State Licensing of Wine Sales in Food Stores: Impact on Existing Liquor Stores

Prepared for

Food Marketing Institute

By

American Economics Group, Inc.

May 2004

AMERICAN ECONOMICS GROUP, Inc. 2100 M St. NW, Suite 810 Washington, DC 20037 (202) 328-1545 TABLE OF CONTENTS

I. EXECUTIVE BRIEFING ...... INTRO 1

II. INTRODUCTION ...... 1 A. Methodology...... 1 B. Wine and Liquor Sales Depend on Multiple Factors...... 2 C. Resident Liquor Consumption Differs from Taxed Liquor Sales...... 3 D. Less Competitive States Lose Cross-Border Wine Sales...... 4 E. Wine Sales in Food Stores Will Repatriate Cross-Border Loses...... 4 F. Repatriation of Sales Will Yield Added Jobs, Economic Activity...... 5 G. Expanded Licensing Revenue if Wine Sales in Food Outlets...... 5 III. ECONOMIC BENEFIT OF INCREASING WINE SALES ...... 7 A. How Wine and Liquor Sales Create Jobs and Other economic Benefits ...... 7 B. Jobs, Wages and Business Derived from Wine and Liquor Sales...... 7 C. Job gains from wine sales in food stores ...... 11 IV. LIQUOR STORES REMAIN PROFITABLE AS WINE OUTLETS INCREASE ...... 12 A. Other States Demonstrate Wine Sales in Food Stores...... 12 B. States with More Wine Outlets Support More Liquor Stores ...... 15 C. Per Capita Liquor and Wine Sales are Higher in States that License Supermarkets to Sell Wine ...... 17 D. Distribution of Store counts Among States Shows Liquor Stores and Wine Outlets Are Mutually Supportive ...... 19 E. Liquor store profitability ...... 20 F. Adding wine outlets in underserved states has mild impact on liquor stores ...... 23 V. APPENDIX: METHODOLOGY ...... 24 A. General Description of The Multiplex Model ...... 24 B. Technical Results of Model ...... 26

I. EXECUTIVE BRIEFING ♦ The Food Marketing Institute asked American Economics Group, Inc. (AEG) to analyze whether or not the sale of wine in food stores would have an impact on existing liquor stores.

♦ As illustrated by states that prohibit food-store wine sales, such as New York, Minnesota and Pennsylvania, the prohibition reduces the number of wine outlets per capita, which translates into the under service of households, higher consumer costs and lower tax and fee revenue.

♦ Food-store wine sales have been shown to not adversely affect liquor outlets in those states that allow such sales. In fact, prohibitive states continue to lose sales and tax revenue to neighboring states. Increasing the number of available wine merchants actually helps states recapture lost cross-border liquor and wine sales.

STATES GAIN SIGNIFICANT AND IMMEDIATE REVENUE FROM WINE SALES EXPANSION ♦ Permitting food stores to sell wine will increase wine sales generally, but it will also increase jobs and boost the permitting state’s economy. Some liquor store owners worry about increased competition from wine sellers, but unlike in other industries, liquor merchants have come to expect the government to shield them from fair competition.

♦ By permitting new wine licenses, currently restrictive states will gain added licensing fees, as well as excise and sales tax revenue. Many states facing today’s current fiscal crisis could benefit from such an important one-time infusion of funds via licensing, in addition to significant recurring new tax and fee revenue.

♦ Increases in wine sales from the addition of retail outlets in permitting states will also generate sales for businesses that service and supply stores selling wine. The resulting higher volume of production, wholesale and retail activity would include packaging materials, container production, advertising and media services, transportation, etc.

STATES CAN REPATRIATE LOST CROSS-BORDER LIQUOR AND WINE SALES ♦ Many restrictive states now suffer large revenue erosion from cross-border beverage sales. One way for them to benefit from expanded and more competitive wine sales is by repatriating a significant portion of their residents’ wine and liquor purchases.

♦ Cross-border losses include both wine and liquor sales. Many state residents who travel to other states to purchase much of the liquor and wine they consume at home will make less frequent trips when wine is more readily available in their home state. This will also return a portion of lost liquor sales to their local package stores.

LIQUOR STORES WILL NOT BE DEVASTATED ♦ This report research shows unequivocally that increasing wine outlets to well above the average number of outlets per capita for all states will not collapse liquor sales or drive profitable liquor stores out of business.

♦ States that now permit wine sales in food stores also support a greater number of liquor stores per capita than states that limit wine sales to package stores. Contrary to the claims of some liquor store owners, more overall liquor is sold and more package stores thrive in states with more wine outlets.1

♦ The argument against expanding wine sales is really not about a reduction in the number of liquor stores. Rather, it is about protectionism for existing firms that earn monopoly profits2 at the expense of consumers. The United States is a free market economy that depends upon competition to derive an efficient number of stores and shield consumers from price gouging.

♦ Profitability analysis shows that the annual flux in liquor stores—some close in difficult markets while new ones open to serve other markets in a given state—will be only mildly affected, even in states now experiencing a long-term decline in the number of liquor stores.

STATES WILL GAIN JOBS, WAGES AND ENHANCE GENERAL BUSINESS ACTIVITY ♦ Expanding wine sales will create additional jobs and wages. As a result, wine wholesale and retail businesses will increase employment. Suppliers will create additional jobs, and new jobs will be induced throughout the economy as workers spend their new pay. Some of this added pay will be spent on liquor as well as a host of consumer items.

♦ The expanding sale of wine from the increase in retail outlets in permitting states will generate sales for other businesses that service and supply liquor and wine outlets.

♦ An added induced impact means that not only will the business of suppliers grow, but also most other businesses will gain sales as employees of wine producers, wholesalers, retailers and their suppliers spend their augmented paychecks on food, clothing, transportation, entertainment, services, etc.

STATES WITH MORE WINE OUTLETS SUPPORT MORE LIQUOR STORES ♦ There is ample evidence, from states that permit wine sales in food stores, that a large number of wine and liquor outlets can coexist. In fact, there is a general statistical relationship that shows how states with more wine outlets also support more liquor outlets.

1 This is true in both a per capita basis and an absolute basis.

2 In economics, a business reaps monopoly profits when reduced market competition allows it to set its prices higher than prices in a free and open market. This may help liquor stores in restricted states, but harms consumers and reduces jobs and business activity generally.

♦ Figure A summarizes this relationship: states permitting wine sales in supermarkets have 40.7 liquor stores per 100,000 adult persons. This is 11.5% more stores than states restricting wine outlets, which average 36.5 stores.

Figure A

States with More Wine Outlets Per Capita Have More Liquor Stores

Per capita stores 2002* Liquor stores Wine stores

States selling wine in supermarkets 40.7 108.3

States without wine in supermarkets 36.5 36.1

Average difference 11.5% 200.0%

*Stores per 100,000 population age 21 and over.

STATES WITH MORE WINE OUTLETS SELL MORE LIQUOR ♦ As the number of wine outlets per capita increases, liquor sales per capita increase. As summarized in Figure B, states permitting wine sales in supermarkets sell 8.5% more liquor per capita on average. Restrictive states sell 1.89 gallons of liquor per capita, while permissive states average 2.05 gallons. In addition, states that permit food stores to sell wine enjoy 30.3% more wine sales than restrictive states. .

