The Political Hangover of Prohibition

This is a guest post by Craig Roche, a data scientist and artisanal landlord.

Whiskey is very easy to make.  Farmers used to make it at home using their crops, and Henry Ford designed the Model T to run on home-distilled ethanol.  George Washington distilled 55,000 bottles/year when he retired from being President. Even the mutineers from the Bounty set up a still on Pitcairn Island, and proceeded to get rip-roaringly drunk for weeks at a time. Whiskey is also very cheap to produce;  a bushel of corn ($5 or so), plus 60 cents worth of natural gas can produce 11 liters of automobile-grade ethanol, which, when suitably diluted and aged for drinking purposes, can fill 35 bottles.  Whiskey for human consumption requires higher-quality inputs, more energy for multiple distillations, and additional handling, but even so, decent hooch can be produced for less than $2/bottle. In the 1830s, the equivalent of a bottle of whiskey went for about $5, and Americans responded by guzzling roughly one each week per capita; as young children generally abstained, actual drinkers drank substantially more, all of which was tax-free.

If we assume that the desire to drink, especially among the poor, is an important motivation in peoples’ lives, you would expect alcohol markets to shed light on political conditions across states.

Jack Daniels is the world’s most popular brand of whiskey, and is widely distributed in every state in the US in a standard 750ml container; it is produced fairly close to the mean center of US population, so it should therefore work as a good lens on alcohol politics. Left to a free market, one would reasonably expect that the cost of a retailed bottle would vary with transportation costs, and somewhat with labor rates, or alternatively, that lower-income consumers would spend about the same fraction of their income on Jack Daniels across the USA, or in other words, that the working time per bottle would be constant.

To test this, I researched the cost of a standard bottle of Jack Daniels in each of the states at a high-volume liquor store in the largest city in each state, and compared it to the average wage at the 25^th percentile:

Figure 1: Labor Cost of Jack Daniels (Image source: Craig Roche)

The results were not what I expected. It turns out that the constant-working-time-per-bottle hypothesis is not even close.

Whiskey and Taxes

New York, where I grew up, was among the last states to raise the drinking age to 21 years old, and NYC has traditionally had a permissive attitude towards alcohol, and relatively few drivers on the road; one would expect that to lead to lower prices relative to incomes.  However, this is definitely not the case; the high-volume liquor store I polled (in Midtown Manhattan) charged $32.57 for a bottle of Jack Daniels, while the same bottle retailed for $18.22 in Arizona.  Even though NY workers earn more per hour than their counterparts out west, wages for those in the bottom quartile only vary by about 10%, vs the nearly 80% difference in booze prices.

This seemed even more confounding when one considers that neither state has particularly high alcohol excise taxes – as shown in the chart below, NY’s taxes are only about $.75 higher per bottle than those of Arizona.

 Figure 2: Excise Taxes by State (Image source: taxfoundation.org)

Even more interesting, Washington and Oregon are the highest alcohol taxed states, yet an average worker need only work for around 2 hours per bottle, while New York and Kansas drinkers, both paying low taxes, have to labor for an additional half hour.

Even average wage data doesn’t fully explain the difference.  One might expect that high wage states such as Washington and NY would have higher ‘sin’ taxes to deter excessive consumption, but this isn’t true either.  Oregon and California have identical wage rates for lower-income workers, but Oregon’s taxes are 600% higher. Likewise Mississippi and West Virginia both have workers making around $9.40/hr, but Mississippi’s taxes are five times those of West Virginia.

Figure 3: Hourly Wages by State (Image source: Craig Roche)

The only rational explanation for the extreme differences of prices relative to wages is politics.

Politics and Prohibition

In 1920, the USA passed the Volstead Act, instituting Prohibition. As would be expected, this was only partially successful in reducing consumption. As home-winemaking was allowed, the Pennslyvania Railroad was ‘forced’ to build an entire new freight terminal in New Jersey to handle the influx of wine grapes from California. Likewise, the bill for bribing police and politicians in Philadelphia often approached $50mm monthly, and politicians and gangsters teamed up to extract massive fortunes from the drinking public.

In 1933, the USA ratified the 21st Amendment to the Constitution, and returned alcohol regulation to the various states and their politicians.

When Prohibition ended in 1934, regulation of alcohol was left to the individual states under a three tier system, comprised of:

1. Producers, who make alcoholic beverages and sell them to…
2. Distributors,  who distribute them to…
3. Retailers, such grocery and liquor stores, and bars

This system was ostensibly set up to ensure that beer brewers didn’t buy bars and try to maximize sales volume; it was designed to be inefficient.

