our society has set up retail sales for other “sin” goods like beer, wine, cigarettes and guns. However, this does not mean that either Initiative 1100 or Initiative 1105 is the proper way to go about privatizing liquor. It comes down to a question of philosophy and finance, is the potential of more gross margin worth the risk associated with certain stress on social services? The answer will likely be stated at the poll this November.

I noticed a post by an old college friend on Facebook who works for the Wisconsin Democratic Party with a new political ad campaign against Scott Walker, a Republican running for Governor of Wisconsin. While I know little about Wisconsin politics, what I find interesting, is their use of the "flip flop" argument against Mr. Walker (with a twist of Transformers).

However, many cases, including John Kerry result where data and/or facts have changed, resulting in a different claim. This begs the question, for what are officials elected? Are they elected to deliver specific votes on specific issues, promised through the bond of a vote? Or rather, should officials be elected based on trust in their judgment to act in the interest of the greater good when presented with data?

The reason that campaigns are run based on promises of future tactical action is likely because the public demands it. A more rationale way to evaluate candidates is to analyze how they acted on specific types of available data, as it is more representative of how they will act in the future. It will be interesting to see how the discourse comes into fruition for this Fall's elections, as the arguments should center around how one candidate performed during a recession (where results will not be measured in isolation of greater economic challenges) versus another which will measure results in isolation.