Figure B

Supermarket Sales of Wine Boost Overall Wine and Liquor Sales

Per capita gallons sold 2002* Liquor sales Wine sales

States selling wine in supermarkets 2.05 3.01

States without wine in supermarkets 1.89 2.31

Average difference 8.5% 30.3%

*Stores per 100,000 population age 21 and over.

LIQUOR STORES AND WINE OUTLETS ARE MUTUALLY SUPPORTIVE ♦ There is a strong relationship between the number of wine outlets per capita and the number of liquor stores that consumers support. Quite the contrary of what some people claim, experience has shown that increasing the number of wine outlets will not reduce the number of liquor stores. Permissive states instead have more liquor stores per capita.

♦ Figure C sorts states by the number of wine outlets per capita; both liquor and wine outlets are counted for low and high states. The lowest 25% of states average 39.0 wine outlets and 16.1 liquor stores per 100,000 adults. Moving up the scale, as the number of wine outlets increase, the number of liquor stores per capita also increase. Therefore, states with more wine outlets support more liquor stores.

Figure C

Distribution of Liquor and Wine Stores Among the States

Per capita stores 2002* Quartile points Liquor stores Wine stores

Low 25% of states 16.1 39.0

Median of states 26.6 76.3

High 75% of states 50.1 116.3

*Stores per 100,000 population age 21 and over.

♦ As illustrated above, increasing the number of wine outlets will not put liquor stores out of business. In fact, the overwhelming evidence states just the opposite: wine outlets support more liquor stores per capita. .

METHODOLOGY ANALYZES ALL STATES TO PREDICT RESULTS OF WINE EXPANSION ♦ Comparison of per capita stores and sales presents only part of the picture. Other factors affect sales, and the analysis underpinning this report accounts for important demographic and economic differences that create differences in per capita wine and liquor sales.

♦ American Economics Group, Inc. calculated the results reported here by using a combination of tax data, industry data, demographic statistics and survey data. We first analyzed the status quo in all 50 states and the District of Columbia. Next, using results from an econometric model and nonlinear programming techniques,

we calculated the changes in both wine and liquor markets as wine outlets increased.

♦ To evaluate the impact on liquor stores, we constructed a profit simulation model based upon reported cost and profitability ratios. Then, using the market change results from the econometric analysis, we calculated the impact of additional wine outlets on existing liquor stores.

II. Introduction The Food Marketing Institute asked American Economics Group, Inc. (AEG) to analyze how the sale of wine in food stores would impact existing liquor stores in states where it is now prohibited. States such as New York and Minnesota, where food-store sales are prohibited, have fewer wine outlets per capita and therefore underserve households.

Allowing food stores to sell wine would increase wine sales generally and boost the economy of states that expanded licensing. However, questions have been raised as to the impact on existing package stores. This study addresses those issues.

This analysis seeks to measure statistically and econometrically what seems apparent: in states that license the largest number of wine outlets, neither the number of liquor outlets nor liquor sales per capita are adversely affected. States that license the most wine outlets per capita are also less restrictive with liquor licensing, and a greater number of wine outlets in a state reduces cross-border traffic with other states. Permissive states thus hold onto liquor sales that would otherwise be lost.

The data show unequivocally that increasing wine outlets in a restrictive state above the median number of outlets per capita for all states will not force a collapse in the number of liquor stores. The impact on liquor stores will be a reduction in the amount of the “monopoly profits” conferred on them by states that restrict the number of stores below a competitive level.

AEG also investigated how additional wine outlets would impact jobs and economic activity in general. This study explains how expanding the number of wine outlets will, of course, increase wine sales. But it will also bring more liquor sales home. This boosts a state’s economy by adding business to the chain of suppliers of a host of products and services—everything from the beverages themselves to paper products, containers, advertising, business services, and hundreds more.

A. METHODOLOGY

This study compared the number of wine outlets and liquor stores per capita as well as sales in restrictive and permissive states. However, a more sophisticated analysis yielded data on the impact of each of the many factors that influence the sale of alcoholic beverages. In particular, the approach takes account of important demographic and economic differences among the states that create differences in per capita wine and liquor sales apart from the number of outlets.

The details reported here resulted from calculations that required a combination of tax data, industry data, demographic statistics, and survey data. AEG first analyzed the wine and liquor situation in all 50 states and the District of Columbia. Next, using results from an econometric model and a nonlinear programming model, we calculated the changes in both wine and liquor markets as we moved from restrictive to permissive states.

Further evaluation of the impact on liquor stores, required a profit simulation model based upon reported cost and profitability ratios of package stores. Then, using market expectations from the econometric analysis, we calculated the impact of additional wine outlets on existing liquor stores in a given state. AEG has developed an innovative and more accurate way to measure all the factors that explain differences in the purchases of alcoholic beverages among the states. This state-of-the-art approach combines two well-accepted techniques (econometrics and nonlinear programming) in a multiplexed model that also includes a 51-by-51 state trading matrix, or grid. The latter accounts simultaneously for beverage purchases by residents within a state, their cross-border purchases in other states and a state’s reverse sales to residents of other states. This trading grid imposes a discipline often missing from other research by fully accounting for each state’s taxed sales as the combination of its residents’ purchases and the cross-border sales to residents of other states. The results show the amount of each state’s sales lost across its borders and the amount it gains from sales to the residents of other states.

Finally, measuring the economic impacts of expanding wine outlets meant separating business activity into 1) direct effects: alcoholic beverage production and distribution; 2) indirect effects: interindustry purchases made to support direct sales, mostly purchases from suppliers and 3) induced effects: household spending by employees and owners of all industries having direct and indirect effects. View the appendix for more details on the economic modeling used in this study.

B. WINE AND LIQUOR SALES DEPEND ON MULTIPLE FACTORS

Many factors affect wine and liquor sales. These criteria include general economic conditions, which determine personal income levels and thus affect consumer spending, as well as demographic trends that influence consumption, such as the age and ethnic composition of the residents in a given geographic area.

Wine and liquor sales depend heavily on price and availability of such alcoholic beverages. The price per bottle of wine or liquor varies according to: type of beverage, excise tax, shipping costs and competitive factors. Influences on price include: tax rates and rules, price-setting regulations for wholesalers and retailers, the ability of retailers to pool purchases and/or deliveries, promotion and merchandising regulations and finally, overhead and operating costs.

In the case of wine, availability and selection has a large impact on its sales. The easier it is for consumers to buy wine, and the more varieties available, the more will be sold in their home state. Allowing the sale of wine in food stores will create more buying opportunities, which means quicker, easier access to a greater variety of wines. With expansion, the market will become more competitive and more robust. Advertising and promotion will expand, and competition will drive the number of brands and varieties offered. Price competition will also lower the cost to consumers and help motivate added purchases. Selling wine in food stores will accentuate each of these competitive factors, which will certainly expand wine sales in a restrictive state that allows additional wine outlets.

