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Press Release

    Fine Wine and Good Economics

    04/02/2002

    In Virginia last week, federal judge Richard L. Williams struck down the state’s archaic laws against purchasing wine and beer from other states as unconstitutional. Like many other states, Virginia has laws prohibiting out-of-state wineries from selling directly to Virginians, even though it is legal to buy and ship directly from a Virginian winery. The decision, which is on hold until the state can appeal, is an important reminder that states cannot pass laws to protect favored industries or special interests.

    Economist Bruce Yandle refers to “Baptists and bootleggers” to describe how political forces are often used for private gain. In his example, the unlikely alliance championed the prohibition of alcohol for totally different reasons. Baptists were waging a war against sin, while the bootleggers sought to avoid competition from legal alcohol sales. But the phrase is used more generally to describe the odd pairings that develop in the political arena as self-interested parties seek to gain advantage over their rivals through the political process. For example, businesses may join environmentalists in calling for tighter regulations or licensing requirements if they drive competitors out of the market.

    The debate over direct shipment of wine bears all the markings of such a political struggle. Wholesalers are highly prized state-licensed franchises that generate substantial revenue streams. The largest, Southern Wine and Spirits, generates annual revenues of more than $2.8 billion. Most wholesalers deal in large volumes and do not carry the products of small craft brewers and vintners. Roughly 20 of the more than 1,600 vintners in the country produce more than 90 percent of the wine sold in the United States.

    Wholesalers are political creatures and they defend their interests vigorously. In fact, several states have enacted franchise laws on their behalf that prohibit producers from switching to another wholesaler, effectively securing a market for their services. Purportedly, this keeps producers from switching wholesalers after the wholesaler had invested heavily in marketing the producer’s products. Although it is unclear why this is more problematic for alcoholic beverages than for shirts, for example, it is very clear that this creates a guaranteed source of income for the wholesalers.

    The arrival of the Internet provides a new challenge for wholesalers. As with other goods and services, the Internet provides information about small wineries and craft brewers as well a means for aficionados to communicate directly with producers. It is now technologically possible for consumers to purchase directly from a winery that has no local wholesaler. In response to this threat, wholesalers have raised concerns that resonate with a wider group of interests. Specifically, the wholesalers have been quick to point out the possibility of a loss of state revenue on such direct sales, as well as the potential for illegal sales to minors.

    While garnering a broader base of opposition to direct sales than a simple plea for protection against competition, such concerns ring hollow. Catalog and mail order sales have existed for some time, and are a major component of commerce. States face the same issue for orders from L.L. Bean, and there is no reason revenue from beer or wine sales should be addressed any differently. Currently, states cannot require taxes from an out of state vendor unless it has a substantial presence in the state. Similarly, Internet tax questions are much broader than beer and wine sales, and they have been addressed as an issue of national tax policy. Direct shipping of wine comprised at best 1 percent of the total e-commerce sales (which totaled more than $32 billion last year). Shipping is expensive and will naturally limit the scope of the market; the vast majority of sales will be in-state and therefore subject to revenue remittance. Wine shipments are relatively insignificant in terms of e-commerce, making it odd to propose singling them out for special tax consideration. And at least for now, the Internet remains free from taxation.

    Concern over underage sales, an issue bound to capture a regulator’s attention, is also a questionable reason to oppose the direct shipment of beer and wine. While it is unlikely that underage drinkers will order expensive wines and craft beers and wait for delivery, safeguards can be established to address such concerns. A simple signature at delivery goes a long way towards eliminating any abuses. States have the authority to control underage drinking without banning direct shipments. And if underage drinking were a concern, it is hard to understand why states such as Virginia allow in-state shipping from vineyards while banning out of state shipments.

    The Founding Fathers were acutely aware of the lure of economic protectionism and deliberately sought to prohibit states from imposing economic restrictions or regulations on one another. James Madison sought to eliminate the "existing and injurious retaliations among the States" that economic protectionism created. A broader market, with the free flow of goods and services throughout the states, was critical to the development of the nation. To address such problems, the Commerce Clause of the U.S. Constitution (Article I, Section 8, Clause 3) placed authority over interstate commerce exclusively at the federal level.

    With respect to the sale of alcohol, however, there is a constitutional wrinkle. To repeal Prohibition, the Constitution was amended in 1933. The 21st Amendment allowed states to enact laws with respect to temperance, and the trade, possession, or importation of alcohol was required to comply with those laws. Amidst concerns that the bootleggers created by Prohibition would dominate the industry, many states developed a three-tiered system that prohibited producers from selling directly to consumers. The producers were required to first sell to a wholesaler who then sold to retailers who provided alcohol for sale to consumers.

    Many argue that the 21st amendment provided an exemption from the Commerce Clause, which meant states were free to regulate as they saw fit—even if that meant engaging in economic protectionism. Yet federal court cases demonstrate that the 21st Amendment does not trump the Commerce Clause. States have the authority to regulate alcohol sales, but the Supreme Court has made clear that this must be balanced against constitutional protections of interstate trade. Laws that protect local monopolies from out-of-state competition violate the U.S. Constitution. As Judge Williams noted in his recent decision, Virginia’s law was discriminatory because it “has both the purpose and effect of prohibiting an out-of-state entity from participating in direct marketing and shipment of wine and beer to Virginia residents.” The 21st Amendment allows states to regulate issues of temperance; it does not allow them to treat out-of-state suppliers any different from in-state suppliers.

    Ultimately, consumers pay the price for economic protectionism. Choice is restricted and prices are higher. The Internet provides a greater degree of economic integration that makes Prohibition-era laws on the distribution of beer and wine ludicrous. A similar debate over clothing or CD sales would be farcical. Yet temperance laws continue to provide opportunities to wring out more profits from the regulatory system. Arguing from pure economic greed is less appealing than framing the issue in broader concerns about temperance and the welfare of the state. It appears that the Baptists and bootleggers still need each other.