Who CAREs About Beer and Wine Consumers?

Josh Wright —  3 August 2010

The Comprehensive Alcohol Regulatory Effectiveness Act — yes, the “CARE Act” — or HR 5034, is a piece of legislation aimed at supporting “State-based alcohol regulation.”  Recall the Supreme Court’s decision in Granholm v. Heald, which held that states could either allow in-state and out-of-state retailers to directly ship wine to consumers or could prohibit it for both, but couldn’t ban direct shipment only for out-of-state sellers while allowing in for in-state sellers.  Most states thus far have opened up direct shipping laws to the benefit of consumers.    While we occasionally criticize the Federal Trade Commission from time to time here at TOTM, its own research demonstrating that state regulation banning direct shipment and e-commerce harmed consumers is an excellent example of the potential for competition research and development impacting regulatory debates.  Indeed, Justice Kennedy’s majority opinion in Granholm cites the FTC study (not to mention co-blogger Mike Sykuta’s work here) a number of times.  But in addition to direct shipment laws, there are a whole host of state laws regulating the sale and distribution of alcohol.  Some of them have obviously pernicious competitive consequences for consumers as well as producers.  The beneficiaries are the wholesalers who have successfully lobbied for the protection of the state.  Fundamentally, the CARE Act aims to place these laws beyond the reach of any challenge under the Commerce Clause as per Granholm, the Sherman Act, or any other federal legislation.  Whether the CARE Act has any ancillary social benefits is an important empirical question — but you can bet that the first-order effect of the law, if it were to go into effect, would be to increase beer, wine and liquor prices.  More on the CARE Act and state regulation of alcoholic beverages below the fold.

Regulation of beer, wine and liquor in the post-Prohibition world largely consists of a patchwork of state laws that benefit wholesalers.  Many of these restrictions you are familiar with.  Others, however, are less well known.  For example, most states mandate a “three-tier” system in which the brewer/winery must sell to the wholesaler, who in turn, must sell to the retailer.  In other words, the laws restrict vertical integration between levels.  Aside from laws on direct shipment impacted by the Commerce Clause challenge in Granholm, and on top of the three tier system, most states also adopt laws that restrict the contractual relationships between alcohol producers and wholesalers.  For example, most states have “just cause” laws that limit (sometimes to the point of effectively prohibiting) the producers ability to terminate the wholesaler.  States also sometimes mandate that the wholesaler be given an exclusive territory by the producer, or ban a producers ability to enter into exclusive dealing arrangements with wholesalers.  Unsurprisingly, many of these state laws harm consumers in the form of allowing higher prices and reduced output.  Therein lies the rub.  In Granholm, the Court explained that the “aim of the Twenty-first Amendment was to allow States to maintain an effective and uniform system for controlling liquor by regulating its transportation, importation, and use.”  Anticompetitive state regulation which raises barriers to entry, reduces competition, and increases price also reduces output.  And while reduced alcohol consumption is a consumer welfare loss in the conventional antitrust sense, it may count as a benefit under a 21st Amendment analysis.

While wine lovers have had all the fun in terms of litigating state alcohol regulation, and most (but not all) of the debate has been about direct shipment laws, state laws greatly impact that distribution, marketing, and pricing of beer, wine and liquor.  There is also a lot more at stake than just direct shipment laws.  The state laws restricting contractual relationships between producers and wholesalers have significant competitive effects and are prevalent across nearly all states and for all forms of alcoholic beverages.  In other words, beer, wine and liquor lovers can unite in their disdain for these laws or federal legislation that places them out of the reach of any challenge.  So, this time, as Mercatus’ Jerry Ellig notes, its not just the wine wholesalers that are pushing the law:

Word on the street is that the biggest pushers of this legislation are the beer wholesalers. Since most of this litigation has involved wine, what’s going on here?

The real goal of this legislation is not harrassing wineries that want to ship a few bottles to out-of-state customers. The real goal is to preserve anti-competitive state laws that force brewers, wine makers, and distillers to market most of their product through beer, wine, and spirits wholesalers, instead of marketing directly to retailers and restaurants. The proposed legislation would effectively insulate these state laws from challenge under the Commerce Clause, federal antitrust laws, or any other federal laws that might give alcohol producers and consumers some leverage to break the wholesalers’ lock on the market.

Call it states’ rights kool-aid with a chaser of economic protectionism.  A strange brew indeed.

That takes us to the CARE Act.  As Katherine Mangu-Ward of Reason explains:

The legislation would privilege the 21st Amendment, which repealed Prohibition and left regulation of alcohol to the states, over the Constitution’s Commerce Clause, which prohibits states from favoring in-state entities in trade. The bill would exempt state booze laws from federal limits—stuff like anti-trust rules and Food and Drug Administration requirements. It would allow states to replace uniform federal standards with their own competing standards for labeling and formulation, making it harder for out-of-state producers to comply with state laws. It would also take away recourse to the courts for sellers or buyers harmed by the new legislation. At present, the burden of proof is on the state to show that it needs to discriminate against outside competitors for a legitimate purpose, such as the health or safety of its citizens. This would be reversed, requiring anyone who wanted to challenge a state alcohol law to first prove that the law has no legitimate purpose beyond protectionism, a nearly impossible task.

A look at the text of the CARE Act confirms Mangu-Ward’s analysis.  Here’s Section 3(b)(c) of HR 5034, where the damage is done:

The following shall apply in any legal action challenging, under the Commerce Clause or an Act of Congress, a State or territory law regarding the regulation of alcoholic beverages:

(1) The State or territorial law shall be accorded a strong presumption of validity.