Interstate sales of alcoholic beverages add another dimension to the study because they are complex to analyze since they can flow in and out of states simultaneously. Such sales are influenced by a long list of factors, and they can vary dramatically over time. For example, liquor/wine outlets in one state may sell to residents of other states

2 who are tourists or who commute, even while a large number of its own residents deliberately travel to other states to purchase their liquor/wine at lower costs.

Sales of beverages vary from state to state for a variety of reasons. Aggregate taxable sales closely relate to the population of a state, and it is no surprise that there is a rough correspondence between the number of drinking-age persons and total annual alcoholic beverage sales. Of greater importance, however, is the variation in taxable sales that are unexplainable by population size alone or by the demographics of the population. These differences are revealed in the disparate per capita sales figures among states, often caused by tax differentials that generate cross-border activity.

Two state populations of equal size may purchase markedly different amounts of alcohol. The reasons may be found in the demographic characteristics of the two states, in their unequal disposable income, in their price and tax differences, in the availability of alternative outlets, in the proximity and ease of cross-border purchases and in myriad other influences such as religion, ethnic composition and taste.

In addition to factors that may affect two populations differently, common influences exist that may affect each equally, adjusting the overall demand for alcohol over time. Such factors include national and regional influences that may alter preferences, advertising and promotions that change brand awareness, the appeal of substitute beverages and, of course, the overall cost, including all federal, state and local taxes.

Once significant demographic and social factors are considered, remaining differences in per capita sales are largely explained by differences among the following variables:

• Tax differences among neighboring states • Price differences among neighboring states (reflecting profit and cost differences) • Preference differences among neighboring states • Border populations among neighboring states • Customary driving distances in the region • Cross-border tourism • Cross-border commuting • Extent of any illegal distribution (moonshine, etc.)

C. RESIDENT LIQUOR CONSUMPTION DIFFERS FROM TAXED LIQUOR SALES

A host of variables influence the volume of cross-border liquor sales and thus the amount of taxed sales in each jurisdiction. There is an important distinction between purchases made by a state’s population (resident consumption) and the total sales of taxed liquor within the state (taxed sales or apparent consumption).

Taxed sales can be either higher or lower than resident consumption depending upon the amount and direction of cross-border purchases, which can flow in both directions at the same time. Even with no price or tax incentives to cross state lines, consumers

3 will make a certain amount of convenience purchases. These residents may travel to another state to commute, vacation, conduct business or to travel to another state.

Should liquor/wine prices (including all taxes) be significantly different between two neighboring states, on balance consumer traffic will be decidedly one-sided. Resident consumption in the high-price state will include substantial purchases of liquor/wine from across the border. Thus, while total resident consumption in both states may change little following a tax increase, taxed sales will fall in the high-price state and may rise in neighboring states.

Ideally, accurate estimates of cross-border liquor sales should take account of a full complement of economic, demographic and social data. The estimation technique should be sensitive to the population size and its characteristics in each state. It should account for price differences and tax differences among the states. It should also consider the location of population centers and the ease and distance of cross-border purchases.

D. LESS COMPETITIVE STATES LOSE CROSS-BORDER WINE SALES

Consumers need not buy large amounts of wine to save money by purchasing it from another state. They can easily pick up cases or even a bottle or two on their way through the state. The price difference between a high-price state and its neighboring states often makes the stop at an out-of-state wine store a great savings to a willing resident or even restaurateur.3

There are claims that some casual transporters fill vans or small trucks with beverages that they deliver to restaurants and other establishments, or even to homes. In some states with strong cross-border alcohol sales, there are alleged organized deliveries to bars, restaurants and various sale-by-the-glass establishments. Such business is driven by price and availability, and it can be dramatically reduced with competitive pricing and easy access to wine and liquor in all states.

E. WINE SALES IN FOOD STORES WILL REPATRIATE CROSS-BORDER LOSES

If a restrictive state allowed wine to be sold in food stores, sales would increase significantly with expected lower prices and greater availability. This growth would directly affect the state’s wine industry. It would also increase economic activity—in sales, jobs, and wages—in hundreds of other state industries through indirect and induced connections to sellers of wine.

When wine outlets expand significantly, there will be an initial increase in sales because the novelty, coupled by expected promotions and price reductions, would attract an immediately greater response from consumers. Inventories within the industry will grow, and both wholesalers and retailers will rapidly buy more wine to provide a wide range of

3 Retail prices of both wine and liquor in restrictive states tend to be higher than the lowest price quartile of all states. Consequently, per capita taxed sales in a restrictive state tend to be low relative to other states.

4 labels for their customers. This so-called “pipeline” effect will result in temporary high stocks and produce added tax revenue in the immediate aftermath of the expansion.

With wine more accessible, customers will experiment with new brands and alternatives; they will respond to sales and promotions, and they will purchase larger amounts of wine than they would over the long run. AEG expects a purchasing surge of approximately 12% to 15% above a normal initial effect.

Within a year, however, the consumer wave would subside as purchases begin to stabilize and inventories reach a steady and more permanent level. At this point, the sale of wine in food stores will depend on more traditional forces, particularly lower prices due to increased competition and a greater availability of wine products. Over the long term, these factors will raise the level of wine sales in the state beyond what would be achieved with sales restricted to liquor stores.

Where do the new wine sales originate? Every dollar increase in wine sales does not mean a dollar taken away from sales of other items within the state. Nor does it all come from increased consumption of wine. Instead, many consumers who formerly traveled out of state for wine and liquor bargains will now buy their bottles in their home state. These results also have a positive impact on state revenue, since repatriated sales mean higher excise and sales tax collections. Even where some consumers did substitute wine sales for other in-state purchases, the state would experience an increase in tax revenues because wine sales provide not only the sales tax revenue produced by other goods, but also excise tax revenue.

F. REPATRIATION OF SALES WILL YIELD ADDED JOBS, ECONOMIC ACTIVITY

Additional jobs and wages will result from repatriating wine and liquor sales lost to other states. Wine wholesalers and retailers will increase employment. Suppliers will create additional jobs, and new jobs will be induced throughout the economy as workers spend their new wages. Some of this added pay will go to liquor as well as a full host of consumer items.

If a state removes restrictions on wine outlets, the resulting increase in wine sales will generate business for companies that service and supply the wine outlets. The higher volume of wholesaling and retailing activity will include packaging materials, container production, advertising and media services, transportation, etc.

An added induced impact means that not only will the business of suppliers grow, but also most other businesses will gain sales as employees of wine wholesalers and retailers spend their augmented earnings on food, clothing, transportation, entertainment, services, etc.

G. EXPANDED LICENSING REVENUE IF WINE SALES IN FOOD OUTLETS

By permitting new wine licenses, currently restrictive states will gain added licensing fees and excise and sales tax revenue. Many states facing the current fiscal crisis could benefit from such an important one-time infusion of funds via licensing, as well as and significant revenue from recurring new taxes and fees.

5 Of course, the revenue to be realized depends upon the license fees established, the number of outlets authorized and the excise and sales tax rates and basis. These can be calculated for specific proposals in specific states.

