EXECUTIVE SUMMARY ALTERNATIVE TO PRIVATIZATIONEXECUTIVE SUMMARY ON PRIVATIZATION Privatization of the Pennsylvania Liquor Control Board (“PLCB") is bad public policy and ‘fiscally irresponsible. It will not yield a two billion dollar ($2,000,000,008.00) windfall, but rather, it wll create a fure financial hole that wil take the Conmmonwealth years to address. Further, any attempt to privatize the PLCB will only result in a long, bitter and divisive legislative and legal battle. Alternatively, monetzaton and modernization of the PLCB will provide atleast one Bion “otlars to the Commonvealihquictly enough to provide meaningful Budgetary reli. These iniatives wil alow the Conmorvoealth to rezin ovmership ofthe wine and spirt sore system ‘hich in Fiscal Year 2009-10 transferred one hundred ive milion dolar (105,000,000.0) in ‘profs and mare than thren handved eighty three milion dalars (8488.00 000 0) tn ta revenue to the General Fund. It will not impose the social and societal costs inkerent in Privatization. Finally twill vod the afore-mentioned legislative and legal bate ‘The Phantom Two Bilion Dollar Windfall ‘The current control system for the sale of wine and spirits reflects a thoughtful balance between raking alcohol available and mitigating the societal damage which can be inflicted through the misuse or abuse of alcohol. The recent economic downturn has provided an opportunity for those philosophically opposed to the current system to argue forthe privatization and/or deregulation (hereinafter, collectively “privatiztion”) of alcohol as a means of addressing. the ‘Commonwealth's budgetary Woes. House Bill 2350, introduced last session by (now) Howse “Majority Leader Michael Turzai, would selloff both the PLCB's wholesale and retail function to the private sector, and, according Representative Turzai, would result in a two billion dollar (82,000,000,000.00) windfall for the Commonwealth, with no adverse effects to the Commonwealth or its citizens and no adverse effect to the Commonwealth's future income sea, Representative Tuzai's statements are simply wrong. His Legislation Fact Shes, ttibutes his assertion of a two billion dollar ($2,000,000,000.00) windfall for the Commonwealth on a 1997 Price Wateshouse study and 2 2007 “study” by the Reason Foundation's Geofrey Segal, entitled “Divesting the Peansyvania Liquor Control Boar.” However, the 1997 Price Waterhouse cody tstimated that selling off the PLCB could genere’ six hundred million dallas {$00,000,000.0, not two billion dollars ($2,000,000, 000.00. ‘As to Geafey Sepals “stuly” which isnot a stady at all but simply prepared remarks he made in Apel 2007, before the Pennsylvania Senate Majority Policy Commitee ~ he arives at his figure by adding the Price ‘Waterhouse estimate fo 2 1991 study by Andrew J. Buck and Simon Hakim from Temple University, which had estimated that privatization could generate spproximately four hundred nillion dollars ($400,000,000.00), plus an additonal amount for the slo of PLCB assets. He then “adjust” for inflaton by adding ttl of seven hundred milion dollars ($700,000,00.00) tothis toa. (Me. Segal's numbers are worthless, First, even though both the Price Watechouse estimate and the 1991 Temple estimate were for the value of the PLCB’s operation as a whole, Mr. SegalPage2 ‘woats the Price Waterhouse estimate as an estimate ofthe wholesale operation and the Temple University estimate as an estimate ofthe retail operation. He is thus selling the system off twice Further and more importantly, Segal is simply manipulating the mumbers in a manner that no reasonable business parson or economist would, to arrive ata predetermined outcome. Rather than applying the methodology used in the Price Waterhouse study and/or the Temple study, to the most up-to-date financial information about the PLCB’s operation, he chooses to employ 14 and 20 year old data so that he can justify inflating the numbers. It would be as if one were attempting to establis the value of the Dow Jones Stock Exchange today by looking at what its value was in 1991 and 1997 and spplying arate of inflation tothe numbers, rather thas using the ‘value from yesterday's closing. No reasonable person and certainly no reasonable bidder would ‘adopt such an approach. Further, once sold, the Commonwealth would lose the recurring profits the PLCB generates trough the sale of alcohol. ‘The Real One Billion Dollar Windfall If the Commonwealth wishes to use the PLCB to generate a cash windfill, it could do so by ‘enacting legislation that would authorize the sale of a revenue bond or bonds agains the future receipts of the Board fiom the sale of wine and spirits through the Board’s wine and spirits sores, fo a fixed numberof years (cg, twenty (20) or thirty (30) year). ‘The tables below éetal projected par amounts, upffont proceeds generated for the ‘Commonwealth, and average annual debt service payments based upon final maturity. average 987,755,000 $913,528255 $79,997,651 $1,191,775 000 $1,095,153,440”” $79,997,206 111,580,000 . 