California Wineries Prepare for the Worst

We all know that in times of turmoil the “sinful” products — namely, alcohol and cigarettes — are always the first to be hit with higher taxes. Most …

We all know that in times of turmoil the “sinful” products — namely, alcohol and cigarettes — are always the first to be hit with higher taxes. Most Americans assume it’s simply the price we must pay for our indiscretions. This has been an especially heated issue in California ever since Gov. Schwarzenegger proposed that the state increase the excise tax on wine by 26 cents per 750 milliliter bottle to ease the huge budget deficit.

Though 26 cents may not sound like a lot of money, it would equate to a 640 percent increase in the excise tax, for which we currently pay 4 cents. Even if the tax increase doesn’t pass, it’s clear that California’s wine industry, which had a statewide economic impact of $51.8 billion in 2006, is facing increased dangers. California’s deficits must be filled and many consumers must preserve their money, foregoing luxuries like wine — or at least expensive bottles of wine.

Since no one knows for sure when the recession will end, NuWire is examining what the winemaking landscape could look like if a similar tax increase was levied in the future or if local wineries are forced to hike prices.

Increasing Sin Taxes

Being a California staple, many of the wineries who expressed concern over the substantial tax increase stated that they were bothered by more than just the financial hit that either themselves or their customers would suffer. They said they were also bothered by the fact that Sacramento wanted a few key industries to bear the brunt of this tax increase.

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The Wine Institute, which represents more than 1,100 wineries and related businesses, recently released its position on Schwarzenegger’s proposal.  “The restaurant and hospitality industry as a whole is already reeling from declining sales and many in the industry, including wineries… [And] wineries would be forced to either absorb the tax increase, which would drive down or eliminate profit margins, or “pass through” the tax, raising the price of many popularly priced wines by 25 percent,” it stated. “We understand the [budgetary] need and will support broad-based revenue measures to help solve the budget crisis.”

Another publication released by the Wine Institute, titled “The Impact of Excise Tax Surcharge,” noted just how large an impact a tax hike could make on the wine industry. It estimated that wineries would experience a drop in sales and revenue that would lead to a job loss of anywhere between 6,756 and 11,545. Ironically, the state (and respective county) would also see a decrease in tax revenue that could total $73.55 million to $125.7 million.

As the tax increase remains speculative at this point, it is impossible to tell how the public would respond if it was implemented. But Karl Storchmann, managing editor of the Journal of Wine Economics and an associate professor at Whitman College in Washington State noted that past studies have shown a direct correlation between price and consumption. “A one percent increase in price will lead to a one percent decrease in consumption,” he said. This means that a $10 bottle of wine, under the current tax proposal, would increase in price by 25 cents, or 2.5 percent. According to Storchmann, this could lead to a 2.5 percent decline in consumption.

For smaller operations that are already hurting, this type of drop in consumption could be the straw that breaks the camel’s back. This is because, despite being considered a luxury good, most wine sales produce very small profits. In fact, more than 60 percent of all California wines sold are $6.99 or less, per the Wine Institute’s Surcharge publication. So it’s easy to see how a tax increase, combined with a flailing economy, could spell doom for some. “Wine is a highly capital-intensive and narrow-margin business,” the Institute’s response to the proposal continued. “A number of wineries are likely to be forced into sale by their lenders if the excise surtax further slows revenues and reduces cash flow.”

Feeling Residual Effects

As consumers back off while the government comes on strong, most wineries are likely to experience some hardship. What many people likely don’t realize, however, is that these hardships extend beyond the wineries and their employees. Restaurants and bars are already hurting, and some may not be able to maintain their current orders if the cost to supply wine continues to go up while consumer demand continues to go down. Though winemakers could clearly pass the additional costs onto the consumer, Storchmann believes that it is a lot more likely that they will either eat the costs themselves or pass them onto bars, restaurants, supermarkets and convenience stores. “In this economy, I doubt that…producers are able to pass the tax onto consumers,” he said.

Grape growers are also likely to hurt if prices rise and consumption falls, as many foreign wines are inexpensive and easy to buy in bulk. The same can be said for wines from nearby states, including Nevada, Colorado, Texas and Washington.

The Wine Institute also noted that any additional costs passed onto the wineries may actually be passed onto the environment, in a way. While other industries and non-California wineries adopt sustainable designs and environmentally friendly facilities, the Institute noted that some in-state wineries may not be able to focus on environmental stewardship. Green practices can be highly expensive, especially when they involve high-tech equipment, and, as much as they may want to, some wineries may not be able to take on these additional costs if they’re dealing with lower profit margins and higher taxes. “The California wine community is committed to adopting sustainable winegrowing as well as complying with increasingly higher standards for air and water quality and more,” the response noted. “[But a] 640 percent tax [increase] would make investing in these practices more difficult and put state vintners at a disadvantage with foreign competitors who do not have our high environmental standards.”

Even if the proposed excise tax increase does not pass, it does not mean that California’s wine industry is out of the woods, making these financial hardships and resulting circumstances all the more likely. Though the state’s wine industry is clearly resilient, having survived for nearly two centuries, the fate of key industry players is unsure, given the current economic downturn and the major deficit that California must make up.
 

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