6 III. Economic Benefit of Increasing Wine Sales

A. HOW WINE AND LIQUOR SALES CREATE JOBS AND OTHER ECONOMIC BENEFITS

The economic importance of all aspects of wine and liquor production and distribution can best be understood in the context of the sales, jobs and income created. Figure III- 1 (next page) depicts the flow of economic activity connected with the production and distribution of wine (and similarly liquor and beer), by sketching the circuit of economic activity generated by the wine industry.

It begins with consumers purchasing wine (G). From those receipts, vineyards, wineries, wholesalers and retailers pay wages to their employees (B) and purchase from their suppliers (A). Their suppliers, in turn, purchase goods and services from their own suppliers (C) and so on down the line.

During the process, all suppliers pay wages and other income to their employees, owners, etc. (D and E). The households of workers then purchase a full complement of household goods and services (F), as well as wine (G), beginning the circuit again.

B. JOBS, WAGES AND BUSINESS DERIVED FROM WINE AND LIQUOR SALES

Each state benefits from jobs, wages, business activity and tax revenue derived from the sale and distribution of wine and liquor. The beneficiaries include not only establishments engaged in some aspect of beverage production and sales, but also all other businesses that benefit. Beverage retailers, wholesalers and producers add sales, jobs and income throughout hundreds of other industries in each state.

Their purchases from suppliers and their payment of wages to workers who spend them on food, clothing, shelter, etc. embrace a loop of economic activity that creates yet additional sales, jobs and income. Each benefiting business and household pays taxes on income and purchases, thereby adding to state and local tax collections.

It is useful to distinguish among three types of economic impacts. The “direct impact” refers to firms and workers engaged directly in the distribution and sale of spirits and wine products. The “indirect impact” is one step removed and refers to the suppliers to direct firms and also the suppliers to these suppliers. Finally, the “induced impact” adds the spending by employees and other households of the wages, profits, interest, and rent paid by direct and indirect firms. Largely employee spending, this last type enriches all the industries that furnish households with a full complement of goods and services.

7 Figure IV-1

How s Atate's Wine and Liquor Industry Creates Jobs and Income

SUPPLIERS (Direct Suppliers to Producers and A Distributors) G Payments for Producers, Wholesalers, •Agriculture Supplies and and Retailers Purchases of Wine •Mining & Construction Services and Liquor •Manufacturing

•Wholesale & Retail Trade •Transportation, Communication Wages, Profits, & Utilities B Interest, Rent etc. •Finance, Insurance & Real Estate

•Business & Personal Services Wages, Profits, Interest, Rent, etc. HOUSEHOLDS Wages, Profits, D Interest, Rent, etc. E F Payments for Supplies and C Services Purchases of Goods and Services

ADDITIONAL INDIRECT AND HOW WINE AND LIQUOR PURCHASES INDUCE ADDITIONAL SPENDING ACROSS VIRTUALLY ALL INDUSTRIES: (Refer to letters A INDUCED PRODUCTION through G in diagram.) (Suppliers to the Suppliers and Households) • "Producers" pay their suppliers (A) and employees. (B). •Agriculture • "Suppliers" (to producers, distributors, restaurants, liquor stores, etc.) pay their suppliers (C) and employees (D). •Mining & Construction • Within the "Additional Indirect and Induced Production," firms buy additional goods and services from one another for their own •Manufacturing These firms produce and make production. Both the supplying and producing firms also pay wages (E), which creates added spending power. •Wholesale & Retail Trade purchases among themselves. • "Households" receive wages and other income from all sectors. They spend most of this income (F) on goods and services produced •Transportation, Communication by all sectors which, in turn, buy additional supplies and pay additional wages. Households also purchase wine (G), which provides & Utilities wine producers and distributors with revenue that repeats through the cycle. •Finance, Insurance & Real Estate • This cycle of purchases-production-wages-purchases-production-wages continues until, by gradually reducing the purchasing •Business & Personal Services strength of each succeeding cycle, it is exhausted. The final result is the noted "Multiplier Effect" whereby the original spending on liquor and wine has multiplied the economic activity of all interrelated industries.

8 © 2004 American Economics Group, Inc. The economic impact of increasing wine outlets is specific to each state. The exact results for a given state will vary depending upon the state’s mix of industry, its tax rates, liquor and wine prices and availability, as well as its demographic characteristics and other factors, including the tendency of its own citizens to purchase beverages across state lines. The following tables for New York State illustrate the possible gains from a significant expansion of wine outlets per capita. The calculations are based upon New York expanding the number of wine outlets from 2,511 to 18,825, which is still well below the top wine-selling states, as measured in outlets per capita.

First, consider a baseline of the existing economic value of New York State’s wine production and distribution in 2001. As Figure III-2 shows, all industries benefit significantly from wine production and sales. For example, the wine industry supported $67.0 million (excluding wine) in manufacturing and $275.6 million in services. Purchases from these industries include paper and glass containers and commercial printing services.

Figure III-2 SALES SUPPORTED BY WINE PRODUCTION AND SALES IN NEW YORK STATE 2001

Industry Direct Indirect Induced Total Grape Growers and Vintners $92,031,923 $0 $0 $92,031,923 Food Stores 0 99,845 5,954,014 6,053,859 Liquor Stores 266,462,752 0 0 266,462,752 Agriculture 0 1,765,197 1,443,850 3,209,047 Mining 0 135,370 177,214 312,584 Construction 0 7,421,603 5,142,276 12,563,879 Manufacturing 0 39,432,253 27,617,648 67,049,901 Transportation, Communications, Public Utility 26,223,404 39,028,984 22,602,900 87,855,288 Wholesale and Retail 604,497,488 43,750,891 57,573,419 705,821,798 Finance, Insurance, Real Estate 0 15,733,656 32,101,199 47,834,855 Services 0 123,191,303 152,391,319 275,582,622 Total $989,215,567 $270,559,102 $305,003,839 $1,564,778,508

9 Figure III-3 shows total employment of 17,748 jobs supported by the wine industry. The wine industry directly supported 12,399 full-time and part-time jobs throughout the state, primarily in wholesale and retail. The production of supplies and inputs supported another 2,176 jobs. An additional 3,173 jobs were required to produce the goods and services purchased by the employees working for the direct and supplier firms.

The compensation paid to these workers (not shown in table) in direct production amounted to $365.2 million under direct production; $95.6 million for indirect production; and $103.8 million for induced production. Overall, workers received $564.6 million in wages and benefits due to New York’s wine industry spending.

Figure III-3 JOBS SUPPORTED BY WINE PRODUCTION AND SALES IN NEW YORK STATE 2001

Industry Direct Indirect Induced Total Grape Growers and Vintners 300 0 0 300 Food Stores 0 3 169 172 Liquor Stores 5,280 0 0 5,280 Agriculture 0 21 19 40 Mining 0 1 1 2 Construction 0 102 66 168 Manufacturing 0 202 114 316 Transportation, Communications, Public Utility 179 188 104 470 Wholesale and Retail 6,640 364 943 7,947 Finance, Insurance, Real Estate 0 65 142 207 Services 0 1,232 1,614 2,845 Total 12,399 2,176 3,173 17,748

10

C. JOB GAINS FROM WINE SALES IN FOOD STORES

Additional wine outlets generating a higher level of sales will fill more jobs in beverage wholesaling and retailing. Retail food stores, distributors, suppliers and their suppliers all benefit. Food retailers and wholesale distributors will increase their spending on all sorts of goods and services: insurance, heating fuel, paper products and boxes, business services. As a result sales will increase for many of the over 500 major industries found in the state. The income created and the spending by added workers and their families will send additional ripples through the entire state’s economy, thus creating even more economic activity.

