Maintaining State Revenue in a Privatized System

This article is one of a series on privatizing wine and spirits sales in Pennsylvania. The full list of articles may be found on the Privatization Index Page.

As the debate rages over whether to privatize the Pennsylvania Liquor Control Board's wine and spirits retail system, advocates on each side of the argument have quoted wildly different numbers regarding the amount of money that the system earns for the state. Wendell Young, the president of one of the unions representing state store employees, says that "selling the Wine and Spirits stores can't replace the nearly $500 million a year they generate for Pennsylvania taxpayers,"1 but the Commonwealth Foundation, a conservative think-tank, says "the state store's annual 'profit' is only around $90 million."2 The PLCB itself says that they earned a profit of $105 million last year, as well as collecting $376 million in taxes.3

All of these numbers are accurate, more or less, but each is misleading in its own way.

Fortunately, we can clarify the situation using data readily available from the PLCB in their annual financial reports.4 In particular, their income statement (also known as a Profit & Loss statement) spells out the PLCB's revenue and expenses in sufficient detail to answer our questions. But first, we need to understand how the state stores set prices for the products they sell.

The Retail Price Formula5

Like private-sector retailers, the PLCB negotiates prices with its wholesalers and then marks up the wholesale price of each item to cover overhead expenses and profit. This mark-up, dictated by PLCB regulations, contains two components: a variable mark-up equal to 30% of the wholesale price, and a fixed mark-up based on the type and size of the product. (This fixed mark-up is variously called the handling fee, the operational cost, or the logistics, transportation & merchandise factor (LTMF).)

On top of the marked-up price, the state assesses an 18% liquor tax.6 This is sometimes referred to as the "Johnstown Flood Tax" or "Emergency Flood Tax," but the flood is distant history. Now it serves as Pennsylvania's liquor excise tax, similar to the excise tax that nearly all states levy on booze. The 18% liquor tax is imposed by state law and goes directly to the state's General Fund, exactly like sales tax, except that liquor tax is included in the shelf price of wine and spirits instead of being added on at the time of sale.

Finally, the price with liquor tax is rounded up by five to fourteen cents so that the final digit of the price is a nine. This is purely for cosmetic reasons.

Let's see this in action, using Old Crow Reserve Bourbon as an example.

Wholesale price7 5.50
30% wholesale markup + 1.65
Handling fee (LTMF) + 1.20
Price after PLCB markups 8.35
18% Liquor Tax + 1.50
Total price with markup and tax 9.85
Final price after rounding up $9.99

As with any non-essential retail purchase, the state levies a 6% sales tax on the retail price, and Allegheny and Philadelphia counties levy a 1% sales tax. This would bring the total amount charged for Old Crow Reserve to $10.59 or $10.69.

From Sales Revenue to State Revenue

With an understanding of what portion of the retail price is taxes, what portion is retailer markup, and what portion is wholesale cost (known in accounting parlance as "cost of goods sold"), we can look at the financial data from the PLCB retail system. The last three fiscal years8 are summarized below:

FY 09-10 FY 08-09 FY 07-08
State and local sales tax collected 112,085,291 109,490,825 102,215,022
Liquor tax collected 271,015,028 266,332,120 250,995,726
Cost of goods sold 1,058,769,004 1,014,032,177 939,780,873
Operating expenses 381,962,459 367,121,231 343,285,606
Operating income9
70,658,946 110,584,357 130,198,907
Gross sales revenue
(total of all lines above)
1,894,490,728 1,867,560,711 1,766,476,134
Transferred to General Fund 105,000,000 125,000,000 80,000,000

Operating expenses include all day-to-day overhead expenses necessary to run the state stores and the associated warehousing and logistics system, including labor, rent, utilities, office supplies, etc. Operating income is the sales revenue remaining after paying suppliers and overhead expenses.

