A Brief History of the Three-Tier System in America

A Brief History of the Three-Tier System in America

Four years ago, the Supreme Court decided the most important alcohol case in a generation, overturning a Tennessee law that allowed only people who had been two-year residents of the state to get a retail liquor license. Justice Samuel Alito, writing for the 7–2 majority, quoted the New York historian Richard Hamm, who has written extensively about the history of Prohibition. Justice Neil Gorsuch, writing for the minority, also quoted Hamm.

Hamm, a distinguished professor at SUNY Albany and the coeditor of Prohibition’s Greatest Myths: The Distilled Truth about America’s Anti-Alcohol Crusade, says, “That should tell you how complicated all of this is, that the same evidence can be interpreted in different ways. How can it be possible that each opinion can cite the same source to prove their point?”

The three-tier system—the collection of laws and rules that regulate 21st-century US alcohol sales—governs alcohol sales in most states, though it is not required under federal law. In a strict three-tier system, sales can move only from producers or importers to licensed wholesale distributors to licensed retailers or restaurants, who sell to customers. States, however, offer many exceptions. Understanding this complex system starts with Prohibition.

Much of the structure that exists today can be traced to the late 19th-century movement that had turned most of the US dry before Prohibition took effect, in 1919. Two aspects stand out: first, the ability of almost any city, town, or county to decide how dry it wants to be—the idea of local option. Second, whether the state regulates retailers or owns them. About one-third of the country uses some form of the latter, called the control state system. In states such as Pennsylvania and New Hampshire, there are no privately owned retailers. Instead, a state bureaucracy decides where to locate stores, what to sell, and how to staff them. The control state system is also considered a three-tier system, with the government operating one or two of the tiers.

Is it confusing? Yes, as the two opposing Supreme Court opinions demonstrate. Do the laws change not just from state to state but even within the same state? Of course, because that was one of the movement’s goals. Does it seem outdated and out of place, almost 100 years later? Most certainly, and those who enforce the laws say that’s a sign that the system works.

The attorney Rebecca Stamey-White, a partner with Hinman & Carmichael, in San Francisco, says, “I always tell my clients it was a very politically divisive issue then, and, to understand it now, you have to put it in perspective in that time frame. More than half of the country had prohibited alcohol in the 10 years previous to Prohibition, and understanding why that happened is the place to start to understand it now.”

History Lesson

Prohibition has long been part of the American social and cultural landscape. Even today, most surveys, including the annual Gallup poll that details US drinking habits, find that about one-third of Americans say they don’t drink, a figure that has been consistent for decades.

But even that is nothing new. In the 1730s, before the country was founded, the British Parliament banned the shipment of rum and spirits into the colony of Georgia to combat drunkenness. The next 150 years are replete with similar examples, including Abraham Lincoln’s speech in 1842 to the Springfield Washington Temperance Society, alcohol bans in the US military in the early 19th century, and eight states and a territory voting to go dry in the years before the Civil War. In the run-up to Prohibition, almost half the states went dry in some form.

This leads to several of the many ironies about Prohibition and the various dry movements associated with it. US alcohol consumption peaked at around 2.5 gallons (9.5 liters) per capita in the early 20th century, and it took more than 100 years for consumption to reach that level again. For most of that time, US drinking was two gallons (7.5 liters) per capita or less. Compared with almost all the wealthy, industrialized world, Americans are practically teetotalers.

So the idea that Prohibition was a moral crusade isn’t necessarily true, says Lou Bright, an attorney and the former executive counsel of the Texas Alcoholic Beverage Commission. He explains, “The moral crusade certainly was part of it, but there was much, much more going on, and that would influence not only Prohibition, but repeal and the laws that we have today.”

How America Went Dry

In the three decades or so before Prohibition and the 18th Amendment, there was an interplay of moral, social, political, and cultural forces that together made the movement stronger and more successful. The groups working to take the US dry were an unlikely combination. They included the Woman’s Christian Temperance Union and the Anti-Saloon League but also the Progressives, political reformers who wanted the federal government to treat booze the way it did tainted drugs and moldy meat, as well as suffragettes such as Susan B. Anthony, who saw Prohibition as a way to get women the vote. Finally, the Ku Klux Klan, then an important political force, was a key part of the dry coalition. Todd Kliman, writing in The Wild Vine: A Forgotten Grape and the Untold Story of American Wine, is blunt: the mostly Anglo and Protestant Drys, as they were known, objected to the mostly Catholic Europeans who immigrated to the US around the turn of the 20th century as much as they did to drinking. The temperance movement, in his view, was an attack on the immigrants.