750,007,000 65,729,333 1615.00 750,000,000 54,808,019 141,125,000 500,900,000 43825377. _544,710.000__sono00.000__ 36,563,361 1) Based pon mast condion asf Yanuary 7, 2011. Aca tes may wry based cn credit spas and spatket odio tine of ing 2) armen rat find det src se fad. 53) ‘Maxiomn rocnd at cn be geocrated Wile manning ant} 25x debt service coverage ‘A bond issue or issues secured by the PLCB's surplus cashflow would be very appealing to the ‘investment community, which remains relatively risk-averse under curent economic conditions. Investors would be purchasing the furure income of a state agency which has s monopoly on & stable commodity that consumers purchase in both good and bad economictimes.Page3 Further, modemizing the PLCB would allow it to consistently generate greater profits which in tum would allow it to tell more bonds and/or transfer more monies to the General Fund. ‘Moderiization would include legislation that would allow the PLCB to: engage in market-based pricing; hire employees outside of the Civil Service Act; acquire goods and service outside the Procurement Code; increase licensing fees and fines; become a lottery retailer, and have al ofits wine kiosks open on Sundays. ‘The Social and routieal Costs of Frivatzation Privatization efforts in other jurisdictions have invariably imposed additional social and ‘government costs on those jurisdictions, and the people residing within them. Privatization typically leads to increases in alcohol consumption as well as an increase in the number of lcobol outles. Numerous published, peer-reviewed studies have established thet increased ‘consumption and increased outlets Jead to increased crimes, increased alcohol-elated medical costs and increased alcohol-related accidents. This in turn has lead to increased costs to the ‘governmental entities that bave to deal with thes issues. Finally, even an attempt to privatize will require the expenditure of significant political capital by those advocating i. The list of pasties that will oppose such an attempt includes the thousands ‘of store employees who will lose their jobs during the biggest economic downturn since the (Great Depression; their families; and the two unions who represent the store employees. One of these unions ~ the Independent State Store Union (“ISSU”) - ceases to exist if privatization ‘oceurs The other, much bigger union the United Food and Commercial Workers (“UFCW”) - helped defeat a recent privatization effort in the State of Washington. Opposition to privatization will also include law enforcement officals, especially in college towns, who have to deal with the proliferation of alcohol-related problems; industry members, who may four that aggressive marketing by the newly privatized wine and spirits stores wil adversely impact thet businesses; frst responders and others who will bear the brunt of the ‘increased societal costs referenced earlier; religious and quasitelisious groups who are opposed to the proliferation of aloakol on religious and/or moral grounds; drug and alcohol counselors, ‘veterans” groups who recognize the PLCB’s commitment to hiring military veterans; and even ‘conservative votes, particularly in the nearly seven hundred (700) municipalities that stil ban the issuance of ene oF more types of liquor licenses within their jurisdiction. ‘These cotltions were recently succesful in defeating two (2) privatization ballot initiatives in the state of Washinglon, and in derailing an ongoing privatization initiative in Virginia. They Ihave alzo been suocessful in derailing earlier privatization attempls in Pennsylvania. ‘Conclusion Bad facts make bad law. The same can be ssid about public policy. This administration should reject the illusion that privatization isa pain free way to solve its budget woes and instead adopt ‘policy of monetizing and modemizing the PLCB.ALTERNATIVE TO PRIVATIZATIONALTERNATIVE TO PRIVATIZATI( INTRODUCTION For more than seventy-seven (77) years, the Pennsylvania Liquor Control Board (‘PLCB”) his provided the Commonwealth with a dependable and steady source of revenue, while atthe same time limiting the societal damage which can be inflicted through the misuse or abuse of alcohol ‘The current control sysem for the sale of wine and spirits, as set forth in the Liquor Code, reflects a thoughtful balance between these two (2) diverse Commonwealth interests. In Fiscal Yoar (FY) 2009-10, the PLCB transfered one hundred five millon dollars (6105000,000.00) in profits and more than thres hundred seventy-six milion dollars (6376,000,000.00) ia tax revense to the General Fund. in the aggregate, the PLCB has cantbuted nary two billion two hundred eighty millon dollars ($2,280,000,000.00) to the State Treasury since 2008. These fands pay for a wide vaity of Commonweal programs end initiatives every fiscal yes ERIVATIZATION ‘The recent economic downturn has had a significant impact onthe Commonwealth, which will ‘compel the new administration andthe General Assembly 1 address a sizeable budget defict for FY 2011-12. Accordingly, itis imperative thatthe Commonwealth look for ways in which to ‘maximize existing revenue streams. The option of selling off the state's wine and spirits stores has been discussed by some as & means to raise a portion of the fands necessary to balance the budget for FY 2011-12. Howover, thee is another viable option in which the PLCB can provide ‘he Commonwealth with # one-time cash infusion needed to help balance the budge, while ‘maintaining the increasingly valuable assct of the wine and spirit store system and the current system of control (.e, a “best of both worlds” solution). Proponent ofthe privatization and deregulation ofthe wine and sii industry in Penosylvania tout the prospect of reonving proverbial windfal of ot least two bilion dollars ($2,000,00,000-00) fom the auctioning of wholesale and retail ivenses. Whoesle licenses ‘would entitle private individual and ents to scquire wise and spirits and sell them to licensed ‘etl wine and spirits stores, who would, in tum, sell profuets to reidents and licenses (e, restaurant, obs, hoes, public venes, performing art fates, and pubic service licensee) Further, proponents of sucha dramatic policy change belive tata new tax stroctre on wine sd spins will enhance the anal tax revenue tat is caren collected and retumed 10 th General Fund by the PLCB, ‘The Two Billion Dollar Shel Game ‘Those in support of privatization repeatedly and steadfastly assert that it will generate a ‘minimum two bilion dollar ($2,000,000,000.00) windfill for the Commonwealth. However, ‘even a cursory review of thet claim shows that a two billion dolar ($2,000, 000,000.00) windfall is extremely optimistic, ifnot ridiculous.Page In spport ofthat claim, proponents of privatization appear tobe relying onthe statements made by others who favored the concept during previous stomp o dismantle the cureat syste. For txample, in April 2007, Geotey F. Seal, Director of Government Reform Policy fr the Reon Foundstion, and Groficy 8. Underwood, Senior Policy Fellow for thr Reason Foundation, testified in support of privatization before the Senate Majority Policy Committee. “They tested that he Commonwealth could generate one lion dell (81,000, 00,00.0) for the ale ofthe wholesale busines and sven ned malion dolar ($70,000,000) should the reil busines be sod es well In mapor of these propositions, they ted a 1997 Price Wiateouse stay and a 191 sty fom Temple University by Andrew J. Buck aad Simon Hakim. In eden, the 1991 study suggested Gat one hmdred sixty milion dolls ($166, 000,00.00 coud be generated though the ae of the Board's asets, ‘Segal and Underwood srrive at the one billion dollar ($1,000,000,000.00), figure by ‘extrapolating fom the six hundred million dollar ($600,000,000.00) figure they claim that Price ‘Waterhouse gave to the privatization of the PLCB's wholesale function. However, Price Waterhouse never gave a specific value tothe PLCB's wholesale function. Price Watethouse's valuation scenarios assumed that the Commonwealth would retain its wholesele function or that ‘the Commonwealth would divest from the entire system as single entity. As tothe later, Price ‘Waterhouse did state that converting the PLCB toa state owned corporation which in tum would selloff its ownership through an inital public offering, could generate six hundred million dollars ($600, 000,000.00). However, that figure already includes the value ofthe retail business, ‘0 it would be disingenuous to edd a separate value forthe