TCS Daily

Bacchus Bytes Back

By Stephen Bainbridge - June 7, 2004 12:00 AM

The Supreme Court recently agreed to hear three cases collectively raising the following question for decision: "Does a State's regulatory scheme that permits in-state wineries directly to ship alcohol to consumers but restricts the ability of out-of-state wineries to do so violate the dormant Commerce Clause in light of Sec. 2 of the 21st Amendment?" It's a fascinating legal issue, with significant economic and aesthetic implications (at least for oenophiles).

Anybody who has ever visited Napa Valley has been tempted to purchase and take home some of the wines you've tasted. Suppose you live somewhere back East, however. Can you ship the wines home or must you schlep them back on the plane? The answer depends on where you live. In a growing number of states, these so-called direct-to-consumer sales are permitted. In many others, however, they are banned by state law. Hence, for example, New Yorkers visiting Napa Valley are prohibited from shipping home a case or two of their favorite wine. (The Wine Institute's website has a handy list of state laws and commercial shipper rules.)

The legal issues involved probably never would have come to a head just because a few thousand Napa Valley tourists got annoyed. Instead, it was a convergence of two trends. First, traditional distribution channels tend to favor large wineries. In recent years, however, we have seen an explosion of small wineries (mostly in California, but also in other states) producing "cult wines" that are available only at the winery or via mailing lists. These small wineries (and their fans) want to be able to sell directly to consumers in all states, rather than just the enlightened ones that permit direct-to-consumer sales. Second, online wine merchants have proliferated, typically providing oenophiles with a much greater selection -- at lower prices -- than local retailers. These folks have a powerful economic interest in challenging the existing legal regime.

On its face, the 21st Amendment seems to give states sweeping authority to regulate the importation of wine and other alcoholic beverages:

Section 2. The transportation or importation into any state, territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.

If states simply prohibited direct-to-consumer sales, Section 2 of the 21st Amendment undoubtedly would validate those law. But there's the rub!

A substantial number of state laws governing direct-to-consumer sales discriminate in favor of local wineries. In New York, for example, it is perfectly legal for in-state wineries to ship their products directly to consumers, but it is a crime for out-of-state wineries to do so. Obviously, this rule has trade protectionist consequences. The numerous wineries on Long Island and around the Finger Lakes are protected from direct-to-consumer competition by out-of-state wineries.

It is this discriminatory/protectionist effect that raises the Constitutional issue. The US Constitution's Commerce Clause gives Congress ultimate authority over interstate and foreign commerce. When Congress adopts legislation regulating such commerce, inconsistent state laws are prohibited. But what about cases in which Congress has been silent?

The Supreme Court long ago created the "dormant Commerce Clause" doctrine to deal with such cases. Under it, where a state law discriminates against out-of-state producers, the law is subject to strict scrutiny and, in effect, a strong presumption of unconstitutionality.

Discriminatory bans on direct-to-consumer sales thus pose a direct conflict between the 21st Amendment and the dormant Commerce Clause. Which will prevail? The appeals courts have split, with New York's law being upheld by the Second Circuit and Michigan's law being struck down by the Sixth Circuit.

The key precedent is Bacchus Imports, Ltd., v. Dias, 468 U.S. 263 (1984), which held that:

It is by now clear that the Amendment did not entirely remove state regulation of alcoholic beverages from the ambit of the Commerce Clause. For example, in Hostetter v. Idlewild Bon Voyage Liquor Corp., the Court stated:

"To draw a conclusion . . . that the Twenty-first Amendment has somehow operated to 'repeal' the Commerce Clause wherever regulation of intoxicating liquors is concerned would, however, be an absurd oversimplification."

We also there observed that "[b]oth the Twenty-first Amendment and the Commerce Clause are parts of the same Constitution [and] each must be considered in light of the other and in the context of the issues and interests at stake in any concrete case." Similarly, in Midcal Aluminum, supra, at 109, the Court, noting that recent Twenty-first Amendment cases have emphasized federal interests to a greater degree than had earlier cases, described the mode of analysis to be employed as a "pragmatic effort to harmonize state and federal powers." The question in this case is thus whether the principles underlying the Twenty-first Amendment are sufficiently implicated by the [law in question] to outweigh the Commerce Clause principles that would otherwise be offended. Or as we recently asked in a slightly different way, "whether the interests implicated by a state regulation are so closely related to the powers reserved by the Twenty-first Amendment that the regulation may prevail, notwithstanding that its requirements directly conflict with express federal policies." (Id. at 275-76; citations omitted.)

Defenders of laws like New York's argue that such laws advance state interests in protecting minors from getting access to alcohol over the Internet. Sure. Like some 16-year old kid is going to order a case of Opus One online when he could just bop down to his local store and buy a six pack of beer with a fake ID.

These laws are pure and simple rent-seeking:

Rent-seeking is often associated with lobbying for economic regulations such as tariffs. For instance, if FooCorp, a domestic producer of widgets, can lobby the legislature to levy a tariff upon widget imports, then FooCorp can sell its widgets at a higher price. If the legislature bans the import of widgets, or effectively bans them through high tariffs, then the additional price extracted can be quite significant. Collusion between firms and the government agencies tasked to regulate them can be a haven for rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market.

Whose economic interests do discriminatory direct-to-consumer bans advance? Local wineries, for one. California produces about 90% of US wine. In terms of quality wine, the percentage is even higher, as the Wine Spectator's Harvey Steinman has observed:

"Capricious weather is one factor that makes it tough for very good wineries in Virginia, New York and Texas to match the quality-price ratio California and Washington can achieve. Eastern wineries can turn out distinctive wines, but the prices tend to be higher than those of similar-quality wines from the west."

It cannot be doubted that New York intends its discriminatory ban on direct-to-consumer sales, in large part, to shield its higher-priced, lower-quality wines from California competition. If New York really were concerned about access to booze by minors, for example, wouldn't New York also ban direct-to-consumer sales by in-state wineries?

In a Wall Street Journal column, famed (or, for some, infamous) former Special Prosecutor Ken Starr identified another economic interest protected by discriminatory direct-to-consumer bans:

"Who could possibly support these discriminatory laws? Those who have the most to lose from repeal: the liquor distributors, known in the trade as the 'booze boys.' These distributors exact massive, and in many areas oligopolistic, profits from wineries as a price for distributing their products to retail stores -- and in some cases, refuse to distribute wine from smaller wineries at all. Like pirates exacting a ransom, they add no value. But they have a powerful incentive to keep the current system in place."

The prospect of online sales and direct-to-consumer shipments terrifies the booze boys, because they would lose their local monopolies.

Would consumers benefit if the Supreme Court struck down these laws? You bet. A study of Virginia's direct-to-consumer sales ban by Alan Wiseman and Jerry Ellig found that "Virginia's direct shipment ban reduces the varieties of wine available to consumers and prevents consumers from purchasing some premium wines at lower prices online."

As regular readers of my blog know, I am no fan of judicial activism. I would prefer to see the direct-to-consumer bans overturned by the legislative process. The proper role of courts in regulating cultural and economic issues, however, is a question for another day. In the world in which we live, these sorts of questions usually end up being answered by the judiciary.

The Supreme Court should strike down these antiquated special interest laws. As I recall my civics lessons, preventing economic Balkanization was one of the principal reasons the Founders replaced the Articles of Confederation with our present Constitution. Discriminatory state bans on direct-to-consumer sales represent precisely the sort of economic Balkanization that would have offended the Founders. These laws advance no legitimate state interests, but rather are designed solely to protect entrenched special interests. It is time for them to go.


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