The economics of selling craft beers and spirits just got a lot better

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Image: Reuters/Thomas White
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Among the many industries benefiting from lower corporate tax rates starting in 2018, the alcoholic beverage industry will now have some added benefits—at least for the smallest companies.

The Craft Beverage Modernization and Tax Reform Act, part of last year’s broader tax-reform legislation, reduces the federal taxes paid by beer, liquor, and wine makers for their initial volumes each year. That means that small, “craft” companies will see the biggest benefits on their overall volume. For instance, taxes on beer and wine will be reduced by half for their initial volumes. Small distilleries are the biggest winners though as their taxes will be reduced by 80%.

Craft spirits is a high growth industry. In 2016, the number of distillers grew 10% while their volume grew 18% and revenue grew 25% according to the American Craft Spirits Association (pdf). While craft’s share of the overall industry is still small, it’s growing rapidly—from 1% of volume and value in 2011 to 2.6% of volume and 3.8% of value in 2016. And employment by craft distillers is booming with almost 20,000 employees in 2017, more than tripling since 2014.

The new tax rates will benefit all craft producers but they will benefit the smallest producers the most since all of their volume will be taxed at the lower rate. Around 1,400 distillers, representing about 1% of total spirits volume, will enjoy the full tax break on their entire volume. This is because alcohol taxes are paid by the distiller and considered a cost of goods. The taxes are based on the volume of alcohol sold so the tax break varies somewhat between different spirits. For instance, the tax on a standard bottle of 80-proof vodka will decline by $1.71 while the tax on a bottle of 90-proof whiskey will decline by $1.93. Either way, it’s a material reduction in cost for small producers.

For example, take a case of a bottle of gin made by a hypothetical small distiller and sold in California using the tax structure in 2017. Based on the alcohol content of gin, the distiller would owe $2.14 of federal tax per bottle. The tax is included in the cost of goods along what we’ll assume is $4 for the distillation and $3 for the bottle and bottling process, making the total cost to produce the bottle of gin $9.14.

The distiller determines how much it will charge the wholesaler based on how much profit it wants to generate. We’ll assume a margin of $8 per bottle, making the sale price to the wholesaler $17.14. The wholesaler adds its 35% margin ($6.00), shipping costs ($0.32), and California state taxes ($0.65), making the total cost to retailer $24.11. The retailer adds its 35% margin ($8.44), making the total cost to the consumer $32.55.

Now let’s consider the possible effect of the new tax rate. If the distiller passes on the reduction in taxes, the wholesaler and the retailer would earn less margin, reducing the price to the consumer by $3.12 to $29.43.

How would that change the price of your cocktail? The tax bill could drop the cost of a negroni by more than a dollar. But a martini could drop by $1.50. Perhaps most importantly, the martini could make it on the menu as a premium cocktail at $15 (assuming standard drink pricing of five times the pour cost). That means a small distiller could compete with the likes of Bombay Sapphire in a gin lover’s high-end martini.

Of course, what distillers do with their tax benefit is an open question.

One option is that distillers use the extra funds to offset current costs. Small distillers are often run at negative cash-flow due to high investment costs or low product margins. So increasing gross margins by 21% could be very helpful.

Another option is to use the extra funds for new marketing campaigns. For instance, one small distiller told us that he might use the extra $2 per bottle for extra marketing expenses with a big US retailer like BevMo, paying to get on BevMo’s club listing or to paying for marketing tags on his bottles.

A third option is to use the lower tax cost to reduce the price to the consumer in the hope of increasing volume. Small distiller spirits are frequently sold at higher prices than those from larger distillers like Diageo, Campari, Constellation, and Brown Forman. Small distillers can’t afford to match the prices of the big guys so they hope to develop a customer base that will pay up for something small and niche. The issue is higher prices reduce their retail market opportunity, and importantly, reduce their opportunities to get on the almighty cocktail menu at important bars that can introduce their product to new customers.

Whether distillers choose volume or value, the new tax bill should benefit the small guy in the alcohol industry.