(2) The party challenging the State or territorial law shall in all phases of any such legal action bear the burden of proving its invalidity by clear and convincing evidence.

(3) Notwithstanding that the State or territorial law may burden interstate commerce or maybe inconsistent with an Act of the Congress, the State law shall be upheld unless the party challenging the State or territorial law establishes by clear and convincing evidence that the law has no effect on the promotion of temperance, the establishment or maintenance of orderly alcoholic beverage markets, the collection of alcoholic beverage taxes, the structure of the state alcoholic beverage distribution system, or the restriction of access to alcoholic beverages by those under the legal drinking age.’’

That’s quite some burden!  Let’s talk about the Sherman Act and preemption here.  Lets say that a party wanted to challenge anticompetitive state regulation on the grounds that it is preempted by the Sherman Act.  Notice that the party challenging the state law would not only have to satisfy the preemption standard, but also demonstrate by clear and convincing evidence that the state law has “no effect” on the promotion of temperance, the orderliness of alcoholic beverage markets, the collection of taxes, market structure, or underage drinking.  If the state law impacts any of those, it survives.  Considering that the purpose of these laws is to raise prices and reduce output, such laws are likely to have at least some minimal effect on temperance, depending on how that term is defined.  If temperance is construed as merely meaning “any” reduction in consumption, than the law of demand implies that anticompetitive state regulations always promote temperance.  That’s absurd.  More likely, temperance must correlate with the social ills associated with drinking, e.g. drunk-driving, health problems, accidents and fatalities. Under that interpretation, it is unclear whether the laws will promote temperance because they will raise the price both to marginal drinkers with higher demand elasticities and infra-marginal drinkers with more inelastic demand.  But no effects?  Taken literally, the law of demand implies that unless the drinkers who create those social harms have perfectly inelastic demand, there will be “some” effect and thus the state law shall be upheld.

But notice how the next clause of 5034(3)(b)(c) requires the challenger to demonstrate that the law has no impact on the maintenance of “orderly alcoholic beverage markets.”  What does this mean anyway?  Antitrust lawyers will recognize “maintenance of orderly” markets as a codeword for keeping prices stable and high.  Well, if that is what orderly means here, then this clause swallows the rest of the rule and all challenges, whether based on the antitrust laws or the Commerce Clause, are doomed to failure.

Realistically, that seems to be what is at stake here: an antitrust exemption for beer and wine wholesalers.  I’ve written before about the weak case for antitrust exemptions.  But the case cannot possibly be weaker than when the cartel is backed by the coercive power of state law.  Unfortunately, the proposal seems to be getting some traction, including a Judiciary Committee Hearing on the subject earlier this year (Darren Bush’s (Houston) testimony is recommended reading).  An exemption for beer and wine wholesalers simply doesn’t make sense on competition policy grounds unless it can be shown that the social harms associated with reduced consumer welfare caused by higher prices and reduced output is more than offset by gains from “promoting temperance.”

A serious cost-benefit analysis of state regulations of the alcoholic beverage industry raises empirical questions concerning these tradeoffs.  We know that consumers are harmed from higher prices and reduced output.  But it is possible that those effects are dominated by benefits associated with reduced consumption leading to reduced social harms.  The CARE Act legislates away an rigorous attempt to deal with these tradeoffs, and bets consumer dollars in the process, by assuming that the reduction in alcohol consumption is “always worth it.”   But there is little empirical evidence that many of these state restrictions are associated with social benefits.

Later this week, I’ll follow up with a post discussing some of my own recent empirical research on this topic.

6 responses to Who CAREs About Beer and Wine Consumers?

  1. 

    I know that in criminal law you are innocent until proven guilty beyond a reasonable doubt, in civil law innocent until proven guilty by a proponderance of evidence, in administrative law guilty until proven innocent(?) But “clear AND convincing” is a new one to me.

  2. 

    You gotta love it when the State gives all these wonderfully altruistic reasons why it’s best for everyone if the favored few make millions at everyone else’s expense.

  3. 

    I’m fairly baffled by the snippet of text you highlighted from this act. How can a federal law basically say, “whether or not a law is in fact unconstitutional (i.e. burdens interstate commerce), it shall be upheld nonetheless”?

    Last I checked, it is not up to a congress to say what laws can and cannot be overturned by courts. It seems rather audacious that this act attempts to do just that. It seems to me that the law can say whatever it wants to say about immunity from the constitution or legal challenge or this and that — but cannot a court exercise its own prerogative in determining whether such is in fact the case?

    I guess what I’m saying is that, being not a legal scholar or attorney, I don’t quite see how this act could be passed and then survive a subsequent challenge intact.

Trackbacks and Pingbacks:

  1. The Law and Economics of Privatizing Alcohol Sales « Truth on the Market - September 1, 2010

    […] and thus some positive effect in reducing external costs (see my earlier post on the CARE Act’s odd approach to burdens of proof regarding this […]

  2. Finger on the Pulse: From Our Blogroll and Beyond « The Legal Pulse - August 13, 2010

    […] Prof. Josh Wright writes why “CARE Act” proposal would create new antitrust exemption in alcohol sales world (Truth on the Market) […]

  3. The CARE Act and State Regulation of Alcohol Distribution: The Competitive and Social Effects of Post and Hold Laws « Truth on the Market - August 12, 2010

    […] by Josh Wright on August 12, 2010 In an earlier post on the CARE Act, I highlighted the fact that the law would essentially immunize state laws regulating the […]