What most histories ignore, however, is that the system was set up by politicians, many of whom had been receiving payoffs from bootleggers and speakeasy owners for the preceding thirteen years.  At the same time, the 21^st amendment was passed ostensibly to raise tax revenue for the states, and to provide employment for workers during the Great Depression.  So individual politicians had competing public and private interests:

• To maximize the public welfare by keeping alcohol prices low
• To maximize employment by creating bureaucracies and inherently inefficient regulations
• To maximize tax revenue by extracting as much revenue from “sin taxes” as possible
• To gain votes for re-election, either by appealing to teetotalers or by creating a bureaucracy of government workers
• To extract campaign contributions, patronage, and (in some cases) personal wealth through kickbacks or outright ownership of corporations by creating regulatory monopolies in one or more tiers, or by controlling the licensing process

The way that politicians have navigated these competing interests have created the hodge-podge of laws, and help explain the wide diversity in costs for liquor in the US.

Let’s look at some interesting examples of how these competing priorities influenced the laws (and prices) in each state:

States with Major Alcohol Producers

Several states are major producers of alcohol.  California and Oregon have huge numbers of vineyards, and Wisconsin, Colorado, and Missouri were traditional beer brewing states owing to the German heritage of many settlers.

As vineyards generate huge numbers of job, California has some of the most liberal laws on wine sales, shipping rules, and has very low taxes – the laws in California appear to be designed to maximize employment in the wine industry and to encourage wine tourism.  Missouri, home of Anheuser-Busch, has some of the most liberal alcohol laws in the country, and is one of the few states that allow drinking in your car.  However, as I’ll show later, Missouri has expensive distributors who have used regulations to lock–in their positions, leading to higher prices than in the free-er states of California and Colorado.

States with Cultural Sensibilities Against Alcohol

Today, it is hard to believe it, but at one point alcohol was as much a religious and social wedge issue as abortion is today.  In general,  Southern Protestants and LDS (Mormons) were ‘Drys’, while Northern Protestents, Catholics, Lutherans, and Jews were ‘Wets’, and opposed Prohibition.  When the 21^st Amendment passed, it explicitly allowed local politicians to continue to ban alcohol within their borders; some states (such as Kansas) had constitutional prohibitions against alcohol that continue into the present day; in fact, until 1987, you could not get a drink in a bar in Kansas. Even New England got into this game, until 2006, you could not buy a six-pack of beer in Arlington, MA, the town directly outside Cambridge, MA (which hosts Harvard and MIT), and you still cannot open a package store there.

Figure 4: Dry Counties in the United States. (Image source: LDS Church)
Red = dry counties, yellow = mixed, grey = no data.

 These kinds of laws curry favor with both wealthy liberals as well as religious conservatives, many of whom actually enjoy drinking; they simply would prefer not to live near bars and liquor stores and their associated drunks and winos, and consequently politicians throw up incredible roadblocks to alcohol sales and impose incredible regulatory compliance requirements.  Some of these kinds of laws include:

• Until recently, in order to open a liquor store in Kansas, one had to have been a US citizen for 10 years.
• In Massachusetts, the only IDs accepted at liquor stores are issued by Massachusetts or are US passports.  The quarter million college students from out-of-state in the Boston area are pretty much out of luck, as are the tourists, and to make matters worse, the IDs can be easily faked, adding compliance costs and risk to the liquor stores.
• Arkansas refuses to allow liquor sales on Sunday, meaning that the stores are empty and the owners have capital tied up in their inventory; this is pretty expensive to the store owners.

Cash Cow States and Retail Empires

When Prohibition passed, many states heaped on taxes, reasoning that these were ‘sin’ taxes, and that the drinkers would be happy to pay.  Other, sneakier, states kept complete control of the retail sale of alcohol and charged huge mark-ups, turning the so-called ‘ABC’ stores into giant cash cows where price competition is prohibited.   Doing so created a giant bureaucracy full of (often unionized) store clerks whose goals (higher pay) conflicted both with the State’s desire to increase tax revenue, and with consumers’ preferences for lower prices.  However, even within these states (shown below in yellow), there’s considerable diversity in how the politicians have made the tradeoffs between different groups; nevertheless, this market structure can offer some benefits to the consumer:

Figure 5: Regulatory Regimes by State (Image source: Wall Street Journal)

Some of the different decisions that dramatically affect retail prices in these states:

• In Pennsylvania, consumers are still paying the infamous (but never-disclosed) 18% Johnstown Flood Tax. The flood was in 1936, and according to one state senator “by 1942 they had the sufficient funds to rebuild the entire city”.  Pennsylvania’s 3500+  unionized (and pension-eligible) store employees are understandably reluctant to change this system.
• Some states charge sales taxes on top of alcohol taxes and state-mandated markups, even in State-owned stores.

