On February 10, 1992, Governor Wilder requested that the Virginia Department of Alcoholic Beverage Control (ABC) study the existing state-run system of liquor distribution and compare it to private sector liquor distribution systems at the wholesale and retail levels. Price Waterhouse was engaged to examine the following two possible options for liquor distribution:
• Partial Privatization -- the state privatizes the retail function, but retains the wholesale function of liquor distribution
• Full Privatization -- the state privatizes both the retail and wholesale functions of liquor distribution
We identified and compared Commonwealth and private sector roles and specified how these roles would be carried out in each privatization scenario. Using these reference points, we compared the current ABC operations to the operations of both partially and fully privatized systems to identify the impacts that privatization would have.
A. Overview of Current System
Exhibit ES-1 presents an overview of the current system of liquor distribution in the Commonwealth. As presented in this exhibit, ABC is responsible for both the wholesaling and retailing of liquor in the Commonwealth under the current system.
B. Summary of the Impact of Privatization
In Exhibit E5-2 we summarize the quantitative impacts of partial and full privatization. (*1) We assume a revenue neutral scenario in which the state would tax and/or mark-up liquor at a level that would generate the current level of net revenue from liquor sales. The current level of revenue is based on state excise tax revenue and net profits from ABC store sales in fiscal year 1992. The 4.5 percent sales tax on liquor, instituted on July 1, 1992, is not included in the fiscal 1992 revenue figure. Therefore, in order to have a direct comparison between our estimates of the impacts of privatization and data from the current system, we do not include the sales tax in our analysis. In Exhibit ES-3 we summarize the impact of privatization on the distribution of money to the General Fund and local governments. In Exhibit ES-4 we summarize the major impacts of privatization on employment and control.
C. Partial Privatization
Under partial privatization, we estimate that revenue neutrality could be maintained with a 35.9 percent state wholesale mark-up, a 20 percent state excise tax, and a resulting 13 percent increase in prices. Apparent consumption (sales) would decline by approximately six percent, primarily due to the increase in prices. Finally, partial privatization would result in a decrease in the number of ABC employees from the current actual level of 1,023 to 393 employees (*2) Most of the positions to be -eliminated come from the Stores Division.
1. Overview of Model
Exhibit ES-5 presents an overview of a partially privatized system of liquor distribution in Virginia. Under partial privatization, ABC would perform the wholesale function of liquor distribution in the Commonwealth, while the private sector would perform the retail function.
2. Financial Analysis
The state wholesale mark-up and excise tax rate in a revenue neutral scenario would be comparable to those in other partially privatized states. Because prices would not increase significantly in a revenue neutral scenario, we assume that revenue neutrality could be maintained under partial privatization. However, given that prices do increase, Virginians living near the border may choose to purchase more liquor in other states. To the extent that this cross-border activity occurs, maintaining revenue neutrality could be more difficult
Although net revenue could remain constant under partial privatization, the composition of this revenue would change. State excise tax revenue would decrease by approximately 57.6 million, while net profits would increase by $7.6 million. Each of these revenue sources provides revenue to different areas. Excise tax revenue is distributed to the General Fund, while profits are divided between the General Fund and localities after statutory adjustment. (*3) Thus, under partial privatization, net contributions to the General Fund would decrease (net profits distributed to the General Fund would be less than the $8 million decrease in excise tax revenue), while money distributed to local governments would increase. Under partial privatization, the state may choose to undertake measures to ensure that the revenue being distributed to each area remains constant.
3. Employment and Facilities Analysis
The number of state employees working for ABC would decrease significantly under partial privatization. Table ES-1 presents our estimates of the positions eliminated and added under partial privatization. Most of the positions to be eliminated (627 out of the 677 eliminated positions) come from the Stores Division. Given the nature of the eliminated positions, most of the employees who lose their jobs would not likely find other state government positions. However, those that are laid-off would probably be able to find other private sector retail jobs. Even if laid-off state employees remain unemployed, the state unemployment rate would not increase significantly and those laid-off would be distributed widely throughout the state. (*4)
In addition to eliminating positions, partial privatization would require additional positions, as presented in Table ES-1. Most of the additional positions would be gained by the Regulatory Division, which is responsible for enforcement activities. Although there are several types of downsizing costs, such as unemployment and paid leave obligations, the savings from salaries and wages paid over time outweigh significantly these costs associated with downsizing. One-time downsizing costs associated with partial privatization total $10.9 million, while savings in wages and benefits total $25.7 million annually.
