Do we still need the three-tier system for alcohol?

Source: R Street Institute

Charles K. Cowdery

June 24, 2016

The 21st Amendment to the U.S. Constitution, which repealed Prohibition, left it up to the states to regulate the distribution and sale of alcoholic beverages. The states did not have to impose a three-tier system – comprising producers, distributors and retailers – but all of them did.

While producers in many sectors rely on distributors to get merchandise to market, with alcohol, it is mandatory. By law, producers may only sell to distributors and retailers may only buy from distributors. Drinks retailers and producers may not do business with each other directly. No business in one tier may own a business in any other tier. Only retailers may sell to consumers.

What’s more, distributors are required to be in-state businesses.

These rules were meant to prevent a return of abusive practices common in the pre-Prohibition era, most particularly what were known as “tied houses.” Back then, alcoholic beverage producers often controlled retailers, either directly through ownership or indirectly through contracts (taverns were the primary concern). Tied houses only sold the products of their controlling producer, obviously, but they also engaged in practices that increased sales, and thus consumption, in ways that were perceived as exploitative and harmful.

In 1933, a compulsory three-tier system seemed like the best way to solve those problems. It allowed a state’s beverage control authority to regulate producers and producer practices through the distributors, who as in-state businesses would have to obey the authority’s rulings.

Very little has changed in the more than 80 intervening years, and not because the system works so well. In fact, it has become a hollow shell. In-state ownership is a joke. Most distribution companies now are national enterprises that merely have subsidiaries in each state. Cross-tier ownership has become common; drinks-makers establish subsidiaries – often in the names of different members of the owner’s family – that buy stakes in tier-two distributors. This is why small brewers, distillers and vintners so often complain that their products can’t get shelf space.

Yet the pre-Prohibition abuses are no longer a problem, because they are regulated in other ways. All retailers are licensed and can lose their licenses for rules violations. States, counties and municipalities control hours of operation, and can pull the license of a retailer or bar that serves drinks to persons who are already intoxicated. Many states prohibit price promotions such as “happy hours” that can encourage overconsumption. States may set minimum prices to cut down drinks-fueled misbehavior. Technology allows regulators to monitor compliance in ways never anticipated in 1933.

Those most in favor of change are producers and large retailers. Why shouldn’t Wal-Mart or TGI Fridays buy directly from Diageo? They do it with every other product – even pharmaceuticals, which arguably are more dangerous than booze. Producers of all sizes favor eliminating the middleman and his markup. So do most retailers.

Most opposed are distributors, regulators and legislators. Distributors stand to lose the most from any change. Instead of having business bestowed on them by law, they will have to work for it. Regulators and legislators favor the status quo because, well, they always do, and distributors are generous with campaign cash.

Because it is alcohol and alcohol remains a red flag for many, change is unlikely. Still, the mandatory three-tier system seems to have outlived its usefulness.

Guest blogger Charles K. Cowdery is the author of Bourbon, Strange: Surprising Stories of American Whiskey (2014); Bourbon, Straight: The Uncut and Unfiltered Story of American Whiskey (2004) and The Best Bourbon You’ll Never Taste (2012).