Peter Franchot Comptroller December 21, 2010 The Honorable Thomas V. Mike Miller President of the Senate H-107 State House State Circle Annapolis, MD 21401 The Honorable Michael E. Busch Speaker of the House H-101 State House State Circle Annapolis, MD 21401 Dear President Miller and Speaker Busch: Senate Bill 858, which was passed by the General Assembly earlier this year and signed into law by the Governor, charged the Comptroller with submitting a report to the General Assembly “on the viability and efficacy of instituting in Maryland the policy of permitting direct shipment of wine to consumers in the State.” To that end, please find attached a report prepared for you and the members of the General Assembly about the direct shipment of wine in Maryland, one which addresses the specific issues enumerated in Senate Bill 858. I hope you find this information useful. Should you have any questions or concerns, please do not hesitate to contact my office. Sincerely, Peter Franchot Comptroller of Maryland 80 Calvert Street P.O. Box 466 • Annapolis, Maryland 21404-0466 • 410-260-7801 • 1-800-552-3941 (MD) Fax: 410-974-3808 • Maryland Relay 711 • TTY 410-260-7157 • [email protected] Acknowledgements As required by Senate Bill 858, this Direct Wine Shipment Report is submitted to the Maryland General Assembly by the Comptroller of Maryland. Joanne Tetlow, Esquire, Tax Consultant II of the Field Enforcement Division performed the research, writing, analysis, and management of this report under the supervision of Jeffrey A. Kelly, Director of the Field Enforcement Division. Jocelyn Aldworth, Assistant to the Assistant Director, managed and developed the survey software and provided other important support functions. Melanie Pyne, Intern, provided assistance in a variety of ways, including the research for the Wine & Spirits Study, and insight into the wine industry. Gratitude is expressed to all who contributed to this report, including industry members and survey respondents. Executive Summary The three-tier distribution system has been the backbone of alcoholic beverages regulation in Maryland and nationwide since the repeal of Prohibition in 1933. While three-tier distribution has been and continues to be the legal framework for the sale and distribution of alcoholic beverages in Maryland, this does not mean it is unalterable. Modifications have been made within the three- tier distribution system as established in Article 2B. However, the rise of direct wine shipment, which is the subject of this report, poses new and different challenges to the three-tier system. Rather than operating within the three-tiers, direct wine shipment is an “exception” to the three-tier distribution system. As such, the direct wine shipper bypasses the second-tier wholesaler and third-tier retailer by selling to the consumer as the end-user. When an out-of-state direct wine shipper and Maryland consumer transact a sale of wine, both act outside of the three-tier distribution system. Because of this, tax collection, compliance, and enforcement problems may arise, though states that have enacted direct wine shipping legislation have reported nominal problems. Senate Bill 858, which was passed by the General Assembly earlier this year and signed into law by the Governor, charged the Comptroller with examining these issues and others to determine the viability and efficacy of direct wine shipment in Maryland. This direct wine shipment report makes evaluations and determinations pursuant to the seven criteria set forth in Senate Bill 858. The last section of this report (section 7) addresses these seven requirements using both qualitative and quantitative data discussed in prior sections. In order to render a legislative or public policy judgment about direct wine shipment, the regulatory context which gave rise to this phenomenon must be examined as well as the constitutional jurisprudence surrounding this issue and the Twenty-first Amendment to the United States Constitution. It is also important to understand how wine is regulated as an alcoholic beverage in Maryland as well as relevant federal laws (sections 4 & 5). A legislative history of direct wine shipment bills is furnished to assist lawmakers in understanding that context as well (section 6). ii The general organization of the report begins with a description of the research design and methodology in section 1, which includes an explanation of the surveys and case study employed to obtain quantitative data. Surveys were sent by the Comptroller’s Office to Maryland wineries, wholesalers, retailers, nonresident wineries, alcoholic beverage manufacturers, local Maryland liquor boards, consumers, and other state regulators. A case study was conducted using the model of the Virginia based McLean Study in the report issued by the Federal Trade Commission entitled, “Possible Anticompetitive Barriers to E-Commerce: Wine” (July 2003) (“FTC Report”) to determine the benefits and costs of