Notes From The Winemaker

Supreme Court Does The Right Thing In Direct Shipping Cases

(Note: I first published this article in another blog, written under the pseudonym "John Falstaff.")

Well the Supreme Court finally decided the suits before it which pitted wineries and consumers against State regulators, alcohol wholesalers and anti-alcohol lobbyists in Michigan and New York. As reported by the New York Times (and pretty much every other national media outlet) the Supremes ruled that bans in Michigan and New York on direct shipment of wines into the state violated the Commerce Clause of the Constitution.

In the majority opinion, Justice Kennedy wrote that "States have a broad power to regulate liquor [under Sec. 2 of the 21st Amendment]. This power, however, does not allow States to ban, or severely limit, the direct shipment of out-of-state wine while simultaneously authorizing direct shipment by in-state producers. If a state chooses to allow direct shipment of wine, it must do so on evenhanded terms. Without demonstrating the need for discrimination, New York and Michigan have enacted regulations that disadvantage out-of-state wine producers. Under our Commerce Clause jurisprudence, these regulations cannot stand."

This ruling has set off a frenzy of celebration in the California wine industry and among the consumer groups fighting to overturn direct-shipment bans. One of the lawyers representing the wineries before the Court dished out the hyperbole by the spit-bucketful: "This is the best day for wine lovers since the invention of the corkscrew!" he gushed.

Not The Big Deal The Spinmeisters Are Making It Out To Be

Falstaff’s initial reaction? "Headline: Common sense prevails! Supremes refuse to validate specious claims and sloppy statistics of wholesalers lobby!" Followed immediately by: "yaaaawwwwwnnn."

Falstaff believes that nothing will change. But if – surprise! – things do change, the change will be for the worse for [small] wineries and wine lovers.

Michigan and New York have 90 days to bring their laws and regulatory agencies into compliance with the Court’s ruling. The States will argue – rightly – that this is not enough time to make sweeping changes to the complex bureaucracies that have regulated alcohol for nearly 75 years. They will ask for a stay and it will be granted – and perhaps extended indefinitely.

Both MI & NY could choose to comply with the ruling by banning all direct shipment of wine, even from their in-State producers. Look at the political calculus: Yeah the wine lovers are "in the right" of this, and they have disposable income, and some have political influence. But the wine industries in MI & NY are relatively small and politically disorganized.

On the other hand, the anti-alcohol lobbies in these States are well-organized and vocal, though perhaps not able to purchase much political interest. However, the wholesalers and their lobbies are a big industry, heavily politically connected and able to purchase influence nearly at will. And the wholesalers see it as taking bread out of their children's mouths should the Supremes' ruling be implemented as wine lovers would wish. The politicians and regulators have little incentive to bite the hand that feeds them the most while holding their balls the tightest with the other.

Wholesalers Will Drag Out The Zero-Sum Game

Nationally, the wholesalers have taken the position that this is a zero-sum game: any gains by direct shippers will cost them money. Not only will they not get their cut on the sale of direct shipments, they firmly believe that dollars spent on direct-shipped wine are dollars that are not spent on the wines they are distributing. They will not take this lying down or standing still.

No other States are directly impacted by the ruling. Those States that still have bans on direct shipments of wine are likely to change nothing until they see how this farce plays out in MI & NY. In the meantime, the wholesalers can fight the battle State by State, adjusting their argument to fit around the framework of the Supremes' ruling in MI & NY, forcing every case as high up the appellate ladder as they can go before some Court says "you’re done – Commerce still trumps Sec. 2 Amendment XXI."

And let's be realistic, if not overly pessimistic: In the end, no matter how many battles they lose in the Courts the wholesalers will still win. They will win because they can use their influence on State politicians to enact "evenhanded" regulations that place an onerous compliance burden on direct-shipping wineries.

Uneven Wine Industry Support For Direct Shipping?