Figure III-4 shows how wine sales in food stores would create an additional 2,030 full- time and part-time jobs throughout New York State. Food store jobs would increase the most (2,386), while liquor store employment would fall by about 755. But this effect would be minimized because many workers will find positions in new wine departments in food stores, which will be looking for experienced personnel (this has already happened in the pharmacy business, where many independent pharmacists sold their businesses and took jobs with chain pharmacies). Total wages (not shown) supported by wine production and sales would increase by $54.6 million.

Figure III-4 INCREASE IN JOBS IF WINE SOLD IN FOOD STORES 2001

Industry Direct Indirect Induced Total Grape Growers and Vintners 24 0 0 24 Food Stores 2,370 0 16 2,386 Liquor Stores -755 0 0 -755 Agriculture 0 0 2 2 Mining 0 0 0 0 Construction 0 3 6 9 Manufacturing 0 6 11 17 Transportation, Communications, Public Utility 15 9 10 33 Wholesale and Retail -8 14 89 95 Finance, Insurance, Real Estate 0 3 13 16 Services 0 51 152 203 Total 1,645 87 299 2,030

11 IV. Liquor Stores Remain Profitable As Wine Outlets Increase

A. OTHER STATES DEMONSTRATE WINE SALES IN FOOD STORES

Critics worry increasing the number of wine outlets will put liquor stores out of business. However, the overwhelming evidence from permissive states shows that experienced markets support more liquor stores per capita than restrictive states now license. There is ample proof from states that permit wine sales in food stores that a large number of wine and liquor outlets can mutually exist. In fact, there is a general statistical relationship that states: more wine outlets also support more liquor outlets.

Examine Figure IV-1, which compares the number of wine outlets with the adult population of each state. The “scatter diagram” plots population across the bottom axis and the number of wine outlets vertically on the left side. Each marker represents a single state and shows the relationship between the number of wine outlets and the population. The solid line is a regression line that denotes the average relationship between the two.

Figure IV-1

Wine Outlets Relative to Population 2002

30,000

Each point represent a California state. States below the regression line have 25,000 fewer outlets than expected, relative to their populations.

20,000

15,000 Regression line showing the expected number of stores relative to population. 10,000

Ne w Yor k (underserved) Minnesota 5,000 (underserved) NumberWineOutlets of sales) (off-premise

0 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 Population Age 21+

Notice that the regression line moves up and to the right. This shows, as one might expect, that there are generally more liquor stores in larger states than in smaller ones. But the significant feature of the line is that markers below it represent states with a

12 less-than-average number of wine outlets relative to its population. A marker above the line means the opposite.

New York and Minnesota have markers well below the line, meaning they are underserving consumers with too few wine outlets; they could move at least to the “average” line or even above it. Many states successfully have a significantly higher- than-average number of stores.

Figure IV-2 (next page) lists all the states sorted by their number of wine outlets per capita. The underserved states are near the bottom, while the higher-than-average states are near the top. As illustrated further in this report, liquor stores do fine in states with higher-than-average wine outlets.

13 Figure IV-2

Number of Liquor and Wine Outlets by State 2002 Sorted*

Outlets per 100,000 population age 21+ Number of Number of wine Supermarket State liquor outlets outlets Liquor Wine sales permitted Vermont 75 1,200 17.3 276.9 Yes North Carolina 393 13,072 6.9 228.0 Yes Wyoming 714 714 209.5 209.5 Yes Maine 229 1,664 24.8 180.1 Yes Louisiana 5,444 5,444 179.7 179.7 Yes New Hampshire 84 1,444 9.6 164.9 Yes Idaho 156 1,374 18.1 159.7 Yes Georgia 1,034 8,402 18.3 148.8 Yes Oregon 237 3,570 9.8 147.0 Yes Dist. Columbia 300 615 70.6 144.6 Yes Washington 312 5,754 7.6 139.4 Yes Florida 1,190 14,979 10.1 127.6 Yes Texas 2,384 17,120 17.1 122.4 Yes Michigan 4,127 8,437 59.7 122.0 Yes Montana 97 770 15.4 121.9 Yes California 12,567 27,004 54.3 116.7 Yes Virginia 258 5,710 5.1 113.3 Yes Missouri 4,273 4,273 109.0 109.0 Yes Hawaii 782 917 90.2 105.7 Yes Ohio 396 8,407 5.0 105.4 Yes South Dakota 535 535 103.8 103.8 No Alabama 546 3,238 17.5 103.6 Partial Alaska 408 412 99.4 100.4 No Arizona 1,421 3,549 40.2 100.4 Yes West Virginia 162 1,141 12.2 86.0 Yes Nevada 1,180 1,180 83.6 83.6 Yes New Mexico 887 887 72.3 72.3 Yes Delaware 369 369 66.6 66.6 No Indiana 1,545 2,749 36.6 65.1 Yes Nebraska 581 759 49.2 64.3 Yes Massachusetts 1,647 2,679 35.9 58.4 Yes South Carolina 876 1,633 31.1 58.0 Yes Connecticut 1,379 1,379 56.5 56.5 No Wisconsin 1,941 1,877 51.7 50.0 Yes Colorado 1,432 1,432 47.5 47.5 No Maryland 1,047 1,760 28.0 47.1 Yes Iowa 437 821 21.3 40.0 Yes Kansas 672 672 36.4 36.4 No Rhode Island 256 256 34.2 34.2 No New Jersey 1,797 1,797 29.8 29.8 Yes Minnesota 981 981 28.7 28.7 No Arkansas 474 474 25.3 25.3 No Mississippi 465 465 24.2 24.2 No Kentucky 669 685 23.3 23.9 No Oklahoma 537 537 22.4 22.4 No New York 2,495 2,511 18.5 18.6 No Tennessee 469 469 11.6 11.6 No Pennsylvania 640 711 7.2 8.0 No *Sorted by number of wine outlets, high-to-low.

14 B. STATES WITH MORE WINE OUTLETS SUPPORT MORE LIQUOR STORES

States that now permit wine sales in food outlets also support a greater number of liquor stores per capita than states that limit wine sales to package stores. Contrary to the claims of some liquor store owners, more liquor is sold and more package stores thrive in states with more wine outlets.

The graph in Figure IV-3 plots the number of wine outlets against the number of liquor outlets. Each marker represents a state, and the solid line shows the relationship between liquor outlets (horizontal scale) and wine outlets (vertical scale). Notice that the markers spread outward and upward and the line slants upward. This shows that, on average, states with more liquor stores have more wine outlets—and that goes for absolute counts as well as per capita counts.