In the table above, the state's General Fund receives three revenue steams from the PLCB: sales tax collected, liquor tax collected, and the final "Transferred to General Fund" line. The taxes are imposed by state law and the stores simply act as tax collectors, just like private retailers do when collecting sales tax. The "Transferred to General Fund" line represents net profit, but it is the net profit from all PLCB operations, not just the state stores.

This bears repeating: the headline number used by the PLCB as the profit they contribute to the General Fund includes revenue from both the retail system and non-retail sources such as certain licensing fees and investment income, less expenses like licensing administration, legal work, education and enforcement programs, etc. While the bulk of this profit does accrue from the retail system, this number should not be used in analysis of store operations.

The most accurate measure of state store profit is the system's operating income, which ranged from $71 million to $130 million over the last three years. During that time, the stores also collected between $353 million and $383 million in sales tax and liquor tax as required by state law, for total net revenue generation of $454 million to $486 million.

Post-Privatization

Now we're prepared to ask the big question: how would privatizing liquor sales affect these revenue sources?
  • Sales tax receipts from off-premise sales would remain unchanged, provided Pennsylvanians continued to spend the same amount of money on wine and spirits after privatization. Receipts from on-premise sales would increase or decrease depending on whether poured drinks would be taxed at the final point of sale under a private system. (Currently bars and restaurants pay sales tax on the liquor they purchase from state stores, and no sales tax is assessed on the per-drink price charged to patrons.)
  • Assuming bars and restaurants would be permitted to buy wine and spirits directly from privately-owned wholesalers, the existing 18% liquor tax would need to be replaced with an excise tax applied at the wholesale level. Until the details of this proposed tax change are published, liquor tax revenue from private sales cannot be estimated.
  • Operating income would need to be replaced with a combination of taxes and fees totalling 4% - 8% of the retail value of wine and spirits sold (or 7% - 14% of sales at the wholesale level). Part or all of this revenue might be accounted for through liquor license fees, as yet undetermined, and existing business taxes that the state-owned stores are exempt from but private liquor stores would be required to pay.
  • A portion of the tax and fee revenue from private stores would need to be set aside to pay for additional license administration and liquor code enforcement expenses which are not incurred under the present system.10
Clearly, little can be said about state revenue under a privately-owned system without having a specific privatization proposal in front of us.

We can, however, look to our neighbors who currently have private liquor sales (known as "license" states) to see how their alcohol tax revenues compare to ours, as a guide to how revenue from our 18% liquor tax might be replaced in a privatized system.

Tax Revenues in Other States

License states impose an alcohol excise tax at the wholesale level, assessed as a gallonage tax based on the total volume of beer, wine or spirits sold. While Pennsylvania's wine and spirits sales are taxed under the 18% liquor tax, beer is taxed at a gallonage rate.

Combined alcohol excise tax revenues from beer, wine and spirits for Pennsylvania and several license states in the region are as follows:11

FY 08-09 FY 07-08 FY 06-07
Pennsylvania 292,302,120 277,284,726 264,549,608
New York 206,452,712 205,252,942 194,221,559
New Jersey 105,487,892 104,101,187 103,293,428
Delaware 15,500,000 14,700,000 14,800,000
Maryland 29,874,000 29,168,000 28,966,000
Massachusetts 71,850,000 71,169,000 70,958,000

Pennsylvania easily tops the list in alcohol excise tax revenue collected. Notably, our revenue is significantly greater than New York's, despite New York having a population roughly 50% larger.

To more clearly illustrate the differences between states, we can divide alcohol tax revenue by total ethanol (pure alcohol) consumed, using state-by-state alcohol consumption rates published by the National Institute on Alcohol Abuse and Alcoholism.12 We obtain an estimate of the consumption rate during Fiscal Year 06-07 by averaging the consumption rates for calendar years 2006 and 2007, the most recent years for which data has been published.

