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In Final Hours of Session, a Liquor-Bill Compromise Bails Out the Little Guys

Private liquor sales began in Washington last June 1, but details of tax policy have yet to be settled.

Private liquor sales began in Washington last June 1, but arguments about the intent of 2011’s Initiative 1183 continue to rage.

OLYMPIA, July 1.—A last-second compromise on one of the big business-on-business battles of the session brings relief to the small merchants who entered the liquor-store business last year when Washington state privatized the sale of booze. The big boys can keep fighting. But in the meantime, lawmakers say, the little guys need a break.

A measure that passed the Legislature in the waning hours of the 2013 session exempts owners of the state’s former liquor stores from paying a 17 percent tax on sales to the restaurant and bar trade. That allows them to compete on an even footing with the liquor distributors who got into the business when the state exited the booze biz a year ago. But Senate Bill 5644 doesn’t provide the same exemption for the big players – the supermarkets and big-box stores that helped push Washington’s liquor-privatization initiative, I-1183, back in 2011. Meaning that the enormous lobbying battle that was waged between retailers and distributors this session will continue next year.

The surprise compromise emerged on the final day of the session, long after the matter seemingly was battled to a standstill. SB 5644 was approved by wide margins in the House and Senate, 77-5 and 41-5 respectively. “It’s really the ‘liquor lite’ bill,” said state Sen. Doug Ericksen, R-Ferndale. Lawmakers split the smaller merchants from the big ones because it seemed they presented a case for immediate action. Many of the smaller stores already have gone out of business because they have not been able to serve the restaurant and bar trade. “This year we are trying to deal with the regulations to give them a shooting chance to survive in the marketplace,” Ericksen said. “The supermarkets don’t like this legislation exactly, but we have to come back next year and make it a fair and even playing field for everybody.”

A Spirited Battle

Signatures for I-1183 are gathered at a Costco store in 2011.

Signatures for I-1183 are gathered at a Costco store in 2011.

The fight has to do with the hyper-complex system of taxation and market regulation that was established by I-1183. The initiative ended Washington’s “control-state” sales scheme through which all hard liquor was sold through state-owned or contract liquor stores. Jim Beam and Jack Daniels turned up on private store shelves last June 1, for the first time since Washington enacted its own Prohibition statutes in 1915. In the state’s smaller communities, the 167 former contract liquor stores were on their own; elsewhere, private entrepreneurs bid an astonishing total of $31 million for the right to take over the 162 old state-owned stores.

Getting the state out of booze was one thing, but it also was a groundbreaking initiative in the way it treated the back end of the business. I-1183 allowed retailers to sell to restaurants and bars – about 30 percent of the close-to-$1-billion biz. Retail-to-retail sales are prohibited in most other states — sales must go through distributors. And because the measure also allowed retailers to buy directly from manufacturers for the first time anywhere in the country, the initiative in effect established the possibility of a new retail channel, bypassing distributors and eroding the “three-tier” system that has prevailed in this country since the repeal of Prohibition.

Here’s the hitch. A provision of the initiative required that a 17 percent tax be applied to retail sales. Distributors don’t have to pay that tax when they sell to restaurants and bars – they get taxed at other points along the way. And while the interests behind I-1183 maintained they never intended the tax to be applied to products for resale, the state Liquor Control Board said the language was plain. It adopted regulations imposing the 17 percent tax on all sales by retailers.

What it meant was that freewheeling competition never emerged. At this point, because of distribution agreements and other regulatory issues, nearly all product still moves from a manufacturer to a distributor, and distributors sell to retailers. But if a retailer tries to resell that product to a restaurant or bar, he or she must charge at least 17 percent more than a distributor in order to cover the state tax. That essentially has closed off retail sales to the restaurant trade and has shunted all sales through distributors. For chain operators and independent groceries, it has cut potential market share. But for the small-store owners whose only trade is liquor, the problem has been deadly. Right from the start that 17 percent tax wiped out 30 percent of their business.

Sympathy for the Little Guy

It was standing room only at a hearing on the liquor bill in January before the House Government Oversight and Accountability Committee.

It was standing room only in January at a hearing on the liquor bill before the House Government Oversight and Accountability Committee.

Figures from the state Liquor Control Board indicate there are substantially fewer small operators than there were before last June 1. Some 121 former state stores remain in business, and 151 contract stores. But that doesn’t necessarily mean that 57 stores have gone under, because some of those who purchased the right to operate the state’s old stores never got around to opening. They were located in strip malls where non-compete clauses prevented them from selling the same product as nearby grocery-store tenants. Trent House, lobbyist for Clearview Spirits, a former contract store operator based in Monroe, Wash., said perhaps as many as 40 stores have closed their doors in the last 13 months. The more important thing, he said, is that those that remain are struggling. “Clearly, without this legislation, most if not all of them would not be in business 12 months from now.”

