Tariff Rates Fall, Foreign-Trade Zone Use Climbs. What's the Deal?
30 Jun, 2004By: Greg Jones
Pharmaceutical Companies and 3PL's Get into the Act
For the past three decades, U.S. tariff rates have fallen significantly, with many new products eligible for duty-free importation into the United States. Yet, over the same timeframe, the use of the U.S. Foreign-Trade Zones program, which is predicated on the ability to reduce tariff costs, has risen. In 1970 roughly 65% of total U.S. import value consisted of dutiable products, with Customs duties comprising 6.5% of the total value of all imports. In 2003, roughly 32% of total U.S. import value consisted of dutiable products, with Customs duties comprising only 1.6% of the total value of all imports. The fall in the effective tariff rates that apply to products imported into the United States can be traced to multilateral tariff reductions such as the Tokyo Round of GATT and the Uruguay Round Agreements, and, to regional and bi-lateral trade initiatives such as the Generalized System of Preferences (GSP), the Caribbean Basin Economic Recovery Act (CBI), the U.S.-Israel Free Trade area Agreement, the North American Free Trade Agreement (NAFTA) and the Andean Trade Preference Act. In 1970 there were eight U.S. Foreign-Trade Zone projects in the United States. Included within these Zone projects were a total of three special-purpose subzones. Today there are more than 150 active Zone projects with a total of more than 200 active special-purpose subzones. Total Zone-related activity exceeds $200 billion annually.
Most people who are familiar with Foreign-Trade Zones are familiar with the idea that companies use Zones to reduce their tariff-related costs. Given this understanding, one might well ask, “Hey – Tariff rates are falling. Foreign-Trade Zone use is climbing. What’s the deal?” The “deal” is that U.S. Foreign-Trade Zones save U.S.-based companies money in ways that are different than so-called “Free Trade Zones” in other countries. In a number of “Free Trade Zones” the sole benefit is the avoidance of internal customs duties on products that are re-exported from the Zone. In some instances – for example, the manufacture of pharmaceutical products – U.S. Foreign-Trade Zones enable companies to reduce or eliminate duties on products produced for domestic consumption. This “tariff rate rationalization” benefit is a key distinction between the U.S. Foreign-Trade Zones program and many other free zone or customs duty regimes.
The Pharmaceutical Industry: A representative example of tariff rate rationalization
The use of the Foreign-Trade Zones program by U.S.-based pharmaceutical manufacturers provides an instructive example of how U.S. Foreign-Trade Zones enable American businesses to compete with their foreign counterparts on a level playing field in what would, in the absence of the Zones program, be an irrational tariff rate environment.
As previously noted, U.S. tariff rates have fallen as a result of several rounds of multilateral tariff agreements. Tariff reductions of the Uruguay Round Agreement, which commenced in1995, were implemented in a number of strategic industries, including the pharmaceutical industry. Because of the Uruguay Round tariff regime, a wide range of medicines and pharmaceutical products are traded freely around the world – that is, they can be sold and imported into more than 100 countries on a duty-free basis. This duty-free tariff regime has created new export opportunities for U.S.-based pharmaceutical manufacturers, however, it has also brought on new financial pressures to “out-source” the manufacture of certain pharmaceutical products to offshore locations. The reason for this is straightforward: In a number of cases, a given finished product may be imported into the United States at a “Free” rate of duty, but one or more of that product’s key raw materials remain subject to U.S. Customs duties under the Harmonized Tariff Schedule of the United States.
For example, a U.S.-based pharmaceutical manufacturer produces a prescription medication in gelcap form for the U.S. marketplace. The plant is a part of a multinational pharmaceutical company’s group of worldwide manufacturing facilities. In the case of the U.S.-based manufacturing operation, its competition is easy to identify: It’s the facility’s overseas “sister” plants. Under the United States’ pre-Uruguay Round tariff structure, the company enjoyed a 6.5% rate of tariff protection against imports of its finished product. Thus, for its multinational parent, it made economic sense to manufacture the medication in the United States. Today the medication can be imported into the United States free of Customs duty. Unfortunately for the U.S.-based producer, the gelatin that it imports to manufacture the medication is dutiable at 3.8% of its value. If the imported gelatin represents 30% of the cost-of-production for the medication, then the U.S. tariff structure imposes an overall addition of 1% to the cost of manufacturing the medication in the United States versus overseas. This is due to the irrational duty rate relationship between the finished product and its raw material. In the absence of a means to restore a rational duty rate relationship between the two, the multinational company would be likely to shift its manufacture of the medication to a foreign location.