These varied groups agreed on several things, beginning with the evils of big beer and the tied house. The late 19th century was infamous for the monopolies, called trusts, that controlled industries such as oil, transportation, and meatpacking. Beer, though still regional in much of the country, was dominated by a handful of big companies, including Pabst in Milwaukee and Anheuser-Busch in St. Louis. The breweries not only made the beer but also owned the taverns and bars. As a result, they could set prices, often in conjunction with other big brewers, just like the trusts did for steel and railroads.

Support for the US in World War I was also unanimous among these groups. Most of the big beer companies were founded by German immigrants, whose ethnicity became decidedly unpopular when the US declared war on Germany in 1917. This eroded German immigrants’ considerable political influence in the various Prohibition votes up to and including 1919. The anti-alcohol campaigners asked, “Will you back me—or back booze?” in a famous poster depicting a uniformed soldier pointing at the viewer.

Finally, the eventual Prohibition backers all believed there was a need for a constitutional amendment. In the 19th century, it wasn’t illegal to ship alcohol into the country’s numerous dry states and cities. The Supreme Court had overturned federal laws prohibiting such shipments, citing the Constitution’s commerce clause. The only way around the court was an amendment that would declare shipping and manufacturing alcohol illegal, nullifying the commerce clause.

Hanging over all this was the saloon—the source of all urban evil, according to the reformers. In the saloon, working men (and they were all men) squandered their pay envelopes every week to enrich the beer trusts, much to the deprivation of their wives and children. The journalist George Frederic Parsons wrote in 1887 that the “influence of the saloon among the poor is wholly mischievous. . . . The man who drowns memory at the saloon does not facilitate his subsequent proceedings. He is poorer, in worse health, less able to confront difficulties on the morrow. But one tendency in him is strengthened, and that is the tendency to repeat the debauch.”

In other words, eliminate the saloon—and Prohibition focused on that—and hunger and poverty will be eliminated as well.

Time for Repeal

Except, of course, that never happened. There were various reasons, starting with Al Capone and organized crime, which surpassed the beer trusts in both organization and violence. It’s crucial to understand that from the first day of Prohibition in 1920 to its end in 1933, Capone and his contemporaries controlled not only the manufacture of alcohol but also the distribution and retailing of it. It was—more irony—the three-tier system combined into one tier by a massive, huge company that would stop at nothing to sell its product.

Organized crime also didn’t pay any taxes. While this had always been a problem, it became a more significant one as the Depression wore on in the years after the 1929 Wall Street crash. The Drys had said the country could afford to forgo alcohol taxes during the campaign for Prohibition, because revenue from the newly enacted federal income tax would make up the difference. It mostly did—until the Depression set in. With government income in decline, restoring the various federal alcohol taxes made economic sense, as did the promise of more jobs, which was why repeal was included in both the Democratic and Republican platforms for the 1932 presidential election. Reopening the breweries was viewed as a chance to shorten soup kitchen lines.

But, and perhaps equally important, much of the country had never wanted to stop drinking. Large portions of the US, and particularly people in urban areas, had ignored the law. The famous statistic is that there were as many as 100,000 speakeasies, or illegal bars, in New York City during Prohibition, but the number almost doesn’t matter. The point is that local police departments—whether in New York, Chicago, Los Angeles, San Francisco, New Orleans, Kansas City, or Washington DC—didn’t enforce Prohibition. Yes, they were paid off, as were the politicians who ran the cities and controlled the cops. But there’s a sense, looking at the literature and talking to the experts, that drinking would have happened anyway.

As the industrialist John D. Rockefeller—who didn’t drink and who had supported Prohibition—wrote in 1932, “I earnestly hoped with a host of advocates of temperance, that it would be generally supported by public opinion. . . . This has not been the result, but rather . . . that a vast army of lawbreakers has been recruited and financed on a colossal scale; that many of our best citizens, piqued at what they regarded as an infringement of their private rights, have openly and unabashedly disregarded the Eighteenth Amendment.”

So, faced with a demand for repeal, even among the Drys, what could be done? How could America go wet again without repeating the same mistakes?

“No one wanted to reset to beforehand,” says Mark Schrad, a professor of political science at Villanova University and the author of Smashing the Liquor Machine: A Global History of Prohibition. “There needed to be some degree of regulation, so that no one would go crazy after repeal.”

The answer? Set up a system that relies on separate tiers of small family businesses—as opposed to the Mob and the beer trust—to make, distribute, and sell alcohol; find a way to efficiently collect taxes; and allow local options for states, counties, and cities to decide whether to go wet.

