More on Why PLCB Privatization is a Bad Idea: State Revenues

As I prepared to do a radio interview with Marty Moss-Cohane yesterday (which you can listen to here), I delved more deeply into the issue of privatizing the state wine and spirits stores than I had before. And it turns out that the arguments for not doing so is even stronger than I had realized when I wrote an op-ed at Newsworks. As the House of Representatives moves toward a decision about this today, I want to explain how I came to that conclusion. This, the first of two posts, will focus on state revenues and show that privatizing the PLCB will blow a huge hole in the state budget requiring us either to raise other taxes or reduce spending for education, health care, and other important common goods. The second will focus on the public harms of alcohol abuse and how privatization of the PLCB will make them worse.

The contribution of the PLCB to state revenues is actually a far more complicated issue than most people realize. But the gist of it is this: the state store system is very effective in generating far more state revenue from alcohol sales than any privatized system could be. Those revenues come at what, from the point of view of free market economics, is a cost: less alcohol is sold in the state than otherwise would be. But the alcohol industry is in fact unique in that there are strong public health reasons to discourage the sale of alcohol.

The state gains revenues from the PLCB in three streams. The first is the “profits” of the state stores, that is, the difference between sales revenues and the costs of the goods sold and the operation of the stores. In recent years this has been about $100 million. If fiscal year 2011-2012 it was $85 million. If we replace the state stores with private retailers, the state will lose all this money.

The second revenue stream is the 6% PA sales tax. In 2011-2012 that came to $123 million. Now you might think that the private sale of wine and spirits would bring in the same sales tax revenue. But that is not the case for two reasons. First, retailers are allowed to keep 1% of the 6 percentage points of the sales tax to pay for the administrative expenses of collecting it and turning it over to the state. Given that the whole process of administering the sales tax is computerized now, this is a crazy provision of state law. But it’s not going to be changed soon. The state stores turn over the full 6%. So the private sale of alcohol would cost the state about $2 million in sales tax revenue. And then there is “leakage” from the sales tax, the retail establishments that cheat. One estimate is that the state lose $800 million a year from tax cheaters. If 5% of the sales tax from the sale of liquor isn’t turned over to the state, which seems about right to me, that’s another loss of $6 million.

If you are keeping track then, we are up to a loss of $108 million in state revenues.

Now what some supporters of privatization say at this point is that we can simply increase the tax on alcohol in order to make up for these losses. But here is the real kicker: We in Pennsylvania already tax alcohol at a much higher rate than most states in the country. And yet our alcohol prices are the same or lower than our neighboring state. How do we do it?

To begin with, our alcohol tax is the 18% Johnstown emergency flood tax. People make fun of the name and the fact that the Johnstown flood happened decades ago. But Pennsylvania never instituted the kind of gallonage tax that other states have—that is a tax per gallon of wine and spirits sold—and just kept the Johnstown tax in place. So despite its history, the Johnstown flood tax is just our version of an alcohol tax. In fiscal 2011-2012 it brought in $298 million.

It’s not straightforward to compare the 18% tax with gallonage taxes in others states, but you can make a rough comparison by dividing the number of gallons sold into the total tax take for both wine and spirits. And it turns out that our tax is quite a bit higher than that found in other states. Our tax falls on wine at an equivalent rate of $5.08 per gallon. The national average is 67 cents per gallon and in New York it is 30 cents per gallon. Our tax falls on liquor at an equivalent rate of $9.60 per gallon. That national average is $3.75 per gallon and in New York it is $6.64 per gallon for liquor over 24% in alcohol strength. In other words, Pennsylvania taxes on alcohol are far higher than in other states. And it shows in terms of the total revenues received from alcohol taxes. New York has 50% more population than PA but its alcohol tax only brought in 206 million. (This data comes from a blog post and excellent report written by Nathan Lutchansky who, I should add, is a supporter of privatization.)

Now here comes the kicker. The alcohol tax in every state is built into the price of alcohol. Yet even though our taxes in Pennsylvania far higher than taxes in other states, the prices we pay for liquor and wine are about the same or even lower, as every report on that subject has found. How can that be?

The answer is that the state monopoly on not only the retail sale but the wholesale distribution of wine and spirits drive down the cost of alcohol in the state in three ways. First, it gives Pennsylvania enormous bargaining power with the distributors of liquor and wine. The PLCB is one of the two or three biggest purchasers of wine and liquor. And it shows in the ability of the PLCB to drive a hard bargain. Second, because the PLCB is a monopoly and doesn’t really want to encourage alcohol consumption, it spends much less than private retails stores on advertising or on creating an ambience in stores that encourages consumption. And, third, the PLCB is both the wholesaler and retailer of wine and liquor and its markup is about 30%. The wholesaler markups for wine and liquor typically run from 18-25%. The retail markup is typically 33-50%. So the total markup in when liquor and wine is sold by private businesses is typically 51-75%.

Now what would happen to the alcohol tax if we move to private wine and spirit sales? There are two options.

Option one is that we reduce the alcohol tax to the levels found in other states. If you go to this website, you can calculate the results of changing our taxes along with the other changes I have been discussing. Plug in the New York tax numbers and the state generates only $130 million in revenue million for a loss of $266 million in liquor tax and profits. . Even if you assume that privatization leads to an 44% increase in the sale of wine and spirits—which in my next post, I’ll show is both likely and likely lead to disastrous public health consequences—the liquor tax revenue is only $188 million in tax revenues and the total loss is $208 million. If the increase in sales is only 22%, which is what some defenders of privatization claim, the liquor tax brings in only $160 million and the total loss of revenues is $237 million.  If you eliminate the Johnson flood tax entirely–which is what some recent proposals call for–the total loss of revenue is $397 million. (Note that these calculations don’t include the loss in sales tax revenues of $8 million.)

Option two is to keep the 18% tax in place. But then two things will happen. In the middle of the state, where there is little competition from retail stores in other states, alcohol and wine prices will increase by about 20 to 45%. That has to happen since the wholesalers and retail markups will be much higher than the state markup and the retailers will have to spiff up their stores and advertise. In areas of the state close to other states, private wine and spirit stores won’t be able to raise their prices so high without losing all of their business to Ohio, New Jersey, Delaware, and New York. So what we will find is grocery stores selling beer and wine at much higher price than other states. And there will be no free standing liquor and wine stores because they simply will not be able to compete with stores across the border. So the idea that a store like Moore Brothers will open in Philadelphia is just a fantasy. It won’t happen. Indeed, we will lose the good state stores we have now on Chestnut Street and in Chestnut Hill. And even with at tax at 18%, we will still lose state revenues because we will lose more sales to others states.

If you don’t think this argument is right, look at what a proponent of privatization, Nathan Lutchansky, has to say on page 4 of the report I linked to above: “It would be reasonable to question whether operators in a free market could offer regionally competitive prices under such an oppressive tax regime [that is the 18% alcohol tax] without the benefit of a state-wide monopoly and the high volume efficiencies that the government owned retail system enjoys today”

So there you have it. In ways that are hard to recognize, we benefit hugely from the PLCB. We have alcohol prices that are about the same as in other states, but we take in around $200 million in state revenues that we could not bring in from private retail stores. There is simply no way around this and anyone who tells you that privatization would not cost state revenues is either bullshitting you or doesn’t know what he or she is talking about. The honest supporters of privatization, like Luchansky, admit that there will be a large loss of state revenues. And that means that we will either need to raise other taxes substantially—something this Governor and legislature will not do—or there will be even deeper cuts in spending for education and other critical needs.

That’s not ideology or opinion talking. That’s plain hard math.