Figure IV-3

Wine Outlets Relative to Liquor Outlets 2002

30,000 California Each point represent a state. Points below the line have fewer 25,000 wine outlets than expected, relative to the number of liquor store s 20,000

15,000

Re gre ssion line showing the expected 10,000 number of wine stores Number of Wine Outlets Wine of Number relative to liquor New York store s. (underserved) (underserved 5,000

Minnesota (underserved)

0 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Number of Liquor Outlets

Figure IV-4 (below) summarizes this same relationship. States selling wine in supermarkets average 1,445 liquor outlets and 4,539.1 wine outlets. Those states that restrict wine outlets average about one-half the number of liquor stores as the permissive states.

15 Figure IV-4

States with More Wine Outlets have More Liquor Stores

Number stores 2002 Liquor stores Wine stores

States selling wine in supermarkets 1,455.0 4,539.1

States without wine in supermarkets 744.6 743.0

Average difference 95.4% 510.9%

The same result is apparent on a per capita basis, as shown by Figure IV-5. States permitting wine sales in supermarkets have 40.7 liquor stores per 100,000 adults. This is 11.5% more outlets than in restrictive states, which average 36.5 stores.

Comparison of per capita amounts presents only part of the picture. Other factors affect sales, and the analysis underpinning this report takes account of important demographic and economic differences among the states that create differences in per capita wine and liquor sales.

Figure IV

States with More Wine Outlets Per Capita Have More Liquor Stores

Per capita stores 2002* Liquor stores Wine stores

States selling wine in supermarkets 40.7 108.3

States without wine in supermarkets 36.5 36.1

Average difference 11.5% 200.0%

*Stores per 100,000 population age 21 and over.

16

C. PER CAPITA LIQUOR AND WINE SALES ARE HIGHER IN STATES THAT LICENSE SUPERMARKETS TO SELL WINE

States permitting wine sales in supermarkets sell more of both wine and liquor per capita than do restrictive states. On average, as the number of wine outlets per capita increases, liquor sales per capita increases. Figure IV-6 compares liquor sales per capita with wine outlets per capita for the adult population. As in earlier scatter diagrams, each marker represents a state. Wine outlets are on the horizontal axis and liquor sales on the vertical one.

Figure IV-6

Liquor Sales versus Number of Wine Outlets

6.00 Simple regression line showing the relationship between liquor sales and the number of wine 5.00 outlets.

On average, liquor sales per capita are slightly greater in states with 4.00 more wine outlets. This is largely due to reduced cross-border loses.

3.00

2.00 Liquor Sales Per Capita (gallons 2002) (gallons Capita Per Sales Liquor

1.00

- 0 50 100 150 200 250 300 Wine Outlets per 100,000 Population Age 21+

Note the upward slant of the solid regression line that describes the relationship between wine outlets and liquor sales. This angle means that as wine outlets increase, the per capital sales of liquor also increases.

17 The results are summarized in Figure IV-7 below. States selling wine in supermarkets sell 8.5% more liquor per capita on average. States restricting sales average1.89 gallons per capita, while permissive states average 2.05 gallons. As expected, wine sales are also higher, by 30.3%, in states permitting supermarket sales.

Figure IV-7

Supermarket Sales of Wine Boost Overall Wine and Liquor Sales

Per capita gallons sold 2002* Liquor sales Wine sales

States selling wine in supermarkets 2.05 3.01

States without wine in supermarkets 1.89 2.31

Average difference 8.5% 30.3% *Stores per 100,000 population age 21 and over.

It is remarkable proof that even with a 30.3% increase in wine sales, liquor sales still expand in states permitting more wine outlets. Numerous factors are involved, and a complete description of the econometric analysis has been included in the appendix of the full report.

18

D. DISTRIBUTION OF STORE COUNTS AMONG STATES SHOWS LIQUOR STORES AND WINE OUTLETS ARE MUTUALLY SUPPORTIVE

The table in Figure IV-7 (above) compared states with and without supermarket sales of wine. Figure IV-8 (below), however, relies on store counts without regard to the type of stores selling wine.

There is a strong and persistent relationship between the number of wine outlets per capita and the number of liquor stores a state supports. Quite the contrary of what some believe, the number of liquor outlets increases as the number of wine outlets grows. The competitive market supports more liquor stores than restrictive states allow.

To calculate the results in Figure IV-8, states were sorted by the number of wine outlets. Both liquor and wine outlets were also counted for each 25% range on the scale. At the bottom 25% of states there are 39.0 wine outlets per 100,000 adult persons and 16.1 liquor stores. Moving up the scale, as the number of wine outlets grows, the number of liquor stores also increases.

Increasing the number of wine store will not force a lower number of liquor stores; more wine outlets means more liquor outlets. Granted the competition may increase, but that is the American way—competitive markets drive prices and consumers get a full selection and full value.

Figure IV-8

Distribution of Liquor and Wine Stores Among the States

Per capita stores 2002* Quartile points Liquor stores Wine stores

Low 25% of states 16.1 39.0

Median of states 26.6 76.3

High 75% of states 50.1 116.3

*Stores per 100,000 population age 21 and over.

19 E. LIQUOR STORE PROFITABILITY

The argument against expanding wine sales is really not about a reduction in the number of liquor stores, but rather about protectionism for existing firms that earn monopoly profits at the expense of consumers. The United States is a free market economy that depends upon competition to derive an efficient number of stores and to shield consumers from price gouging.

Profitability analysis shows that the annual flux in liquor stores—some close in difficult markets while new ones open to serve other markets in a state—will be only mildly affected by expanded wine outlets, even in states now experiencing a long-term decline in the number of liquor stores.

Economic theory is quite clear that restricting the number of sellers of a good or service means that fewer overall units will be sold. What’s more, prices will be higher and sellers will reap monopoly profits at the expense of buyers. In this regard, wine and liquor package stores are no different than most other stores.

A lower, restricted number of outlets per capita means overall wine and liquor sales in a state will be lower than a competitive market can support. States with fewer liquor stores have greater sales per store, reflecting market concentration, in effect a subsidy of these private firms by a state. Restriction is a hidden tax on consumers, who end up paying more for their wine and liquor.

States such as New York that have a declining number of liquor stores experience stronger liquor sales per outlet. The reduction of outlets results from smaller, less profitable stores closing, particularly in declining areas of the state. However, other stores then expand their business, and merchants build new stores in expanding neighborhoods.

As businesses open and close their doors, the average volume per store and the total sales of wine and liquor grows. Also, the fewer remaining stores gain the dual benefit of captive sales and more buying power to deal with suppliers. The state restrictions create increasing subsidies of these remaining (and expanding) stores; overall, consumers lose.

20 Figure IV-9 contains the distribution of profit rates for privately owned liquor stores, including those that sell wine. In the graph, “profit” means net profit before taxes as a percent of sales including liquor and wine sales. Notice that about 3.5% of stores had a loss during their fiscal year 2002-2003. Another 5.9% made less than 0.5% profit on their sales. These are the stores most at risk. Many will go out of business or change ownership to a more profitable operator, representing a fluctuation of stores under the existing mix of liquor and wine outlets.

Figure IV-9

Net Profit Rates for Package Stores 2002-2003

18.0% About 3.5% of private package stores lose money, while another 16.0% 5.9% make less than 0.5% profit on sales. 14.0% A number of these fail each year, and others 12.0% sell to more profitable operators.

