A battle is brewing between Costco (search) and Washington state's government over the price of wine and beer, and the fight is expected to be as long as the legs of a fine wine.

The retail giant, based in the Evergreen State, is suing, saying that government involvement in regulation of beer and wine means higher prices, mandatory mark-ups and middlemen. That, says company officials, prevents the retailer from selling beer and wine in bulk at lower prices, which is what the company prides itself on.

"Obviously we want to be able to bring products to market at a lower price, irrespective of what that product is," said Jim Sinegal, president and CEO of Costco.

Costco is suing the state over its three-tier distribution system, claiming it violates free commerce laws. The lawsuit also challenges Washington's state-run liquor stores (search), claiming unfair competition, because state stores are the only place where residents can buy hard alcohol, but they also sell beer and wine.

Smaller rivals to Costco say they like the current system because it levels the playing field against the large bulk sellers.

"This is about market share and market dominance. It's not about getting lower prices for the consumer," said Lonnie Schott, who owns a small wine shop.

Opponents also argue that the state's regulations give consumers more choice.

"If the system is dismantled you won't have the ability for the small producers to get to the marketplace and you will see small producers go out of business," said Paul Shipman, president and CEO of Redhook Brewery (search).

Washington state's inflated pricing system was commonplace nationally after the fall of prohibition in the 1930s. The goal was to keep beer-makers from dumping their suds on saloons so cheaply that people would end up drinking too much. In other words, they hoped to hike the cost in order to limit consumption.

But Costco argues the system is outdated, and states with looser liquor laws do not report a greater drinking problem than states with tight regulations.

"I believe probably that the distribution system would go on for the small retailers on an ongoing basis. The consumer would benefit because there would be greater competition and sharper pricing," Sinegal said.

Click in the box near the top of the story to watch a report by FOX News' Dan Springer.