FY 06-07
alcohol excise tax revenue
Est. ethanol consumption (gallons) Tax revenue
per gallon of ethanol
Pennsylvania 264,549,608 22,072,000 11.99
New York 194,221,559 32,391,000 6.00
New Jersey 103,293,428 16,481,000 6.27
Delaware 14,800,000 2,287,000 6.47
Maryland 28,966,000 10,087,000 2.87
Massachusetts 70,958,000 13,474,000 5.27

Pennsylvania clearly stands out here. While most of the other states impose an excise tax of approximately $6 per gallon of ethanol consumed, Pennsylvania's tax burden is nearly double that.

Because all states except Utah tax beer at a gallonage rate, we can estimate the portion of revenue attributable to beer by multiplying the NIAAA beer consumption rate by each state's beer tax rate.13 Subtracting beer consumption and the estimated beer tax revenue from the overall totals gives a rough estimate of the tax revenue resulting from wine and spirits:

Tax rev. per
gal. of ethanol
(beer only)14
Tax rev. per
gal. of ethanol
(wine & spirits)
Pennsylvania 1.78 28.42
New York 3.11 8.31
New Jersey 2.67 8.69
Delaware 3.56 8.68
Maryland 2.00 3.62
Massachusetts 2.44 7.31

Pennsylvania has one of the lowest beer tax rates in the nation (behind only Missouri and Wisconsin), but the excise tax burden on wine and spirits is enormous. Per drink, we pay more than three times the state tax of New Jersey or Delaware, and almost eight times the state tax of Maryland.

If excise tax revenues are to remain unchanged post-privatization, potential bidders for wholesale and retail liquor licenses must take into account the unusually large tax burden that would be imposed on their products. This would likely translate into a competitive disadvantage for retailers located near the state border, where customers have the option to shop in neighboring states with lower liquor taxes.

Future Work

A more thorough treatment of excise taxes will be published here in a forthcoming study, including revenue projections of various excise tax models using detailed sales data from the state stores.

Once a complete privatization proposal is published in the legislature, further analysis can be made of its effects on government revenue.

Footnotes and References
  1. Young, Wendell. "State stores won't fix the budget." Opinion. Philadelphia Inquirer, 5 Jan 2011.
  2. Currie, Katrina, and Nathan Benefield. "Liquor Store Union Distorts Facts to Skew Poll." Commonwealth Foundation. 10 Jan 2011.
  3. Guerriero, John. "State discontinuing 400 wine and spirit products amid movement to privatize." Erie Times-News, 23 Feb 2011.
  4. PLCB financial statements can be found on the Facts and Figures section of their website.
  5. Price formula provided by Stacey Witalec, Director of External Affairs, PLCB. Personal correspondence, 18 Feb 2011.
  6. More accurately, the 18% markup is an estimate of the tax liability generated by the sale of the item. The actual liquor tax remitted by the PLCB to the General Fund is calculated by dividing gross liquor sales by six and five-ninths.
  7. The wholesale price of Old Crow Reserve includes $2.30 in federal excise tax.
  8. Pennsylvania's fiscal year runs from July 1st through June 30th.
  9. The recent trend of decreasing operating income is due to higher pension and worker's compensation costs. This trend will be corrected by an LTMF rate increase. ("PLCB again proves need to privatize." Editorial. Scranton Times-Tribune, 28 Sep 2010.)
  10. The Bureau of Liquor Control Enforcement does not currently perform enforcement checks at state stores as they are not considered licensed establishments. (Boehm, Eric. "State Liquor Stores Face No Scrutiny From State Police." Pennsylvania Independent, 4 Mar 2011.)
  11. State tax revenues were collected from the following sources:
  12. "Volume beverage and ethanol consumption for States, census regions, and the United States, 1970-2007." National Institute on Alcohol Abuse and Alcoholism. Oct 2009.
  13. "State Tax Rates on Beer (January 1, 2010)." Federation of Tax Administrators. 7 Apr 2010.
  14. Calculated by dividing gallonage tax rate by NIAAA standard 4.5% ABV for beer.

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