The small stores joined a broader lobbying effort launched at the beginning of this year’s session by the big players in the I-1183 coalition – the Northwest Grocery Association, the state Restaurant Association, the state Retail Association. Also lending support was Costco Wholesale, which put up more than $22 million for the yes-on-1183 campaign. The original legislation would have eliminated the 17 percent tariff for all retailers who sell product for resale. Distributor interests battled them every step of the way, and crowds of merchants and restaurateurs made for jam-packed hearings during the first two months of this year’s legislative session. Small-store operators said state regulators pulled the rug out from under them when they said at first the 17 percent tax didn’t apply to restaurant and bar sales – then changed their minds.

But the two distribution companies that dominate the business in this state, Southern Wines and Spirits and Young’s Market Co., complained that the supermarkets and big-box stores were trying to get into the distribution business without paying the same fees and taxes. The snarl of claims and counterclaims brought momentum to a standstill. The issue seemed to disappear from lawmakers’ radar screen by the time the cherry blossoms bloomed around the Capitol. Which made the final-day compromise seem all the more remarkable.

Treats Small Merchants Differently

State Sen. Steve Conway, D-Tacoma.

State Sen. Steve Conway, D-Tacoma.

Lawmakers said they decided to break the small stores from the big ones because they sensed an injustice had occurred. Contract store owners clearly were told initially that they would be able to continue serving restaurants and bars, as they had done under the old state regime, without paying the 17 percent tax. By the time the Liquor Control Board reversed its position in spring 2012, many already had obtained loans and were committed to business expansions. Though the Liquor Board’s position was clear by the time the former state stores were auctioned in April 2012, many of the purchasers, including a high percentage of immigrants, assumed they also would be able to serve bars and restaurants.

“These little players were really left in the dark, and didn’t realize how this was going to impact their model of business,” said state Sen. Steve Conway, D-Tacoma. “Certainly some of the larger players in the liquor business here would like to have a share of that action as well, but I think that this is the smart step at this time. And it will give us a bit more time to look down the road and see what the consequences are of retail-to-retail sales, [in a way] that is much broader in scope.”

Senate Commerce and Labor Chairwoman Janea Holmquist Newbry, R-Moses Lake, acknowledged that some of the larger retail interests opposed the final bill while others remained neutral. “While there are many who would have liked to have been included in this tax relief measure, there will certainly be future conversations in their behalf.”

Sets Stage for Next Year

Bruce Beckett, government affairs director for the Washington Restaurant Association.

Bruce Beckett, government affairs director for the Washington Restaurant Association.

Though the state Restaurant Association was among the interests that remained neutral, government affairs director Bruce Beckett said passage of the measure augurs well for a broader exemption from the tax next year. This year a two-thirds vote was required in order to pass the bill because it amended an initiative within two years of passage. Next year only a simple majority will be required. Beckett said it is highly unusual for the Legislature to tax two classes of retailers at different rates on the sale of identical products.

“It is a get-started approach,” he said. “It is a step in the right direction, and significantly the Legislature adopted a policy that the 17 percent fee should not apply, at least for some retailers, which is kind of an odd policy, when you think about it. So yes, we will be back in partnership, I am sure, with the large and independent grocers and others next year on this issue.”

Passage of the bill changes the dynamics a bit — it’s an issue for the big players now. And by settling the problems for the small liquor-store owners, lawmakers have deprived the I-1183 coalition of a major argument. Next time around, you might not see the small stores fighting on the same side as Safeway and Costco. Even as they presented a united front with the larger retailers this year, some small-store owners argued they deserved an advantage over the supermarkets and big box stores — the larger outlets have the ability to charge less markup for their liquor because of greater sales volume and the fact that they can make up losses through sales of other products. Eliminate the 17 percent tax for the small guys, some said, not the big boys.

Distributors Advocated Measure

John Guadnola of the Washington Spirits and Wine Distributors Association.

John Guadnola of the Washington Spirits and Wine Distributors Association.

John Guadnola, executive director of the Association of Washington Spirits and Wine Distributors, said the bill was lawmakers’ idea, but it is very similar to a proposal his organization advanced during the session. Under the bill, distributors will briefly pay a higher license fee to offset any money the state will lose, making the bill revenue-neutral. “We have supported the approach of giving the exemption to the 17 percent to the contract liquor stores for some time,” he said. “Whether it solves the problem is something you’re going to have to ask the restaurants.”

Guadnola said it makes sense to give a break to the small store owners. But because the big chains have the ability to deal directly with manufacturers, buying in volume and competing with distributors, their situation is different. He points out that the initiative required distributors to make a $150 million payment to the state, but it did not apply to retailers. “They have avoided any participation in the $150 million,” he said. “It is really just an attempt to get into position without paying for it, without imposing the same burdens that you impose on everyone else.”

Guadnola noted that Costco and other members of the 1183 coalition are appealing a court ruling that upheld another regulatory decision of the Liquor Control Board, imposing a 10 percent fee on sales from manufacturers to retailers. Should they win the case, he said retailers would have an unfair competitive advantage over distributors, which must pay the fee. “That is a major part of the problem with the position Costco wants to take,” he said. “They want to be a distributor, but they don’t want to pay the fee.”


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