10.0%

8.0%

6.0% Percent of Packageof Stores Percent 4.0%

2.0%

0.0% Stores 0% - .5% .6% - 1% 1.1% - 1.6% - 2.1% - 2.6% - 3.1% - 3.6% - 4.1% - 4.6% - 5.1% - 5.6% - Over 6% with 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5% 5.5% 6% loss Net Profit as Percent of Sales

21 Profitability among these liquor stores is widely varied, but on average profitability is greater for larger stores. Figure IV-10 shows that stores with sales under $1.0 million annually average about a 1% profit rate, while those over $2.5 million average a 4% rate.4

Figure IV-10

Larger Package Stores Have Higher Profit Rates

12.0%

10.0%

8.0%

6.0% Stores with sales over $2.5 million average 4.0% about a 4% profit rate. Net Profit as Percent of Sales 2.0% Stores with sales under $1.0 million average about a 1% profit rate. 0.0%

-2.0% $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 Size of Store: Annual Gross Sales (in $1,000)

4 The results in this section are based upon data from tax returns and data from RMS, a firm that tabulates industry statistics for the banking industry. For the change analysis that reflects an expansion of wine outlets, the multiplex model described in the appendix was used to calculate sales and price impacts as well as shifts in cross-border wine and liquor sales.

22 F. ADDING WINE OUTLETS IN UNDERSERVED STATES HAS MILD IMPACT ON LIQUOR STORES

Adding wine outlets affects the profitability of liquor stores, but not by so large a number that most or even many feel dramatic effects—as claimed by opponents to expanding wine outlets.

Figure IV-11 shows the result of a simulation of liquor store profitability based upon current statistics on profitability and their variable and fixed costs. Most stores would adapt, although most would loose a significant part of their monopoly profits. Notice the shift in the histogram in Figure IV-11 as compared to those values from Figure IV-9. The latter is shown by the blue (or darker) bar, while the orange (light) bars show the new position after expanding to the average number of wine outlets per capita of non- restricting states. Here, New York State was used as an example.

The result is a moderate shift to lower profits overall, but a minimal impact on the number of liquor stores at risk. If wine sales were allowed in food stores, about 9.1% of private package stores would lose money, while another 8.3% would realize a return on sales (profit) of less than 0.5% annually. In New York State’s case, this would mean about 200 out of more than 2,500 additional stores would be at risk of terminating operations or selling to other operators.

Figure IV-11

Net Profit Rates for Package Stores 2002-2003

18.0% Existing profit level Profit level with wine in food outlets If wine sales were allowed 16.0% in food stores, about 9.1% of private package stores would lose money, 14.0% while another 8.3% would make less than 0.5% profit on sales. 12.0% In New York State, this would increase by just 10.0% 200 stores the number at financial risk. 8.0%

6.0% Percent of Packageof Stores Percent 4.0%

2.0%

0.0% Stores 0% - .5% .6% - 1% 1.1% - 1.6% - 2.1% - 2.6% - 3.1% - 3.6% - 4.1% - 4.6% - 5.1% - 5.6% - Over 6% with 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5% 5.5% 6% loss Net Profit as Percent of Sales

23 V. Appendix: Methodology

A. GENERAL DESCRIPTION OF THE MULTIPLEX MODEL

AEG’s methodology provides a state-of-the-art investigation of cross-border liquor sales that combines well-known and accepted techniques. The first is regression modeling and analysis, which is useful in extracting the separate influences of many variables working in concert. The second is nonlinear programming, which can make sense of more complex relationships, while accounting for identities and constraints outside the practical realm of linear regression methodology.

Finally, there is a balanced 51-by-51 state matrix, or grid, to account simultaneously for each state’s alcoholic beverage inflows and outflows to and from each other state. This matrix approach requires that the exports of any state appear as imports in some other state, and vice versa. This relationship imposes a discipline on the regression model that can be estimated using the nonlinear programming technique. The technical aspects of this approach are discussed later.

More importantly, for the first time this study takes account of all of the inflows and outflows from every state simultaneously. Such consideration requires first, that total imports equal total exports and that each possible pair of trading states has an accounting identity5.

This combination of regression analysis, nonlinear programming and matrix accounting assesses the full purchase-shifting impact of liquor taxes that affects cross-border activity. The methodology estimates consumption in a state based upon that state’s economic and demographic factors and liquor prices.6

AEG’s analysis takes account of reported taxed sales by subtracting from consumption those cross-border purchases by residents in higher-taxing states and adding exports to consumption in lower-taxing states. One of the benefits of introducing the matrix accounting is that the calculations can recognize that a given state may simultaneously be both an exporter and importer to other states with higher and lower tax rates.

5 This simply means that the exports of one state to another appear as imports in that state’s calculations. Maintaining this requirement for every possible pair of trading states dramatically increases the calculations that must be done simultaneously.

6 While differing alcohol regulations may also be significant, the simplifying assumption is made that consumers work around them by adjusting their time and place of purchase and of consumption. Including regulations as separate variables would add significantly to the complexity of the study.

24 Past Cross-Border Analysis Failed To Use Significant Available Data

A technique often employed to analyze cross-border estimates is multiple regression alone. This is a powerful method that estimates the influence each of a list of factors exerts on another. For example, a regression equation might express how per capita liquor sales change from state to state depending upon the population characteristics of each state, income, average liquor prices and taxes. Previous studies of cross-border impacts rely heavily upon such single or multiple equation regression models.

However, a serious problem with the regression approach for cross-border liquor/wine estimates is the limited data available. There is no direct observation of in-state consumption or cross-border sales, and only limited reliable and consistent data exist on liquor prices and tax collections. Consequently, if research is to arrive at solid estimates of consumption and cross-border sales, it must extract all possible information from available data. Most models are not so ambitious, with the result being that they are limited in their accuracy and in the guidance their results can provide. Part of the problem is the complexity of accounting for each of the possible state trading partners across the country.

Some researchers attempt to account for this cross-border complexity by creating an all-encompassing, cross-border proxy variable. It is typically an amalgam of the population of competing states, their taxes and, perhaps, some measure of distance. These factors are mathematically combined into a single number and used as the proxy for all cross-border activity for the state in question. In these models, imports are not usually separated from exports and there is no provision for cross hauling, or trafficking in both directions. Also, there is no way to control for important known constraints about the balancing of imports and exports between states or even the overall equality of nationwide exports and imports. This study explicitly measures the unbundled variables that were previously lumped together.

As described below, the matrix structure employed in this study adds “accounting identities” to the calculations to extract more useful information from the data by allowing multiple cross-border possibilities simultaneously. For example, the reported taxed sales in a low-tax state may be high because it includes sales to residents of several other states. In contrast, the taxed sales in those states will fall below their expected resident consumption. An accounting identity7 recognizes that one state’s exports have to show up in other states’ imports. Defining this mathematically in the matrix for all cross-border states together can force the estimates of resident consumption and cross-border activity to a better level of accuracy.

