That would have been white lightning they'd be mixing it with, not water. Or maybe even "bathtub gin" (fermented, but not distilled, sugar beer). So the alcohol content wouldn't be affected much by it. But Mt. Vernon's flavor would probably have been pretty strong for it to be the flavoring of choice. Then again, any kind of increase in flavor would be an improvement. And it was probably cheaper (and less suspicious to buy) than commercial whiskey flavoring, too.
Hmmm, wonder if THAT's what Chuck's dad remembers so fondly from the old days? :-))
Legend has it that Pappy Van Winkle used to sell Weller bourbon to local moonshiners who would use it to improve the flavor of their hootch. I suppose it also helped to ensure more dependable deliveries of his own product as well.