To complicate matters, the wine industry does not even speak with one voice in this argument. It is small and medium-sized wineries that call for lifting restrictions on direct shipping, to even the playing field with the large wineries and conglomerates that get all the attention of the big wholesalers.

The large wineries with good distribution through the established 3-tier system have little incentive to push for deregulation of direct shipping. Yes, margins on direct-purchased wine can be higher, but there are large overhead costs in dealing with thousand, tens-of-thousands, or more individual transactions that none of the bigger producers are prepared to deal with.

Gallo's mission statement says something like "Gallo will be the number one or number two producer in every market [they] choose to enter." It is Falstaff's opinion that Gallo cannot accomplish this goal by competing on quality and cachet with small, high-end producers. And historically, Gallo has shown repeatedly that they are able and completely willing to control the industry by driving small producers out of business, co-opting them, or absorbing them. Gallo does not do well by doing better, Gallo does well by eliminating choice in the marketplace. When there is only Gallo, there will be Gallo on every table.

This attitude is shared and emulated by virtually every large producer or conglomerate in the wine industry today, including the wholesalers. Falstaff does not see any economic motivation for this alignment to change. The big wine industry players need to publicly support direct shipping because it is what well-heeled wine consumers want. Behind the scenes they can use the threat of support for direct shipping to wring concessions and margin from their distributors.

It is a given that small and medium-sized wineries need direct shipping to compete. It is true that wine consumers want, deserve and have the right to greater choice in the marketplace. But it is also true that there are massive political and economic interests arrayed against easing restrictions on direct shipping.

The Good, The Bad And The Ugly

Falstaff believes that it is a Good Thing that the Supreme Court ruled against Michigan, New York and the wholesalers in these cases. State protectionism really is unfair and un-American. And perhaps from this point forward we won't hear the same old lame arguments about underage drinkers buying fine wine over the internet used to attempt to discredit direct shippers.

It is a Bad Thing if wine consumers see this as some huge victory and think that small wineries are now able to ship directly to them. It is also bad if the States respond to this ruling with "evenhanded" regulation that is tantamount to a direct shipping ban for small wineries.

It is going to be Ugly if wholesalers and their political allies view this ruling as a shot across the bow, and decide that they have not yet begun to fight. They are dinosaurs, and sooner or later the comet is going to get them. But they could do a lot of damage in their death throes.

The Ultimate Solution?

What is needed is a complete repeal of the anachronistic 21st Amendment, which is increasingly irrelevant in the internet age and within the global economy.

Sooner or later the trade representatives for the EU and the rest of the wine-producing countries of the world are going to file a complaint with the WTO over the burdens State-by-State regulation place on the global wine trade. This would be a fight neither the States-Rightists, the Puritans nor the Isolationists could win.

If the Commerce Clause (Federal law) really does trump Sec. 2 of Amendment XXI (States rights) then it is incumbent on Congress to make law which regulates and regularizes interstate trade in alcoholic beverages. This law should severely limit the regulatory authority of every State alcoholic beverage control agency, and impose a modest Federal tariff on all out-of-State sales of wine – both direct to the consumer and wholesale or FOB to the distributor.

All out-of-State consumers would pay sales tax on their direct shipment – in the place where the wine is produced. This suggestion touches on the larger area of who gets to tax internet and mail order sales. Falstaff believes strongly that the answer is very simple – internet and mail order sales should be taxed exactly as if the customer were standing in the storefront, and the local government where the business selling the product has its largest physical footprint (the building where the big trucks come and go) gets all the sales tax revenue.

Through their restricted local beverage control agencies the States would still collect taxes on wholesale wine shipments sold in their State, just as it is done today – the businesses doing the in-State selling have a physical footprint and infrastructure requirement and so should pay local taxes. But in addition, the Federal agency responsible for collecting the tariff on interstate shipments would be charged with returning a portion of those dollars to the States receiving the shipments, based on the actual total transaction value of wine moved into each State.

(and Falstaff bows and steps off his soapbox)

posted 5/18/2005 03:38:00 AM