retail business when assessing a value to the syatem as a whole A similar manipulation was made to arrive a the seven hundred million dollar ($700, 000,000.00) figure. The 1991 study concludes that a successful auction would aise between three hundred fifty-seven million dollars ($357,000,000.00) and four Imndred five million dollars {6405,000,000.00) forten year licenses and an additional one hundred sixty million dollars ($160,000,000.00) forthe sale of PLCB assets. Ags, however, this is a value asseased to the system as a whole, not just the PLCB's retail operation. Indeed, in a 1997 paper, Professor Buck opined that a West Virginia style auction ofthe PCB's retail operation would raise atleast two ‘hundred million dollars ($200,000,000.0) fr ten-year licenses. ‘More importantly, Segal and Underwood are simply manipulating the mumbers in a manner that no reasonable business person or economist would, to arrive at a pre-determined outcome. Rather than employing the methodology used inthe Price Watechouse and Temple studies to the most up-to-date financial information about the PLC's operation, or even using'the actual ‘bumbers in those stadies, they choose to enploy fourteen (14) and twenty (20) year olddata and ‘use the passage of time to justify inflating them. It would be as if one were attempting to ‘establish the value ofthe Dow Jones Stock Exchange today by looking at what its value was in 1901 and 1997 and applying # rte of inflaton to the nurers, ater than seeing what the value was at yesterday's closing Indeed, the 1991 paper opined that the monies thet would be ‘generated though the sale of the system would decline over time, not increase. The Segal and Underwood approach is ridiculous, borderline fraudulent and most importantly, inaccumate I isPoge3 certainly not the approach that would be taken by those inthe private sector who would actully pay forthe licenses in question." In fact, when industry experts and national consultants, familiar with the wine and spirits Dbasiness, have analyzed the prospective values of selling off PLCB assets asset forth in House Bill No, 2350, they have opined that an auction would yield somewhere between five hundred ‘million dollars ($500,000,000.00) and eight hundred million dollars ($800,000,00000). These ‘numbers would be much more consistent with the revenues generated in recent privatization initiatives in West Virginia and Maine, as well as the actual Price Waterhouse and Temple ‘University estimates Another review conducted by a spirits industry leader suggests the troubling result that retail prices will have to rise by spproximatcly 25%, post privatization, in order for the (Commonwealth to continue to receive the income it is curently receiving from the sale of wine snd sprit.” In fac, price increases would seem likely since the private sector cannot operate the ‘business of slling wine and spirits as cost effectively as the PLCB, because the private sector ‘ill not be prepared to invest the upfront monies necessary to secure their business. The simple reality is thatthe PLCB is both wholesaler and retailer, where if privatized, both a wholesaler and a retailer segment would need to be created. Both will have significant margin requirements and retail prices will have to rise dramatically to feed those profit appetites” Similar studies, ‘conducted in Virginia have yielded similar results, ‘Loss of tax reveaues resulting from the failure of private industry to collect and pay its full tx ‘burden must also be considered. The intemal Revenue Service estimates that as much as sixteen percent (16%) of taxes due are not paid. Given the size of the PLCB's tax contributions, the ‘amount of lot revenue could be substantial. Finally, while the statewide operation of the sale of wine and spirits has proven io be very profiuable for the Commonwealth, through the operation of the wine and spirit sores, itis "unknown what amount of money an individual or entity will pay for the privilege of conducting ‘wholesale or retail sales within a specific geographical region. This is particulary trae when one ‘considers thatthe initial license is only fora two (2) year period, when the geographic territories 7 Yai wts ta have een undergone prvesztion intvs have not reaped the purported “wal” hat they were promised. oa tod West Vl, he lyf (2) see hat have fly pez te al tres tbe lant tro @) decades each sive late tan twenty milion dol (20,0000 wpe wesiag fons wen ‘ey pated. Oo ees av cx tat we i chang panos ied er ‘fieoy thas eae Sa vetead cas savings, the process hs ot produced te anced wall (See "Vieina may ad to fr on labo?” by Anta Kuen’ (Washington Pos Sepember 42010). 