How Not to Legalize a Drug

Yanking alcohol back out of the black market left America with a wicked Prohibition hangover.


By the time Franklin Delano Roosevelt was elected president of the United States in 1932, the Great Depression had been underway for three years—and Prohibition had gone on for what the literary critic and crank H.L. Mencken quite accurately described as nearly "Thirteen Awful Years." A quarter of the American workforce was unemployed. FDR had run on Repeal, proposing a win-win solution: The federal government would allow states to reopen the breweries and distilleries to create much-needed jobs, then heavily tax the alcohol to pay for what would become the New Deal.

Prohibition, which started as a "noble experiment" in 1920, ended up rolling out the red carpet for organized crime. Violence wracked cities as criminal syndicates fought over territory while the police force, politicians, and Prohibition Bureau agents were bribed to look the other way. Citizens widely disregarded the law of the land, and even congressmen employed their own bootleggers, despite the fact that most voted "dry."

The 18th Amendment had made the manufacture, sale, and transportation of alcohol illegal. It wasn't illegal to possess alcohol—the powerful Anti-Saloon League understood that people would rebel if they couldn't drink the stocks of booze they already had at home. Instead, drys naively believed that people would finish off what was in their liquor cabinets and then simply stop drinking.

end of prohibition
Imagno/Getty Images

But Prohibition didn't snuff out the liquor traffic as planned; instead, it merely deprived buyers and sellers of recourse in the courts when sales went sour. Bootleggers met the American public's undiminished demand for drink with a robust but unpredictable supply. Consumers had no dependable idea what they were buying, often winding up with rotgut industrial alcohol repurposed as "gin"—topped off with water in the bathtub, hence the term bathtub gin—or "Scotch," the same brew blended with some food coloring and iodine.

So Americans were sick (sometimes literally) of Prohibition. But the logistics for repeal were tricky: If Prohibition ended, how should the country control and regulate alcohol? With so much money at stake, and with a robust black market currently controlling sales, it wasn't going to be easy to create a new legal regime.

John D. Rockefeller Jr., a teetotaling Baptist and the richest man in the country, turned his back on Prohibition in a June 6, 1932, letter to his friend, Columbia University President Nicholas Murray Butler. The letter was printed on the front page of The New York Times the next day.

"When the Eighteenth Amendment was passed I earnestly hoped—with a host of advocates of temperance—that it would be generally supported by public opinion and thus the day be hastened when the value to society of men with minds and bodies free from the undermining effects of alcohol would be generally realized," Rockefeller wrote. "That this has not been the result, but rather that drinking generally has increased; that the speakeasy has replaced the saloon, not only unit for unit, but probably two-fold if not three-fold; 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 unabashededly disregarded the Eighteenth Amendment; that as an inevitable result respect for all law has been greatly lessened; that crime has increased to an unprecedented degree—I have slowly and reluctantly come to believe."

Though committed to the temperance movement, Rockefeller now supported Prohibition's repeal through the 21st Amendment. Rockefeller also proactively sought solutions for how to regulate alcohol once Prohibition ended. The goals: to undermine organized crime and turn bootleggers into law-abiding businesspeople, while ensuring there would be no return to the saloon culture that existed before Prohibition. Rockefeller underwrote a study, published as Toward Liquor Control, that to this day frames how Americans regulate alcohol. The study argued for a three-tier system of alcohol distribution.

Three Cheers for Three Tiers?

The 21st Amendment—better known as the Repeal Amendment—gave states the authority to regulate alcohol. That was one of its selling points to a public still wary of the alcoholic beverage industry. Those states that wanted to stay dry could. In fact, Oklahoma didn't go wet until 1959 and Mississippi legalized alcohol in 1966.

The proposed three-tier system strictly separated the industry into functions. The first tier was the alcohol producers: breweries, distilleries, and wineries. The second tier was the distributors: the middlemen who shipped the product to market. The third tier was the sellers: bars, liquor stores, and supermarkets where consumers bought the finished goods.