Fortunately, someone had written a book. Titled Toward Liquor Control, it remains what Alex Koral, the regulatory general counsel for Sovos ShipCompliant, calls the urtext of post-Prohibition alcohol regulation. The book, written by Raymond Fosdick and Albert Scott, in 1933, was commissioned by Rockefeller to offer a regulatory framework for repeal. The authors recommended two approaches: control states, which own the retailers, or state regulation of retailers. In either case, they suggested eliminating the tied house, didn’t think wine needed to be as strictly regulated as beer and spirits, and highlighted the need to efficiently collect taxes and to allow local option. That way, those who didn’t want to stay dry wouldn’t have to, eliminating the need to “disregard” the law.

Put simply, the book outlined roughly what exists today, complete with quirks and idiosyncrasies: a control county in the middle of a noncontrol state (Montgomery in Maryland); city-owned liquor stores in Minnesota; and Texas’s combination of wet, damp (some alcohol sales are allowed), and dry counties and cities.

Fosdick seemed to prefer the control state system, which had been pioneered in the 1860s in Scandinavia, where it was called the Gothenburg System. Named after the Swedish city that first used it, it set up local monopolies to sell alcohol. Its premise, says Schrad, was that the profit motive, and not necessarily alcohol, was the problem. Eliminate the need for profit, as a local monopoly would, and the evils of alcohol could be controlled more easily.

This concept impressed US Prohibitionists. The social scientist E. R. L. Gould wrote in 1893 that Gothenburg had been more or less effective in curbing many of the same ills that plagued this country: “Drinking is discouraged and the saloon purged of gambling and immorality.” (Not surprisingly, Minnesota’s city-owned liquor stores are a legacy of its Scandinavian immigrants and their experience with Gothenburg.)

Yet state ownership had not been as successful in the US, says Schrad, despite several attempts in the 19th century. The most notorious failure was the dispensary system in South Carolina in the mid-1890s, which resulted in rampant corruption, a bloated bureaucracy, and what one source describes as an abortive armed rebellion by those opposed to it.

Most state regulators, looking at their options as repeal loomed, saw the failure in South Carolina and opted for state regulation. Schrad explains, “Obviously, regulation was cheaper and easier to do than ownership. But they also saw how difficult it would be to eliminate the profit motive, and especially for a system that brought revenue into the state.”

Through the Decades

The problem with the Fosdick template is not that it hasn’t aged well; one can argue that local option still matters. Rather, it assumed the alcohol business would not change. In this, it failed. How could it not, given the invention of the internet and direct-to-consumer sales? But it also failed to foresee the rise of national retail chains, the increasing importance of restaurants for alcohol sales, and consolidation among each tier.

In the Fosdick world, the only retailer that matters is the saloon. There were few wine, beer, and spirits retailers as they exist today, and restaurant sales were almost as insignificant. In addition, says Tom Wark, the executive director of the National Association of Wine Retailers, Fosdick never imagined a world where a handful of retailers, wholesalers, and producers would dominate their markets, akin to the beer trust.

The result is that a system designed to regulate a lot of small, local companies that sold mostly beer and whiskey must oversee an economic landscape dominated by a handful of giant companies that bear little resemblance to their repeal forebears. Consider just two examples: in 1933, E & J Gallo, today the world’s biggest winery, made some 75,000 cases, or about 0.8% of its current production. Similarly, a local wholesale drug company run by three brothers would eventually become Southern Glazer’s Wine & Spirits, the biggest alcohol distributor in the world, with an annual revenue of $25 billion.

Is it any wonder that the courts have been full of lawsuits questioning how three-tier should work in the 21st century, even before the 21st century began? These lawsuits argue that alcohol still needs to be regulated, because no one wants to return to the antiregulation of pre-Prohibition days. But isn’t there a way to update the three-tier system to give it a 21st-century face? Can it be reworked to give individual states more flexibility in dealing with out-of-state retailers, which would allow more competition and more choices for consumers? Is there a way to level the playing field for the handful of giant wholesalers and their smaller counterparts, so that it’s more difficult for the former to succeed solely because of their size?

“This is not the 1930s,” says Koral, “and now we have problems that need solutions that Fosdick never anticipated. We’ve gone from very small local businesses to national companies. How is the consumer supposed to have a choice when a handful of major off-premise retailers control the market?”

Call that the most ironic of the ironies surrounding 21st-century alcohol regulation: the system still works exactly as it was designed to work. It’s just that everything else has changed.

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