2 Convery, ire prices remain het, the Commonweal wil lose apprxinately $230000,008.00 «yer ® On reves (pot and ux) of 1.3 billion dollars the PLOB generates anol even fo the Commonweal in excat of fou Bonded 8 clon dolla ($450 0000.00), «reed twelve perceat (295) peaing ‘pro which imprnive fran busines, publi or pat. Operating coe fr he PLC re appoxily thee ‘dre igh-ane milion dlr ($380,060, 00.0) er pproviately twenty percent (20%) of tales. Compare ‘rte sector coms would be between seven hundred lon doles ($70,000.00) and eight ed milion ‘elas ($500,000.20) aul.Paged have not been estblished and when the PLCB is obligated to issue repos to the General ‘Assembly, in five (5) and ten (10) years, onthe feasibility of expanding franchise zones, which ‘would necessarily mean the elimination of existing franchise holders.’ Moreover, once the tuetion of al Hoenss is consummated, te Commonwealth's long-held asst, ie win end sii ‘Sore stem, wil forever be lot othe private sor MONETIZATION 1n view ofthe above, iis mportnt to Took at sltematives to privatization ané deregulation tht ‘would 1) provide a one-time cash infsion of known emoun, Which could be reeped quickly before the beginning of FY 2011-12; 2) pemait the Commonwealth to retain the current cont ‘te, avering the averse social concerns assoated with privatization and deregulation, and 5) alloy the Commonwealth to retain the valuable eveaue-genrating asst ofthe sate store system. All ofthese objectives can be accomplished though a two-pronged approach, monetization and tmodemization ofthe PLCB. Monetization will come to futon by enactig legislation that ‘would authorize the PLCB to release forsale one or more issues of bonds that wil be secured by Surplus cash flow fom the operation ofthe PLCB's wine and spirits stores. ‘Over the past tea fiscal years, the PLCB has transferred approximately $1(0 million dollars ‘nmually 0 the Commonwealth. There is an opportunity to monetize a portion of this surplus ‘ash flow to either generate one-time proceeds of approximately $1 billion dollars for deficit reeiuction, or annual proceeds of bonds issued over three or four fiscal years, also for deficit reduction. There are several practical and financial benefits to pursuing the monetization altemative, the primary of which include: (1) the Commonwealth retains ownership and control over revenue generating asses, and any Fature profits; (@) the certainty of outcome (in contrast to privatization) because the PLCB's surplus cash flow isa known revenue source, which wil help to quickly obtain investment grade ratings; and (@) the monetization alterative can be implemented quickly, 2 60 to 90 day process that could be concluded before June 30, 2011, the commencement ofa new fisal year. ‘The tables below detail projected par amounts, upftont proceods gmerated for the ‘Commonwealth, and average annual debt service payments based upon final maturity. one BU! 2350 PN 4192), azeduced in the 2008-10 legisative secon, woud hve mands the action of seven nde Sy (750) rel ceases and ne hundred (00) wholes cess which woud lave the exchive ‘gkrtsol wine abd opts wikin pete geographic fsa sone Er eoing tw ft) yar * contrat, pivatition and deregulation wil lead to beh legisatve bale and Itigson, which in tr will ely the implementation of ey sack propos Furr, te aout at wl be eed it bet ndeteriae ad, ‘der the tre ofthe curently proposed lepslton, be yea cu ove a two ye period fine"Average Anata "Average Annu RarAmount NetProcesds DebiServct’ © Paramount = NetProceads Dei Service| 3987785000 3913523255 Sr9g976s1 ——_5,191,77500_$1,095,153840 $7999.06 s11ssop00 750000006528 338 116515500 730.e00800 S408. n19 sais; a0, samssrt seri0g00 $0000 365565361 1), Bad ypon mae contin a of Jamar 7, 2011 Actual ates may vary based on credit pends end ‘ue coatione wie of rig. 2) Asounes pos faded debt wrvice reserve id, 43) Mim proce at ca be geneted we munuloiog alent 12Sx debt service coven. ‘A bond issue or issues secured by the PLCB's surplus cash flow would be very appealing to the investment community, which remains relatively risk-averse under eurent economic conditions. Investors would be purchasing the future income of a state agency which has a monopoly on @ stable commodity that consumers purchase in both good and bad economictimes. “Moreover, a bond financing secure by the PLCB's surplus cash flow would be