The means for restoring the rational duty rate relationship between the medication and the gelatin is the U.S. Foreign-Trade Zones program. Upon application to and approval by the U.S. Foreign-Trade Zones Board, and upon approval of activation by U.S. Customs and Border Protection, the company can bring the imported gelatin into its Foreign-Trade Zone facility without paying Customs duty. The gelatin may then used in the manufacture of the medication. The medication may then leave the FTZ production facility and be entered into the U.S. commerce at the same tariff rate that would apply to the medication if it was manufactured overseas – that is, “Free.” This tariff rationalization feature of the U.S. Foreign-Trade Zones program enables the U.S.-based pharmaceutical manufacturer to maintain the cost-of-production structure it needs in order to compete with its overseas sister plants.
3PL’s: Using Zones to streamline supply chain management
Third-party logistics companies, popularly known as “3PL’s,” are using U.S. Foreign-Trade Zones to streamline their customers’ inbound supply chains, and doing so in ever more creative fashion. For a number of years 3PL’s located in Zones have enabled their customers, including FTZ manufacturers, to enjoy the combined benefits of Foreign-Trade Zones and Just-In-Time logistics. A number of 3PL’s located in Zones have helped U.S.-based manufacturers succeed in their efforts to employ “lean” manufacturing techniques. In many cases this involves the 3PL’s management of the Just-In-Time flow of parts, components and materials from their staging facilities to the manufacturers’ receiving docks or manufacturing areas. The ability of 3PL’s to provide Just-In-Time support and, at the same time enable the Zone benefits associated with FTZ manufacturing authority to be realized through Zone-to-Zone transfers, has enabled them to help U.S.-based manufacturers enjoy the benefits of Zone status without sacrificing the efficiencies of “lean” manufacturing techniques.
More recently, 3PL’s have expanded their use of Foreign-Trade Zones to a more diversified set of client needs. One key development that has enabled them to do so is the expansion of so-called “weekly entry” procedures for Foreign-Trade Zone operations. As noted above, the Customs “entry” into U.S. commerce occurs when goods leave the Foreign-Trade Zone. Since 1986, FTZ manufacturers have been able to streamline the flow of their finished products into the U.S. commerce through the use of weekly entry procedures. Under the weekly entry regime, the FTZ manufacturer filed for a transfer permit once a week, shipped its product into U.S. commerce during the weekly period, and filed its consumption entry and paid Customs duties after the close of the weekly period. This valuable benefit enabled FTZ manufacturers to efficiently ship their products to their distribution networks without filing Customs entries on a shipment-by-shipment basis. It also prevented Customs personnel from drowning in needlessly repetitive entry paperwork. Under the provisions of the Trade and Growth Opportunity Act of 2000, Foreign-Trade Zone weekly entry provisions were expanded in order to be made available to all Zone users.
Today, 3PL’s help their customers manage the efficient movement of products destined not only for other Zones, but also for movement into the domestic and export marketplaces. For example, the 3PL’s customer files for a weekly entry permit for products located in the 3PL’s FTZ facility. The 3PL handles the merchandise and monitors shipments to ensure that the products shipped fall within the scope of the weekly permit. At the end of the weekly period, the 3PL forwards the requisite information about the products that are transferred from the Zone during the week to its customer, who then uses this information to file its entry summary and pay Customs duties.
The Bottom Line
The bottom line is that the U.S. Foreign-Trade Zones program is much more than an export platform. The FTZ program was created to “expedite and encourage” international trade activity in a manner that would provide the economic benefits of trade to the citizens of the United States. The use of the Zones program by companies as diverse as pharmaceutical manufacturers and 3PL’s demonstrates the diverse way in which the Zones program does so. The bottom line for the U.S. Foreign-Trade Zones program is that it enables U.S.-based businesses to enhance their bottom line, and, more importantly, maintain their economic activity here in the United States.