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A
Brief History on the U.S. Foreign Trade Zones Program
Today, the trade policy of the United States is based on a free
trade model. This
theoretical model recognizes only the economic beneficiaries of free
trade; it
acknowledges that the costs (or losers) resulting from free trade
are negligible. In
reality, however, free trade has benefits and costs. No doubt, the
benefits far
outweigh the costs; however, the costs are very real. The Foreign-Trade
Zones
program offers a way to mitigate the costs of free trade. In doing
so, the program
allows the United States economy to enjoy relatively greater benefits
from its free
trade initiatives. The various benefits offered by the Foreign-Trade
Zones program
make it an effective response to the problems that arise when the
$8.5 trillion dollar
U.S. economy operates within the rapidly changing international trade
environment.
The U.S. Foreign-Trade Zones program was created by the Foreign-Trade
Zones Act
of 1934. The Foreign-Trade Zones Act was one of two key pieces of
legislation
passed in 1934 in an attempt to mitigate some of the destructive
effects of the
Smoot-Hawley Tariffs, which had been imposed in 1930. The Foreign-Trade
Zones
Act was created to "expedite and encourage foreign commerce" in
the United States.
This is accomplished through the designation of geographical areas,
in or adjacent to
Customs Ports of Entry, where commercial merchandise receives the
same Customs
treatment it would if it were outside the commerce of the United
States. Merchandise
of every description may be held in the Zone without being subject
to Customs
duties and other ad valorem taxes . This tariff and tax relief is
designed to lower the
costs of U.S.-based operations engaged in international trade and
thereby create
and retain the employment and capital investment opportunities that
result from
those operations. These special geographic areas – Foreign-Trade
Zones – are
established "in or adjacent to" U.S. Ports of Entry and
are under the supervision of
the U.S. Customs Service. Since 1986, U.S. Customs' oversight of
FTZ operations has been conducted on an audit-inspection basis, whereby compliance
is assured
through audits and spot checks under a surety bond, rather than through
on-site
supervision by Customs personnel.
The FTZ program has grown profoundly over the last 30 years. In
1970 there were 8
Foreign-Trade Zone projects (with a total of 3 Subzones) in the United
States. Today
there are over 230 Foreign-Trade Zone projects (with nearly 400 Subzones)
in the
United States. This growth is the result of changes in the FTZ program.
These
changes have caused the FTZ program to evolve into an important means
by which
U.S.-based companies can enhance their cost-competitiveness, and
as a means by
which the United States can practice both the letter and the spirit
of its trade laws.
From 1934 through and beyond the Second World War, Foreign-Trade
Zones were
used only on a very limited basis. The reason for this was clear:
the prohibition
against manufacturing activity. While Zones lay virtually dormant,
the 16 years
between 1934 and 1950 saw a complete change in the dynamics of trade – a
change
which would create the need for the FTZ program within the U.S. manufacturing
sector.
The General Agreement on Tariffs and Trade (known by its acronym "GATT")
became
the working model by which more than 120 nations participated in
round after round
of multilateral tariff reductions for nearly 50 years. From 1946
until 1995, the GATT
served to break down the barriers to trade on a worldwide basis.
This expansion of trade played a critical part in the 50-year economic
boom in member countries following the end of the Second World War.
Early in this period, an important amendment to the Foreign-Trade
Zones Act was made. In 1950, those members of Congress who were the
original champions of the
Foreign-Trade Zones Act of 1934 (Yes, they were still members of
Congress!),convinced their colleagues of the wisdom of allowing manufacturing
activity in
Foreign-Trade Zones. Approval for manufacturing in Zones would be
done on a caseby-case basis, and, as was the case in other FTZ’s
around the world at that time,
goods manufactured in Zones would be assessed Customs duty based
on their full value, including domestic parts, labor, overhead and
profit, upon entry into domestic
commerce. This was in keeping with the so-called "island" model
of FTZs in which the activity conducted within each Zone is totally
segregated from the domestic
economy.
While this new amendment to the Foreign-Trade Zones Act advanced
the cause of U.S. Foreign-Trade Zones significantly, it did little
to spur Zone manufacturing
activity. Since the U.S. tariff structure was still largely biased
in favor of domestic production activity, firms who imported foreign
parts to produce finished products for
the domestic market were at a competitive advantage in relation to
their foreignbased counterparts. Zone manufacturing for production
devoted exclusively to
export sales was a rare phenomenon.
Thus, throughout the 1950's and
1960's the U.S. Foreign-Trade Zones program was of little practical
utility to businesses. During
this time period, round after round of GATT agreements were reached,
and the competitive environment of global trade changed significantly.
Many of the tariff
barriers were reduced by the simple reduction in Customs duty rates
on a multilateral basis.