Many of the facilities currently in use by ABC would not be needed under a partially privatized system. These facilities include state stores, both owned and leased, land owned by ABC, and equipment. Under phased-in partial privatization, ABC could coordinate a withdrawal from the existing leases without any significant lease-breaking expenses. All property and equipment that is no longer needed would be declared surplus and filed with the Department of General Services to be redistributed to the state or sold to the public.
4. Control and Regulation
In our interviews with interested groups throughout the Commonwealth, such as MADD, PTA, DISCUS, NABCA, and several Virginia legislators, control was often highlighted as the major advantage of the current system. Approximately three-quarters of those whom we interviewed brought up control as a specific advantage of the current system. Most of the concerns raised about a privatized system of liquor distribution involved the loss of control that could occur.
Furthermore, in our survey of Virginia residents, the reasons most commonly given for keeping the current system were that the current system maintained control, limited accessibility, and kept the amount of underage drinking at a low level, as presented in Table ES-2.
Therefore, while partial privatization appears feasible economically for the Commonwealth, policymakers will need to weigh the economics of partial privatization against these concerns before making a decision to change the present liquor distribution system.
D. Full Privatization
Under full privatization, revenue neutrality would require Virginia to institute a state excise tax of $15.43 per gallon (approximately equal to 53 percent of the estimated wholesale price), which is more than 300 percent higher than the average license state excise tax of $3.49 per gallon. This excise tax, along with the wholesale and retail markups, would result in a 32 percent increase in prices. Primarily due to this price increase, apparent consumption would decrease by an estimated 16 percent. The number of state employees working for ABC would decrease by 713 under full privatization. As with partial privatization, most of the eliminated positions are in the Retail Stores Division.
1. Overview of Model
Exhibit ES-6 presents an overview of a fully privatized system of liquor distribution in Virginia. Under full privatization, ABC would primarily be involved in licensing and enforcement activities. The private sector would perform both the wholesale and retail functions of liquor distribution.
2. Financial Analysis
It is not certain whether revenue neutrality could be maintained under a fully privatized system. In order to maintain revenue neutrality, the state would have to implement an excise tax of $15.43 per gallon (or approximately 53 percent of the estimated wholesale price), which is 165 percent higher than the current rate of 20 percent. Prices would increase by 32 percent to an average of $11.23 per bottle. Because of this price increase, Virginians living near the border of a lower-taxed jurisdiction may purchase more of their liquor in other states. Such cross-border activity may cause sales to decline more than initially estimated, fueling further the price increase that results from full privatization. As the price of liquor continues to increase, it appears less likely that the state could maintain revenue neutrality under a fully privatized system.
Under full privatization, net state revenue would be derived solely from state excise taxes. Under the current system, all excise tax revenue is distributed to the General Fund, while net profits are distributed between the General Fund and localities. Thus, under full privatization, money distributed to the General Fund would increase, while money distributed to localities would decrease. Furthermore, money distributed to the Department of Mental Health for the treatment and rehabilitation of alcoholics would be eliminated because the money currently comes entirely from net profits. If the state were to decide that revenue to localities and to the Department of Mental Health should remain constant under full privatization, measures would have to be taken to change the current revenue distribution system.
3. Employment and Facilities Analysis
The number of state employees working for ABC would decrease significantly under full privatization, as presented in Table ES-3. However, the majority of positions eliminated would also occur under partial privatization. Full privatization results in an incremental elimination of 83 positions over partial privatization. Most of the positions to be eliminated (627 out of the 767 eliminated positions) come from the Stores Division. Though most of the laid-off employees would likely not find other state government positions, they would probably be able to find other private-sector retail jobs. As is the case under partial privatization, even if laid-off employees remain unemployed, the state unemployment rate would not increase significantly and laid-off employees would be distributed widely throughout the state.
