At the Tumwater Safeway the week before liquor sales opened last June 1, shelves were shrouded in giddy anticipation.

OLYMPIA, Feb. 26.—The state Liquor Control Board finds itself in the hot seat as skeptical lawmakers question a tax decision that kept big-box stores, restaurants and the little guys out of the restaurant trade. After a grilling Tuesday in the House Finance Committee, that decision is looking curiouser and curiouser.

Lawmakers are considering House Bill 1161, a measure that would eliminate a big tax on sales when a retailer sells to a restaurant or bar. The state Liquor Control Board decided last spring that the 17 percent tax had to be imposed under Initiative 1183, the 2011 ballot measure that shut down the state liquor stores and put hard liquor on supermarket shelves. Liquor distributors don’t have to pay that tax, and the effect has been to ensure that they have been handed the trade – some 94 percent of it going to two large national companies. Meanwhile, the little guys say they’re getting the business, all right – they’re losing their shirts.

Jas Sangha of the state Liquor Store Association says some 40 percent of the entrepreneurs who paid $31 million for the state’s old liquor stores at auction last year have either never opened their doors or have already gone out of business. “It is bad,” he says. “There’s a big bloodbath out there, and I feel for those guys, man.”

Tuesday’s hearing before the House Finance Committee showed how quickly things can turn in a legislative session. Just a few weeks ago, the competing retail interests in the state’s new billion-dollar-a-year booze biz were seemingly at each other’s throats. But after a tweak to the measure in another House committee, retailers have patched up their differences. Now the state’s big-box chains, supermarkets big and small and the moms-and-pops are presenting a united front. That has put the central issue into sharp focus – did the state Liquor Control Board overstep its bounds when it decided to impose the tax?

Tuesday’s hearing brought out a startling fact that suddenly casts the decision in a dim light. Anyone might have seen it from the start – the problem is that you actually have to read the initiative to do it. I-1183 says plainly that no tax was ever supposed to be levied.

Wording is Clear

At a meeting just before privatized liquor sales began, the state Liquor Control Board adopted regs that essentially kept the retailers out of the restaurant business.

To understand why this is news to anyone, you have to know something about the legislative process. Few people ever read legislation – certainly never reporters, seldom lawmakers. That nitty-gritty work is left to lobbyists and staffers who spend hours and days parsing the words and tracing the references and boiling down the meanings. They write summary reports, or else they try to explain things during a few minutes in a committee hearing. And so it has gone for one of the most complicated initiatives ever passed by a vote of the people. Initiative 1183 runs on for a daunting 60 pages, laying out the rules for the newly privatized liquor market in Washington state.

So until this point, the argument has sounded as if it is an ordinary dispute over interpretation. The initiative imposes a 17 percent “license fee” when a retailer sells to the general public – everyone agrees on that point. The question is whether the initiative imposes the tax when a retailer sells to a restaurant or bar, for resale. For the most part, the retailers all get their booze from the same place, from the distributors. But because the state imposes a 17 percent tax on retailers when they sell to the bar trade, the markup essentially puts them out of the running. Only a smidgeon of such sales now go through retail stores, mainly for reasons of convenience.

Last May 29, when the state Liquor Control Board adopted its rule, Deputy Director Rick Garza explained that the board was compelled to impose the tax because of the way the initiative was worded. The tax applies to all retail sales, he said. “The new law is quite clear that you must pay that 17 percent fee on your retail to retail sales to a restaurant,” he said. But part of the reasoning also appeared a hangover from the three-tier system that governs the marketing of other alcoholic beverages in this state and throughout the country. American tradition since Prohibition has carved out a distinct role for distributors, routing all sales through them. Even though Washington’s initiative aimed to blur the distinctions by allowing retailers to buy from manufacturers and allowing retailers to sell to restaurants, the board maintained the distributor tier ought to be protected.

Amy Brackenbury, lobbyist for the Washington Food Industry Association.

Retailers and restaurateurs have argued they never intended it to be that way – and they ought to know, because they wrote the initiative. Where the tax issue is involved, they say an even longer-held tradition in this state ought to demonstrate that products sold for resale aren’t taxed further up the chain. What Tuesday’s hearing demonstrated was that there was something more to the argument. Amy Brackenbury of the Washington Food Industry Association dropped the bombshell: “I want to state that I believe in Initiative 1183, there is a provision that makes it clear that sales for resale are not retail sales.”

It’s there, all right. Has been all along. Section 103 (2) states: “A sale by a spirits retailer is a retail sale only if not for resale.”

Interpretation Has Big Impact

The liquor board’s decision to ignore that sentence of the law has had a big impact. For the big-box stores and supermarket chains that pushed the measure, it has closed off a line of business. For restaurant owners, particularly in the state’s smaller communities where distribution is spotty, it has meant they have few choices for supply. But most plaintive are the comments of the small shopkeepers who hoped to build a business on the liquor trade alone – the owners of the 162 former smalltown contract stores that once sold booze under contract with the state, and those who purchased the state’s 167 former liquor stores at auction. They point out that the Liquor Control Board initially told all the players that the 17 percent tax would not apply to the restaurant-and-bar trade, and they say the board’s reversal hung them out to dry. Official minutes of a Nov. 21, 2011 conference call between the Liquor Control Board and liquor suppliers about I-1183 implementation demonstrate that the board changed its position. They contain this exchange:

“Q: Will retail-to-retail sales be subject to this new 17 percent fee?

