Privatizing State Wine and Spirits Stores a Bad Deal for Pennsylvania, New Study Confirms

Date of Press Release: 
February 21, 2012

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As with other public assets, privatization of state stores oversold

HARRISBURG, PA (February 21, 2012) — Legislative efforts to privatize Pennsylvania’s wine and spirits stores have lost momentum in the General Assembly, leading the governor and Senate Appropriations Committee chairman last week to refocus their attention on modifying the existing system. A new study by the Keystone Research Center (KRC) indicates that this change in direction makes sense from a state budget perspective.

The KRC study finds that privatizing state stores would not benefit the commonwealth financially, especially in the long run. Privatization would generate a small upfront fee from companies that buy the right to sell wine and spirits but cost the state millions in lost annual revenue from state store operations. Sensible modernization of the state’s wine and spirits stores makes it even more likely that privatization would hurt the state budget.

“When pushing privatization, the Corbett administration wanted to have its cake and eat it too,” said Roland Zullo, a University of Michigan privatization expert and the author of the new KRC report. “But it’s not possible to achieve a large upfront payout from selling state stores without costing the state substantial annual revenue available now for education and healthy communities. That’s a bad deal for taxpayers.”

Zullo’s report, Beware the Free Lunch, analyzes a report on privatization that was commissioned by the Corbett administration, conducted by Public Finance Management (PFM), and released publicly last October. The consulting firm was tasked by the state with making the financial case for privatization.

Zullo presented a preliminary analysis of the PFM study in testimony before the Pennsylvania House Liquor Control Committee in December. His comprehensive new report finds that the PFM study had significant flaws:

  • In the first year of its projections, PFM’s estimate of the income the current wine and spirits system would generate for the state was off by more than 50%. Actual revenues for this first year are now available and show that the public system generated $104 million in 2010-11, 54% more than the $67 million projected by PFM.
  • The privatization scenario recommended by PFM would have resulted in an estimated $113 million less in revenue for the commonwealth in FY 2010-11 than the current state system actually delivered.
  • Based on West Virginia’s experience in a 2010 auction of liquor licenses, Zullo estimated that Pennsylvania would have received 41% less than PFM projected from privatizing retail stores — $428 million as opposed to $772 million (the average of three projections made by PFM). Zullo adjusted the West Virginia experience based on differences in consumption and population between the two states. Surprisingly, PFM made no use of West Virginia’s 2010 auction.

Zullo also notes that PFM’s comparisons stack the deck against the public system by failing to consider changes that would benefit consumers and generate more state revenue. Last Thursday, Joe Conti, Chief Executive Officer of the Pennsylvania Liquor Control Board, estimated that adopting a series of improvements to the public system would generate an additional $71 million annually. Zullo recommended many of these improvements in the last section of his report.

Underlying the flaws in the PFM study is the difficulty of the assignment it received from the Corbett administration. PFM was tasked with maximizing the upfront sale value of liquor distribution franchises while assuring that the state achieve “revenue neutrality” — that is, collect the same amount of money each year from the wine and spirits industry (e.g., through taxes, annual license fees, or transfers to the General Fund).

To achieve revenue neutrality, PFM built into its recommended model annual retail and wholesale license fees that are at least four times higher than neighboring states; and per gallon taxes six to 21 times those of neighboring states on wine and up to five times higher on spirits.

High taxes and annual fees, however, will drive up prices, reducing sales and profits and leading more Pennsylvania customers to shop in neighboring states. Lower sales and profits will also make businesses unwilling to pay high upfront fees for licenses to distribute wine and spirits. To achieve decent estimated profits from its models despite high taxes and fees, PFM assumed implausibly low operating costs. It justified these assumptions using confidential data that cannot be scrutinized. Zullo shows that PFM’s assumptions are at odds with published data.

The PFM study was likely on target when it indicated that rural consumers would see higher prices, less product choice, and less access to wine and spirits as a result of privatization. This is partly because of a proposed shift to taxing wine and spirits based on volume rather than price. This shift hits lower-cost products sold in rural areas hard: for example, a customer would pay twice as much tax on a two-liter bottle of wine that costs $7.50 as on a $15 one-liter bottle of premium wine. Today consumers pay half as much tax on the cheaper but larger bottle of wine.

While the PFM privatization scenarios are no longer the focus of legislative discussion, it is important to understand the flaws in the PFM study because they drive home a more general point: privatizing state and local assets, including wine and spirits stores, is often a bad deal for taxpayers. In many cases, upfront revenues from the asset sale are more than offset by reduced annual revenues. Legislators are right to scrutinize proposed privatization deals with great care.

The Keystone Research Center is a nonprofit, nonpartisan research organization that promotes a more prosperous and equitable Pennsylvania economy.