Figure 6: Sales Taxes by State (Image source: taxfoundation.org)

This helps explain why a bottle sold in New Hampshire with a posted price of $21.99 still winds up being cheaper than the bottle offered at $18.99 in Washington; New Hampshire has no additional taxes, while Washington tacks on an additional $6.41.

• In Oregon, posted prices are extremely high, as most of the population lives in the north-east section of the state, and it is a several-hundred mile drive to the nearest state with lower prices.  This helps enforce the Oregon Liquor Board’s pricing regime.
• By contrast, New Hampshire, a small state near lots of higher-taxed states, has elected to be the price-leader in alcohol in New England, and has invested in special rest areas with giant liquor warehouses on the Interstate Highways.

Figure 7: New Hampshire rest stop (Image source: Marc Tomik)

• Estimates vary, but supposedly half of the alcohol consumed in New England (NH, VT, ME, CT, MA, RI) is purchased at New Hampshire liquor stores, enabling them to negotiate huge volume discounts with producers; New Hampshire’s politicians have thus found a great way to extract revenue from out-of-state travelers without the ancillary social issues.

Market Structure and Incumbency

A further explanation of why certain states have such expensive liquor is that the politicians are beholden to various rent-seeking interests, and have agreed to market-structures that produce unusually high profits for distributors or retailers.

Some examples of this are:

• In a number of states, high-volume ‘liquor warehouse’ chains are the norm.  Costco,  a ‘warehouse style’ club, often sells single malt-scotch, and can sell 30,000 cases fairly quickly.  Likewise, the cheapest prices in WA, AZ, and CA are often found at BevMo, a chain of roughly 100 warehouse-style liquor outlets.  By focusing on top sellers, these retailers can extract huge concessions out of producers and distributors, and can sell at very low prices; there are tremendous economies of scale.
• By contrast, in New York, each company can own at most one liquor store, and the owner/operator has to live nearby.   This is why most NY liquor stores are quite expensive and rather small; it is hard to order in bulk when you only have one outlet, and if you can’t order in bulk, there’s no reason to have a larger selection; it also leads to inefficient use of employees and real-estate.  This a major for the reason that a crappy bottle of Barefoot goes for $5 in New Hampshire, where they buy it by the boatload, and costs $10.90 in my local bullet-proof liquor mart; a local store with bearded hipster employees, ipads, and a heavily ‘curated’ and rarely sold liquor selection was asking $39.99 plus tax yesterday for the same bottle that would go for $16.99 in Arizona.
  • One benefit to politicians is that the huge number of liquor stores and licensees produces a steady stream of ‘licensing’ opportunities, each of which needs ‘community input’, and ‘expedition’, often dispensed by associates of the local politicians; the liquor store owners also donate heavily to political campaigns.
• In Missouri, Wisconsin, and several other states highlighted in red in Figure 5 Regulatory Regimes by State, producers cannot fire their distributors.  This prevents consolidation of distributors, but more importantly, can give the distributor a near monopoly over a brand.  To see how this can be problematic, consider how this works in Connecticut:
  • Each distributor posts liquor prices for the next month in advance, but, once all distributors have posted them, they can lower them to the lowest price posted for the same item.  This might seem competitive, but, in fact, as Chris Conlon has shown in a paper, this is entirely anti-competitive, as it encourages the limited number of distributors to implicitly collude on pricing and obtain monopoly-style profits.   This is why even though Connecticut’s taxes aren’t oppressive, prices in Connecticut are extremely high. In fact, the authors of the paper actually recommended raising taxes as a means of capturing the excess profits going to the distributors!

• Finally, consider that the earliest distributors often turned out to be former bootleggers who had pre-existing relationships with the politicians that wrote the alcohol regulations.  It is no secret that Joseph Kennedy Sr. became the largest distributor of Scotch Whisky, partially by ensuring that the profits for doing the same would be unusually rich; his earnings were sufficient to fund three Senate campaigns and to help obtain the Presidency for his son.

A Gift to Politicians

There are many reasons why whiskey prices vary by nearly 80%, but they all come down to the following observation: the entire system was a gift to politicians.  Unlike the retailing of nearly every other product, in which deviations from the free market need to justify their worth in terms of welfare gains to society, by re-legalizing a highly desirable product, yet taboo product, politicians in certain jurisdictions were, and continue to be able to, pick winners and losers.

So next time you pay more than $20/bottle for Jack Daniels, ask around and figure out who is siphoning off the excess revenue.  Chances are they’ve been donated to bunches of local politicians.