Before Prohibition, brewers and distillers produced the alcohol, shipped it to market, and often owned or provided financial backing for the saloons that sold it. Memories of these vertically integrated markets dominated by huge producers made Americans leery of returning to the pre-Prohibition status quo. The so-called tied-house saloons were a major bugaboo of the temperance movement. Booze slingers had offered freebies to workingmen during the day—often thirst-inducing salted pork sandwiches and pretzels—to lure them in to spend their paychecks on beer at lunch. And the powerful producers constantly bullied independent bars, trying to push competitors out of the market.

Prohibition hadn't done much to burnish the reputation of alcohol producers. Makers of distilled spirits were particularly suspect, since hard liquor was generally the bootlegger's drink of choice, as it was concentrated and therefore more profitable than beer or wine. A steady diet of overpriced liquor of dubious pedigree made Americans skeptical about the industry's willingness or ability to return to reasonably priced high-quality goods. State-by-state markets with heavily regulated middlemen seemed like a good way to prevent low-quality products and devious marketing practices.

When Prohibition ended on December 5, 1933, states had to quickly build regulatory frameworks, known as alcohol beverage control (or ABC). Thirty-two states and the District of Columbia adopted Rockefeller's three-tier system, and became known as "license jurisdictions." The other 18 states went further and became "control jurisdictions," whereby the state itself became the retailer, effectively eliminating one of the three tiers.

Getting Loopy on Loopholes

More than 80 years after Prohibition ended, the three-tier system is still the dominant legal framework for alcohol, making it one of the only industries in America where vertical integration is routinely against the law. And it still works, sort of. Alcohol is safe and legal, but the industry remains weirdly distorted by Rockefeller's regulatory compromise. By separating producer from distributor, wholesaler from retailer, the three-tier system obstructs the evolution of 21st century producer-to-consumer relationships (think: farm-to-fork and online sales) while creating artificial scarcity, which in turn reduces choices and competition and increases prices.

To understand how archaic these arrangements are, consider wineries. During Prohibition, people were allowed to brew 200 gallons of wine a year for home use, and the grape market exploded. Most of these were sweet grapes, which made wine taste much more like Coca-Cola. Meanwhile, the actual winemaking industry was devastated. It wasn't until the 1960s that craft wineries began to produce quality wines-three decades after Prohibition ended. They had to work hard to convince wholesalers to distribute their goods, as most people thought the only good wine came from Europe. And they had to lobby states to allow tasting rooms, samples, and the ability to sell wine directly on site. This increased tension with wholesalers, who saw that they would have to compete against wineries themselves.

In order to get around regulatory roadblocks, states where alcohol production is concentrated started pushing open a series of loopholes. California, for instance, which produces about 90 percent of U.S. wine, became home to the nascent wine-tourism industry in the 1970s and '80s and the tourists began asking to take a bottle or case back home, or to join the winery's wine club to get regular shipments.

A number of states created loopholes allowing their own wineries to ship direct to consumer but barring out- of-state producers from doing the same. Another protectionist trick was to require a winery to open an office in a state before being able to ship directly (New York's approach).

But in a landmark 2005 case with direct implications for the three-tier system, the U.S. Supreme Court ruled 5-4 in Granholm v. Heald that states were permitted to either allow or block direct-ship-but they had to do so on a non-discriminatory basis. In other words, allow it for everyone or allow it for no one, but don't play favorites.

Over the long term, consumers have demanded new ways to buy products, and legislatures and regulators have responded. In the wake of Granholm, 40 states now allow direct-ship wine to consumers, so you can get your favorite Napa Valley chardonnay or cabernet sauvignon delivered right to your doorstep.

But this is less a substantial reform than a very large loophole. Direct-to-consumer wine shipments bypass distributors entirely, making these often well-connected middlemen frantic to maintain their regulation-enabled privileges-even though direct-ship only accounts for about 3 percent of the overall wine market. In recent years, the number of distributors nationwide has drastically consolidated, giving alcohol producers fewer choices and less leverage to get their products to market. Volume counts for more than ever, and it can be difficult for a small family winery or a craft brewery to get distribution. In the Internet age of one-click shopping, such gatekeepers may feel like a relic from another era, but they still have political clout.

