Use of Foreign Trade Zones and Economic Development Projects to Help Deal with Financial Challenges and Lack of Sufficient Tax Revenues
by James E. Spiotto, Co-Publisher of MuniNet
The new reality of tariff wars and 20% surcharges on foreign manufactured parts and goods
The tax reform of 2018 created a 20% surcharge on foreign manufactured goods or parts coming into the United States. Recent U.S. tariffs on imported steel and aluminum has triggered reciprocal tariffs on U.S. exports to foreign countries. The ability to attract new business and help current businesses in the Midwest to expand will depend on the states’ ability to deal with this new reality. One such method is the use of foreign trade zones.
What is a Foreign Trade Zone?
Around the world there are specially designated areas within countries’ borders that are established and controlled by national legislation and through which the receiving, handling, manufacturing, repurposing, and exporting of goods can occur free from import duties and taxes. These areas are usually known as free trade zones.
The Foreign-Trade Zone Act of 1934 as amended (“Act”) created the possibility for this type of area within the United States of America. They would be known here as foreign trade zones (“FTZ”). According to the Regulations of the U.S. Foreign-Trade Zone Board (19 CFR Part 400):
“[A] Foreign Trade Zone (FTZ or zone) includes one or more restricted-access sites, including subzones, in or adjacent to a [Customs and Border Protection or CBP] port of entry, operated as a public utility under the sponsorship of a Zone Grantee authorized by the Board, with Zone operations under the supervision of CBP.”
According to the U.S. Foreign-Trade Zone Board Annual Report to Congress:
“[A] Foreign Trade Zone is created when a local organization, such as a city, county or port authority, applies to the FTZ Board for a grant to establish and operate a zone to serve a specifically defined geographic area. Upon approval of the zone by the FTZ Board, the organization becomes known as the FTZ ‘grantee’. Grantees are then able to submit applications to the FTZ Board to establish FTZ sites or subzones for use by companies in that area.”
Use of foreign trade zone status (with industrial parks and alternation site framework):
- A city or public corporation can apply for Foreign Trade Zone (“FTZ”) status which must be approved by the Department of Treasury and Commerce:
–Foreign Trade Zone Act 19 U.S.C.§81(u).
–Foreign Trade Zone Board Regulation 15 C.F.R.§400.
–Custom Regulation 19 C.F.R.§146.
- Alternation Site Framework (“ASF”) gives participating zones greater flexibility to a much simpler, faster minor boundary modification procedure to designate locations where companies are ready to use FTZ.
- FTZ maintain and create jobs and involvements in the U.S. as opposed to in a foreign country by customs/tax financial savings.
- FTZ stimulate American economic growth and development because FTZs encourage companies to continue to expand their operations in the United States.
What are the benefits of a FTZ?
To manufacturers and distributors: Both manufacturers and distributors can benefit from operating in a FTZ. Because FTZs are considered outside of customs territory, businesses may import product into a zone without paying customs duties. Duties on products destined for domestic destinations are deferred until products leave the zone, and products that are re-exported, either in original form or as part of a product made in a zone, are generally exempt from customs duties. With approval from the Foreign Trade Zones Board, a manufacturer may elect to pay duty on an imported component either at the duty rate applicable to the component or at the duty rate applicable to the finished product. In either case, U.S. value added in the zone is not subject to duty. In an inverted tariff situation, one in which the duty rate on the finished product is lower than that on the imported component, manufacturing in a FTZ results in a lower overall duty to the manufacturer.
To states and local governments: A FTZ helps attract foreign manufactures looking to reduce the retail sale price of the product by assembly or manufacturing in a FTZ in the United States thereby avoiding the 20% surcharge or other tariff and taxes in whole or in part. This benefit of a reduced cost of manufacturing can help create new, good jobs in a FTZ created by foreign manufacturers or domestic distributors to assemble the parts or manufacture the product in the FTZ in the United States. The parts and machines to manufacture come into the FTZ duty free and there is a negotiation of a duty on the finished product that is generally far more favorable than the duty on the foreign assembled or manufactured products. The new jobs created generally promote related manufacturers of parts or components as suppliers to participate in the FTZ, thereby increasing even more jobs in the FTZ. This process produces the job multiplier of direct, indirect and induced jobs of two to five or more jobs. There is the job created to produce or assemble the product (direct) and the job created for supplies, goods and services provided to the FTZ manufacturer for manufacturing or assembling (indirect job) and jobs created by the new worker spending their salaries for goods and services (induced jobs):
–Companies that operate in FTZs import parts, material, components or equipment for manufacturing, and they finish the goods or parts for distribution in the U.S. or to be exported.