As trade negotiators completed these agreements,
duty rates on a
wide variety of products were lowered worldwide. This promoted
international trade through freer market access and lead to its expansion.
However, as round after
round of global trade agreements were implemented, it became clearer
to some that this freer market access came with an unexpected cost.
As befits most professional negotiators, the community
of international trade negotiators shared (as, no doubt, it still
does), the common characteristic of trying
to gain the most for their native countries, while yielding the
least. Naturally, over the course of time, high value-added manufactured
goods would be the subject of
intense trade negotiation. As agreements for tariff reductions
on high value-added finished products proliferate, so do inconsistencies
within the tariff structures of
individual nations.
The classic, domestically-biased duty rate relationship between
raw materials, parts and components which make up intermediate stages
of production, and a given
finished product, is characterized by increased rates of import duties
as value is added in the production process. This classic structure
meets the twin aims of tariffs:
to raise revenue and encourage domestic production activities (which,
in the United States are taxed through individual and corporate taxes).
However, as multilateral tariff agreements reduce duty rates on
a world-wide basis, an odd set of duty rate relationships can sometimes
occur as a result of a particular
end product's reduced tariff rate. On occasion, the duty rate applicable
to imported intermediate parts is higher, rather than lower, than
the duty rate that applies to the
finished product.
While providing market access for the end product – a
desired result because of a corresponding concession by other member
nations – this duty
rate relationship also imposes an unintended counterproductive cost
on the domestic producer of that end product. Now the domestic producer
is competing with its
foreign-based counterpart at an inherent cost disadvantage.
Why?
Because it must now pay a higher rate on one or more of its imported
parts than its foreign-based competitor pays to import its finished
product. This tariff imposition reduces the
domestic producer's profit margin and thereby makes it irrational
for it to continue to make the finished product domestically. Such
duty rate relationships are known as
irrational duty rate relationships or "inverted tariffs." Such
a tariff structure is biased against the higher value-added activity
to produce the finished product domestically.
In this situation, value-added activity (which, if conducted domestically,
would produce income taxes on profits and wages) is encouraged to
be moved to a foreign
location.
By 1980, the combination of cheap and efficient transportation,
and the use of such programs as Mexico’s Maquiladora, or "twin
plant" program, provided the means for
U.S. firms to shift production of their products overseas, and for
foreign-based firms to more easily compete in the U.S. market. Falling
tariff rates, and, in particular, the
way they affected the U.S. tariff structure, provided additional
motivation to conduct value-added activity overseas.
Fortunately, a truly effective remedy was at hand.
Since 1972, the
National Association of Foreign-Trade Zones (NAFTZ) has served
the interests of the
communities and companies who participate in the U.S. Foreign-Trade
Zones program. The NAFTZ observed the existing Customs and tariff
treatment afforded to
domestic parts shipped overseas for value-added activity and then
returned to the U.S.. The NAFTZ began to press for equivalent tariff
treatment of products
manufactured in a U.S. Foreign-Trade Zone environment. The NAFTZ
asserted that Customs duty on products manufactured in Zones should
not be assessed on U.S.
value-added – that is, value which consists of domestic materials,
parts, labor,overhead, or profit.
On April 12, 1980, the U.S. Customs Service issued a formal ruling
that agreed with the NAFTZ's position. At last, the U.S. Foreign-Trade
Zones program, born in 1934,
could be of real utility in attracting and retaining U.S.-based economic
activity. This economic activity generates investment, labor, and
profit, which collectively produce
far more tax revenues than do Customs duties.
Now, at last, the U.S.-based manufacturer could bring foreign-sourced
parts or materials into the Zone, pay no duty, incorporate those
parts or materials into a
finished product using U.S. parts and labor, and, if the finished
product entered the U.S. commerce, pay duty on the value of the foreign
non-duty-paid content only.
This "integrated" model, which has replaced the previous "island" model,
has spurred the growth in the U.S. Foreign-Trade Zones program, and
has allowed U.S.-based
manufacturers to engage in economical sourcing – from both
foreign and domestic suppliers – to displace imports of foreign-produced
finished products. This, along
with the overall expansion of global trade, is why the number of
Zone projects, and the number of Subzones, has grown so profoundly.
In historical summary, the 1950 amendment which allowed manufacturing,
and the 1980 ruling which effectively eliminated the "island" model
for U.S. Zones (thereby
integrating Zone activity with the U.S. economy), provided the legal
and regulatory framework for the Foreign-Trade Zones program to effectively
serve U.S.-based
businesses. Round after round of multilateral trade agreements created
the need for the U.S. government to make exceptions to the published
tariff rates in instances
where the structure of the U.S. tariff is counterproductive. Therefore,
today, the Zones program acts as a tool by which the United States
can practice both the letter
and spirit of its trade laws and policies.
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