direct wine shipment to Maryland consumers. The top 50 restaurant wines selected by Wine & Spirits magazine for 2009 were used as a “sample” to compare prices between Maryland bricks-and-mortar retail stores, online wineries, and online retailers. Section 2 attempts to describe the rise of the phenomenon of direct wine shipment, i.e., a convergence of small winery growth, direct-to-consumer sales, and consolidation of the wholesalers as a result of the United States Supreme Court decision, California Retail Liquor Dealers Association v. Midcal Aluminum, Inc., 445 U.S. 97 (1980). Also, the impact of the national economic crisis in 2008 on the wine industry is briefly examined. Our assessment of the positive economic benefits of the wine industry is balanced by a subsection regarding the costs of alcohol-related injuries and illnesses. Included in this are studies about underage wine drinking. It appears from a report issued by the National Center on Addiction and Substance Abuse at Columbia University (“CASA”) that compared to beer and distilled spirits, “wine” is not the drink of choice for underage drinkers, both pathological and non-pathological. Nevertheless, underage drinking is a documented national problem, so any additional access to wine by youth is undesirable. Perhaps the most important consideration and the one that is central to this report is the United States Supreme Court decision in Granholm v. Heald, 544 U.S. 460 (2005), which set the legal parameters and logic of direct wine shipment and the Twenty-first Amendment. The analysis of this report uses Granholm as a benchmark to evaluate the issue of direct wine shipment and its implications for three-tier distribution in Maryland. Section 3 of the report discusses pre-Granholm constitutional jurisprudence and Justice Kennedy’s majority opinion in Granholm and his reliance on the FTC Report. Justice Stevens’ and Justice Thomas’ dissents in Granholm are also considered, and then post-Granholm statutory and legal developments. In many ways, the majority opinion in Granholm expresses the arguments made by those supporting direct wine shipment, and the dissenting opinions express the arguments made by those opposing direct wine shipment. iii There is a tendency in this policy debate to conjoin considerations that should remain distinct. For example, a recent United States Court of Appeals Fifth Circuit case discussed in Section 7 – Wine Country Gift Baskets.Com v. Steen, 612 F.3d 809 (2010) – stands for the proposition that Granholm applies to out-of- state wineries, but not out-of-state retailers. The court in Wine Country distinguishes “out-of-state wineries” from “out-of-state retailers”: the former are an “exception” to the three-tier distribution system, while the latter are an integral part of the three-tier system itself. In-state retailers, as the third tier, are subject to state power under the Twenty-first Amendment. They are physically located in the state and proximate to consumers. By contrast, an out-of-state winery or producer, while acting as a first tier manufacturer, is by definition not located in the state creating a different relationship to state regulatory authority. Because of this, the court in Wine Country held that treating in-state retailers differently than out-of-state retailers was not Granholm discrimination. Under the Twenty-first Amendment, a state is not required to provide equal treatment between out-of-state retailers and in-state retailers. Wine Country provides the insight that out-of-state wineries and out-of- state retailers cannot be merged together. They are separate and distinct in how they operate within the three-tiers, and in their unique relationship to state regulatory power. Wine Country is not the only case that has been decided in the post-Granholm world; but, it is one that makes the type of distinctions crucial to lawmaking and public policy analysis. As a matter of logical inference, since direct wine shipment by out-of-state wineries is an “exception” to the three-tier distribution system, and direct wine shipment by out-of-state retailers relates to an integral part of the three-tiers itself, allowing direct wine shipment from out-of-state retailers is incompatible with existing alcoholic beverage laws in Maryland. Having said that, the remaining part of this summary will outline the key findings made in section 7 of this report as required by Senate Bill 858: (1) Evaluation of best practices used by 37 states and the District of Columbia where direct wine shipment to consumers is legal: A. Establish a “Direct Wine Shipper’s Permit,” whether it be a revised expansion of the current Direct Wine Seller’s Permit or a newly created one to repeal and replace the Direct Wine Seller’s Permit. B. Impose a $100 permit fee, and $100 for a renewal permit fee, which is consistent with Article 2B, § 2-101. iv C. Allow direct wine shipment for in-state and out-of-state wineries, but not for out-of-state retailers.