Growlers for Freedom

Wineries aren't the only producers looking to get around the three-tier system. Brewpubs, which began taking off in the 1980s, not only brew their own beer and sell it to the public—recreating the saloons of yore—but are now allowed in many states to fill up a growler (a large bottle, up to 64 ounces) for home consumption. That makes them producer and retailer all in one, with consumers acting as distributors when they take the beer to go.

Visitors to many brewery tasting rooms around the country can buy a six-pack of beer for home consumption. Cutting out the middleman has proved quite profitable to these small enterprises, providing them with immediate cash flow. They virtually always charge full retail price. (Wineries do the same thing: you'll pay more for their wine in the tasting room than you will in a wine store.)

So even as they rail against regulation, these small businesses often take advantage of the same inflated prices that the three-tier system produces; it's just that they pocket the wholesalers' markup themselves. Consumers enjoying an enhanced experience (such as tasting delicious alcohol in an evocative setting) are usually happy to pay what is effectively the same price—or are so unfamiliar with the inner workings of the industry they don't realize what goes into a price. 

Drunk on Booze Money

The three-tier system isn't the only distribution system that has faced challenges. In recent years, two-tier control jurisdiction states such as Ohio, Washington, and West Virginia have made successful attempts to get out from under the state umbrella, or at least to allow the private sector to compete against government-owned stores.

Other states have been less successful. Pennsylvania has tried repeatedly to privatize its 600-plus state stores, but has met strong opposition from package store clerks, unionized state workers who believe they will lose pay and benefits if the system goes private.

Virginia in 2010 attempted to privatize its state-owned liquor stores. Armed with a GOP majority in the state capitol, Republican Gov. Robert McDonnell nonetheless ran up against a wall of money. The commonwealth's ABC stores were making more than $100 million in profits a year for the state, and no economic model shy of greatly increasing the number of privatized liquor stores and raising liquor taxes could replace that lost revenue. (Although increasingly a political swing state, Virginia has many religious conservatives who want no expansion in liquor stores, which they see as a social malady.) Today many Northern Virginia residents trek to the District of Columbia, which has many good liquor stores (all of them privately held), better selection, and lower prices thanks to competition.

States that adopted the control jurisdiction model after Prohibition did so because they believed that the state had a role in espousing temperance and that state package stores would allow better control of distribution. The other key reason was the revenue they knew they'd earn from selling alcohol. Today the temperance justification has withered away, leaving only money as the reason why control states hang on to these outdated liquor stores. Alcohol sales are enormously profitable for these states. They have become reliant on state package store revenue and sales tax receipts to balance the budget.

Consumers don't buy gasoline or jeans from the state, so why should they buy booze from it? Your friendly neighborhood state-run package store might feel like something out of the Soviet era, with unattractive shelving and employees who aren't terribly knowledgeable about the products they are selling. The private sector is far more adept at supplying the market and responding to consumer demands.

Alcohol has always been a fundamental part of American culture. Two-thirds of American adults drink today, and the temperance movement that gave us Prohibition is dead and buried. Alcohol and Prohibition have become chic topics for us to reminisce about; we dress up in 1920s attire and sip once-clandestine cocktails at nostalgic speakeasy parties.

But no one talks much about what we were left with after Prohibition ended, in part because the system and its markups are largely hidden from the end consumer. Choices for consumers proliferate in spite of the tiered systems, which further muddies the case for wholesale reform. And since alcohol regs are—rightly—created at the state and local level, there is no magic federal bullet that can erase the inefficiencies in the system.

The three-tier system was designed for another time and a different social context. Most Americans now drink unapologetically, and the word "temperance" has fallen out of use. But thanks to entrenched interests and general apathy, we're likely stuck with the loophole-ridden status quo for a good while longer.