In addition to eliminating positions, full privatization would require additional positions, as presented in Table E5-3. Most of the additional positions would be gained by the Regulatory Division, which is responsible for enforcement activities, and the Accounting Division, which is responsible for auditing and other accounting functions. Although there are several types of downsizing costs, such as unemployment and paid leave obligations, the savings from salaries and wages paid over time significantly outweigh these costs associated with downsizing. One-time downsizing costs associated with full privatization total $11.8 million, while savings in wages and benefits would total $27.7 million annually.
Most of the facilities currently in use by ABC would not be needed under a fully privatized system. These facilities include state stores, both owned and leased, land owned by ABC, and equipment. Under phased-in full privatization, ABC could coordinate a withdrawal from the existing leases without any significant lease-breaking expenses. All property and equipment that is no longer needed would be declared surplus and filed with the Department of General Services to be redistributed to the state or sold to the public.
4. Control and Regulation
As mentioned previously, control of liquor distribution and consumption is a key concern of many groups in the Commonwealth, and is the reason that many of those we surveyed and interviewed gave for retaining the current system. In contrast to partial privatization, revenue neutrality may not be obtainable under full privatization because of the significant price increase needed. Therefore, as policymakers compare a fully privatized system to the current system of liquor distribution, they will need to consider concerns about control and the uncertainty surrounding a revenue neutral scenario.
E. Conclusion
Price Waterhouse conducted this study to determine the impact of both partial and full privatization of Virginia's liquor distribution system on the Commonwealth, the private sector, and consumers. From a financial standpoint, it appears that the state could maintain revenue neutrality under partial privatization, while maintaining revenue neutrality would be more uncertain under full privatization.
According to our survey of Virginia residents, there is not overwhelming support among residents of the Commonwealth for privatizing the current system, as presented in Table ES-4. Furthermore, a large majority of residents strongly or somewhat disapprove of a privatized liquor distribution system in which liquor is sold in grocery stores and convenience stores, as well as in privately-owned liquor stores. In fact, the majority of residents appear to approve of the current system of liquor distribution. One of the reasons often cited for approval of the current system is that it provides for control over the distribution and consumption of liquor.
As part of this study, we examined how other states handle alcohol. From our examination of five license states, it appears that license states are able to control the distribution of liquor. Based on their experiences, we believe that it would be possible to maintain control under a privatized system of liquor distribution. However, there would probably always be questions about whether a privatized system has the level of control of a state-run system. Virginians still may perceive a privatized system as being characterized by less control than the current system. Therefore, efforts to evaluate the feasibility of privatization will need to weigh carefully the quantifiable benefits and costs against the other, less quantifiable concerns of the citizens of the Commonwealth.
In the performance of this study, we talked to many ABC employees, reviewed documents, and viewed ABC operations. While it was not our primary mission to identify possible areas in which ABC could be more efficient, we indicated that if such areas for improvement were identified, we would report them. From our interaction with ABC over four months, we were not able to identify any areas that obviously could be made more efficient. To the extent that areas for improvement could be identified and successfully addressed, full and partial privatization would probably be less appealing alternatives to the current system.
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(*1) For the Executive Summary, we use estimates for the second year of privatization because of the many one-time costs and cost-savings associated with privatization. One-time costs include former employee benefits that continue for one year, sick/annual leave liability, unemployment obligation, counseling, and vehicle purchases for additional special agents hired. One-time costs total $10.9 million under partial privatization and $11.8 million under full privatization. One-time cost savings include inventory sales and land and buildings sales. One-time cost savings total $10.3 million under partial privatization and $10.5 million under full privatization.
(*2) ABC has 1,175 appropriated full-time positions, but is staffed at a level of 1,023 full-time employees.
(*3) Statutory adjustment money is deducted from profits prior to distribution to the General Fund and localities. The majority of the money for statutory adjustments is distributed to the Department of Mental Health for the treatment and rehabilitation of alcoholics.
(*4) As of August 1992, the number of people in Virginia's labor force was 3.4 million, and the number of unemployed was 200,000, yielding an unemployment rate of 6.38 percent. The 677 positions eliminated under partial privatization would increase the unemployment rate by 0.2 percent, if the laid-off employees remained unemployed.