In practice, the 51-by-51 export and import matrix is set up to show selling states in the left column (called row states because their selling activity is in the row opposite their name) and purchasing states along the top (called column states). A column on the far right of the matrix is the sum for each row, and it reflects total sales of a row state to all

7 One accounting identity is that total taxed sales, less resident consumption in the low-tax states (amount exported), will equal the sum of expected resident consumption less taxed sales in the neighboring high-tax states (amount imported). By imposing these export-import identities between each pair of trading states, a regression that estimates expected consumption can be forced to recognize the full pattern of cross-border sales and purchases among the states.

25 other states, including itself (the diagonal of the matrix is a state’s sales for consumption within its borders). The total column is the actual reported taxed sales for each state, which must be distributed to itself and other states across the row.

The row along the bottom sums the column states and represents the consumption (as opposed to taxed sales) in each state. The sum of consumption equals the sum of taxed sales nationwide, but it will not be equal for any given state unless the state’s residents neither import nor export spirits.

Total consumption for each state is set to equal the influence of the variables in the multiple regression demand equation (discussed below). However, consumption can only be known for a state once its imports and exports are calculated and used to adjust taxed sales (C = S – E + I, where C is resident consumption, E is exports, and I is imports). Arriving at exports and imports requires filling in the matrix, which is the task of the nonlinear programming component of the analysis.

Several additional matrices are devised for the nonlinear programming: 1) a price-with- tax differential matrix whose elements show the price differences between each pair of states; 2) a relevant population matrix that shows the population of an importing state likely to trade with an exporting state, determined on the basis of the price differential; and 3) a distance matrix showing the average distance from appropriate population centers in an importing state to border sales areas of lower-priced states.

The cells of these matrices are multiplied with each other after first being weighted by: 1) a tax differential function that allows for nonlinear, increasing magnetism between pairs of states as price differentials increase; 2) population weights that reflect concentrations of populations near borders; and 3) distance weights represented by a sigmoid function of the likelihood of travel between 0 and 1. The weights are initially put in the export-import matrix as seed values for the calculation. These are altered dynamically during simultaneous interaction of the demand equation and the parameters of all weighting functions. It should be noted that many of the seed values are small because trade between certain pairs of states is low (for example, Iowa and Hawaii are assumed to have no traffic between them for the sole purpose of reducing the tax on liquor or wine.)

The least squares solution of the multiple regression demand equation requires simultaneous estimation of the weight parameters and the fulfillment of all constraints on the export-import matrix, including that aggregate exports equal aggregate imports.

The result is more useful than the conventional regression approach because self- consumption, exports and imports are measured for each state, and each is observed separately. Also, because the model is dynamic as to trading partners and relevant populations, the impact of a tax change that reverses the direction of trade between any two states is calculable. This is not directly possible in a regression because it requires a recalculation of the export-import weighting variable, perhaps for multiple states with any given change in tax rates for one or more states. This multiplexed approach handles all that simultaneously and dynamically.

B. TECHNICAL RESULTS OF MODEL

26 Figures B-1 and B-2 give the results for liquor and wine, respectively, in the regression segment of the multiplex model. Each equation specifies taxable sales as a function of a constant term and each state’s wine outlets, liquor outlets, Asian population, average residential property wealth, relative tourism and an export-import vector determined by simultaneous interaction with the nonlinear matrix calculations.

The regression for liquor explains 83.7% of the variation among states, has a significant F-statistic and significant t-statistics for each variable except the number of wine outlets per 100,000 adults (t-Statistic = .437 indicating no significant5 impact on liquor sales as the number of wine outlets increases). The latter result is important because it indicates that the amount of taxed liquor sales is not significantly affected by the number of wine outlets in a state, other things equal.

Figure B-1 Regression Results for 51 State* Liquor Model

Dependent Variable: Per Capita Taxed Liquor Sales

Method: Least Squares Observations: 51

Variable Coefficient Std. Error t-Statistic Prob. Wine outlets per 100,000 adults 0.00032 0.00073 0.4371 0.66420 Liquor outlets per 100,000 adults 0.00273 0.00112 2.4288 0.01940 Percent population Asian -0.03088 0.01188 -2.6002 0.01270 Alaska dummy variable 0.83072 0.31751 2.6164 0.01220 Wealth index 0.00612 0.00166 3.6915 0.00060 Tourism index 0.56267 0.16256 3.4613 0.00120 Export Import vector from matrix 0.93038 0.08755 10.6269 0.00000 Constant term 0.90669 0.18881 4.8020 0.00000

Statistics R-squared 0.837449 Mean dependent var 2.00177 Adjusted R-squared 0.810987 S.D. dependent var 0.69665 S.E. of regression 0.302873 Akaike info criterion 0.59210 Sum squared resid 3.944485 Schwarz criterion 0.89513 Log likelihood -7.098431 F-statistic 31.64748 Durbin-Watson stat 2.012958 Prob(F-statistic) 0.00000

*Determined interactively with 51X51 cross-border trading matrix including DC.

The regression for wine explains 90.9% of the variation among states, has a significant F-statistic and significant t-statistics for each variable, except the number of liquor outlets per 100,000 adults (t-Statistic = -1.42 indicating a weak negative impact on wine sales as the number of liquor outlets increases). The latter result is significant because

27 it indicates that the amount of taxed liquor sales is not significantly affected by the number of wine outlets in a state, other things equal.

Figure B-2 Regression Results for 51 State* Wine Model

Dependent Variable: Per Capita Taxed WIne Sales

Method: Least Squares Observations: 51

Variable Coefficient Std. Error t-Statistic Prob. Wine outlets per 100,000 adults 0.00544 0.00146 3.7240 0.00060 Liquor outlets per 100,000 adults -0.00319 0.00225 -1.4167 0.16380 Percent population Asian -0.08514 0.02377 -3.5820 0.00090 Alaska dummy variable 8.35099 0.63539 13.1432 0.00000 Wealth index 0.03017 0.00332 9.0960 0.00000 Tourism index 1.47408 0.32531 4.5313 0.00000 Export Import vector from matrix 0.93808 0.17520 5.3544 0.00000 Constant term -1.30226 0.37784 -3.4466 0.00130

Statistics R-squared 0.909158 Mean dependent var 2.96765 Adjusted R-squared 0.89437 S.D. dependent var 1.86486 S.E. of regression 0.606094 Akaike info criterion 1.97954 Sum squared resid 15.79606 Schwarz criterion 2.28257 Log likelihood -42.4782 F-statistic 61.47845 Durbin-Watson stat 2.366406 Prob(F-statistic) 0.00000

*Determined interactively with 51X51 cross-border trading matrix including DC.

28 Accuracy of the multiplex model is demonstrated in the scatter diagram of Figure B-3, which compares actual per capita taxed sales of wine and separately liquor with the model’s predicted sales in each state.

Figure B-3

Comparison of Actual and Estimated Wine and Liquor Sales 2001

12.0

Each point represents one state. If on the line, there is an exact match of actual and estimated sales 10.0 volume. Above the line signals an overestimate and below an underestimate.

Notice the dots arelined up well 8.0 and vary on both sides of the line, meaning the estimates are very close to actuals.

6.0

4.0

Estimated Taxed Gallons Sold per Adult per Sold Gallons Taxed Estimated Gallons of LIQUOR Sold per Adult

2.0 Gallons of WINE Sold per Adult

0.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 Actual Taxed Gallons Sold per Adult

29