“A: No, retail-to-retail sales are not subject to the new 17 percent fee.”

So what happened is that the small-store owners ramped up, took out loans and bid liquor-store prices into the stratosphere. There’s one mitigating fact: The board announced its new interpretation in February 2012, when it proposed permanent rules to implement the initiative. The liquor store auction didn’t take place until April. So it at least would have been technically possible for purchasers to know that the board was thinking about changing its mind. But contract-store owners say that for many of them it was too late to turn back; they’d already lined up financing and lease agreements and were scrambling to line up restaurant contracts. And those who purchased the liquor stores, many of them first-or-second-generation immigrants, say they simply trusted the state to make things right.

Says Sangha, “You know, we are the innocent bystanders. This was really pump and dump on a lot of unsuspecting folks, and a lot of people were leveraged and were trusting the numbers that the Liquor Control Board had presented.”

Turned out some of the state’s old liquor stores were in shopping malls where lease agreements forbade the new owners from competing with supermarket tenants. Sangha, who purchased a store in Belfair, is among those who were unable to open. Others who did open learned they couldn’t compete for the restaurant business after all; a number of them have already closed their doors and taken painful losses. Only about 90 of the state’s former liquor stores remain in operation today; about half of those remaining are losing money, Sangha says. Just recently Sangha says he spoke with a store owner who had to turn over $200,000 in inventory to his landlord in order to break his lease. “A lot of us blindly trusted the brand ‘Washington state,’ ” he says.

Committee Raises Questions

House Finance Committee.

At Tuesday’s committee hearing, members gave Liquor Control Board budget manager Mike Kashmar a grilling. Asked state Rep. Cary Condotta, R-East Wenatchee, “Are you aware that the people who bought these liquor stores were under the assumption, and were even told in their pro formas, that this tax didn’t apply and that that was going to be part of their business plan?”

Kashmar offered, “Early on that was the assumption. And February was when we clarified it.”

Kashmar said the board changed its position on advice from the state attorney general’s office. As for the board’s reasoning, he said the law “specifically states all retail sales. It doesn’t give any exemptions to restaurants or wholesale or retail to retail sales.”

Though the committee did not raise questions about the provision of the initiative that specifically exempts sales for resale, members raised other questions. A fiscal note offered by the Liquor Control Board estimates a loss of $5 million in tax revenue if the bill passes. State Rep. Ed Orcutt, R-Kalama, suggested the trickle of restaurant and bar sales flowing through retail stores comes because distributors are serving their markets poorly — but in that case the restaurateurs are paying too much. And Rep. J.T. Wilcox, R-Yelm, honed in on the liquor board’s reversal: “In the private world, if I was a supplier and people had made these kinds of investments and then I changed the rules, then I probably would be sued.”

Battleground is Narrowed

The committee hearing demonstrated that the debate has taken a considerably different tack since the battle began in the Legislature in January. On the one side, the two big distribution companies, Southern Wines and Spirits and Young’s Market Co., continue to argue that competition from retailers is unfair. The initiative requires the distributors to make a big balloon payment this year, somewhere in the neighborhood of $110 million, to compensate the state for the loss of the liquor stores. That makes the case for special treatment, they say. “Costco and the restaurant industry basically wrote this initiative,” said Jim Richards of the Teamsters Joint Council, which represents the distributors’ truck drivers. “After much negotiation they agreed to the tax and fee structure in the initiative. They also spent tens of millions of dollars seeking its passage. Now, about a year later, they are looking to change the results of those negotiations.”

The big switch has come on the retail side of the fight. When session started, the retailers were in disarray. The big chains and the state Restaurant Association also sought to overturn another Liquor Control Board decision that limits sales by most retailers to 24 liters a day – two cases of booze. The initiative said retail sales are limited to 24 liters per sale, but it mentioned nothing about a daily limit. The board maintains the limit is meaningless otherwise. The big players ditched that provision when it became politically troublesome: The small retailers and the state’s small grocers, represented by the Food Industry Association, argued that it would allow the Costcos and the Safeways to dominate the business. There still is an element of big-versus-little in the debate — a similar Senate bill, SB 5644, was amended in committee to eliminate the 17 percent tax for the former state liquor stores and for the former contract stores, but it leaves the tax place for supermarkets and other retailers. Sangha’s association prefers that one for competitive reasons.

However, it appears the House bill has wider support, precisely because it allows all the state’s retailers to serve the restaurant trade. Holly Chisa of the Northwest Grocery Association, representing the state’s larger chains, said the House version “has broad support from the retail community, from former contract liquor stores in small communities, to large retail stores in urban areas,” she said. “Retailers want the opportunity to provide quality service to our local restaurants and provide them with spirits they can’t get from a distributor, and to work within our own communities.” If there is a loss in tax revenue, she said it is more than outweighed by the additional liquor-tax revenue generated by the initiative, as well as business and occupations taxes paid by retailers.

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