eligible for tax- exempt financing, lowering interest rates and thereby providing more proceeds tobe available to address Commonvvealth budget concems. In contrast, potential private operators wil be raising capital inthe taxable markets at higher interest rates, and each operator's financial strength will ‘be uncertain ~ as opposed to the investment grade credit ratings that should be received for the PLCB's surplus cath flow bonds. ‘The PLCB bonds would not constitute general obligation bonds and debt ofthe Commonwealth because they will be payable solely from surplus cash generated by the operation ofthe PLCB's Wine and sprit stores. However, the stores themselves would be pledged as security for the bonds. ‘The PLCB bonds would aot be secured by any ofthe tax revenues collected atthe PLCB's wine and spirit stores, Those revenues would continue to flow frely tothe Commonwealth and the risk of loss of tx revenues resulting from their collection by private operator would not exist ‘The monetization financing structure and the PLLCB's historic performance could be quickly reviewed by credit rating agencies, and bond documents and disclosure materials could be ‘prepared quickly. The fincing would take between 60 and 90 days to complete. Importantly, asthe levels of surplus cashflow grow inthe future, especially asthe modernization initiatives discussed below take full effec, the Commonwealth retains the full benefit of {increased cash flow, a benfitit loses forever ina privatization. In any event, retention of such & valuable revenue-generating asset is of paramount importance ins time, such as this, of economic uncertaintyPage 6 ‘MODERNIZATION INITIATIVES To strengthen the PLCS, it is recommended that the new sdminiseation and the Genel Assembly consider the following modernization initiatives, which the PLCB believes will ‘generate substantial additional aval revenue forthe benefit of the Commonwealth Proposed legislative language required to implement such modernization is attached 1) Allow market-based pricing: + Under the Liguor Code, the PLCB must apply is markup (current 30%) equally on al products (, itmust adhere to proportional pricing on ll products). ‘+ Flexibility would allow the PLCB to function mor like a private retailer, with the ability to increase revenue and proStubilty on higher-end or higherveloiy items, ‘while being able to offer beter deals to consumers on other products. Private rele enjoy complete flexiility to mark-up ther produc. * The PLCB is not secking “variable pricing.” the PLCB intends to charge the same price fora bottle of Grey Goose Vodka regardless of whether itis sold in Pitsburg, Harrisburg, or Philadephia, thereby eliminating any potential regional bias + Anamendmeat othe Liquor Code wich would have allowed the PLCB to engage in such market-based pricing was introduced in Howse Bill 2038, but was never voted ‘out of the House Liguor Control Coramitte. + Ona separate but related note, consideration should be given to allowing the PLCB to adj the licensee discount (urently 10% pursuant fo section 305() ofthe Liguor (Code) on a periodic basis to provide an incentive for licensee participation in various initiatives, such as, ulizing the PLCB's licensee service centers. In addition to amending section 305(t), any proposed amendment would need to explicitly superede the Regulatory Review Act, given that the Regulatory Review Act currently defines regulation, among other things, a eay action bythe PLB which hasan effect onthe discount rte for retail licensees ‘© FISCAL IMPACT: While iti dificalt to quantify the actual Sscal impact ofthe initiative, grating the PLCB the discretion to make such pricing decisions could casly lend to an increase of twenty million dla (S20,000,000.00) t9 seventy rillion dollars ($70,000,000.00) per yes, depending on market conditions, a 0 Human. Management: ‘+ Restrictions imposed on the PLB by the Civil Service Act and the Administrative ‘Code impair its ability to effectively hire the right employees with the right ail sets in a timely fashion, remove underperforming or insubordinate employees, and cstablish the right amount of pay and benefits to its employees. These existing limitations hamper the PLCB’s ability to effectively operate asa business and create inefficiencies within the agency. ‘© Exemption from Civil Service coverage for fture hires - ‘©. Section 302 ofthe Liquor Code provides tat employees ofthe PLCB shall be sppointed and employed subject othe provisions ofthe Civil Service Act.