–The benefit of FTZ status is that the custom duties on foreign parts, materials, components or equipment imported by the company operating in the FTZ either are eliminated or substantially reduced or deferred so that generally the only duty is on the finished product which is a significant reduction in duty expenses. This applies to foreign products admitted into the FTZ for storage, exhibition, assembly, manufacture and processing.
The Midwest already has FTZs in most states:
- There are over 230 FTZs in the United States with nearly 40 sub zones.
- There are 50 FTZs in the 12 Midwest states with the highest number (30) in four states, namely: Ohio (9), Illinois (8), Michigan (7) and Indiana (6).
- Use of the FTZ combined with industrial parks could help local tax issues by creating not only increased economic activity but also creating additional employment opportunities, business and infrastructure expansion. All of this creates additional tax revenues that should ease tax and leverage problems. Note: tax incentives to relocate to the FTZ can be costly. See Foxconn negotiations with Wisconsin.
Examples of an approach to FTZs and economic development that may work for distressed municipalities: Upside Chicago – Creation of 10-18 industrial parks in the Chicago area creating 20,000 new good jobs for about 100-140 new or relocated companies and the City of Pittsburg’s recovery plan:
The use of natural attributes of Chicago for business development:
- Nation’s transportation center. Chicago is the center of commerce especially as far as Transportation (major rail, land and air as well as water).
- Major manufacturing center. Chicago USA is the second largest manufacturing metropolitan area in the U.S.A. and has a long history in manufacturing given its central location and ease of transportation.
- Educated workforce. Chicago has an educated workforce and the ability to educate and train new workers for the new manufacturing models of the future.
Development of Upside Chicago:
- Business leaders’ innovation. The Concept was created by local business professionals on a pro bono basis who had experience with operations, manufacturing, finance, insurance and Special Economic Zones, both domestically and internationally.
- Use of special economic zone experience. The factors that produced lower cost for production and distribution of goods that led to the development of the Maquiladora in Mexico and Special Economic Zones in China and elsewhere are now present in Chicago.
- Significant cost saving. For Labor and Freight Intensive Manufacturing the cost of shipping can be 8-16% or more of Sales Price while labor can be 15-22% of Sales Price. A savings of 3-6% or more of sale costs is the equivalent of reducing employment cost by about 25% or more.
- Project costs. Chicago’s unique transportation facilities could reduce shipping and handling costs by 4-6% or more of Sale Price depending on the comparative shipping locations.
- Benefit of managing agent and shared services savings. Establishing a non for profit special purpose entity that would be the Industrial Parks Coordinating and Supervising Managing Agent (“Park Agent”) that would offer manufacturing site with cost efficiencies for smaller manufacturing companies, 100-250 employees by shared services (similar to condominiums for manufacturing) where building outside maintenance, public safety, freight services, public safety inspection, insurance (worker compensation and other general liability) etc. are shared costs with the leverage in negotiation of the mega manufacturer with 20,000 workers. In additional all available financing assistance through local government economic development incentives, site improvement assistance and financing structures would be pursued to the extent appropriate.
- Target manufacturing businesses. The main focus would be the lower skilled jobs with the higher shipping and handling costs such as auto reclamation, parts remanufacturing (roughly 2,100 companies in U.S.A.), recyclers (about 3,000 companies in USA, 103,000 employees), return processing (or online sales return processing), data storage and processing center etc. Given the projected savings (from reduced shipping costs and shared services savings as well as possible governmental incentives), it would be very attractive to these companies to move to Upside Chicago.
- Sufficient workforce. More than sufficient supply of high-quantity, low-skilled and semi-skilled workers in Chicago area — the commutable area has at least 1.4 million workers.
- Attraction of industrial park. Companies can envision themselves in a clean, modern, safe, digitally wired, next generation industrial park opposed to being attracted to disparate (perhaps) degraded individual site. Park companies will bond with each other for the benefit of all. They will learn from each other with regard to workers, safety, security, environmental compliance, security, etc. The bundled economics benefits of Upside Chicago gives small companies the benefit of a larger enterprise and increased free time by reducing or eliminating time which would have been spent negotiating individually on shared services provided by the Park Manager.
Projected economic benefits of Upside Chicago concept. Upside Chicago and the goal of creating 20,000 new manufacturing jobs (with additional indirect and induced jobs) should over the long run:
- Create 44,000 jobs more or less (direct, indirect and induced job multiplier).
- Increase state and local taxes by $426 million or more.
- Help improve infrastructure and government services with increase tax revenues in addition to the Industrial Park site improvements and infrastructures.
- Produce an estimated economic benefit of the Industrial Park Program of over $8 billion.
The Pittsburgh story and recovery efforts:
- Between 1950 and 2000, Pittsburgh lost the same percentage of population as Detroit with similar adverse affects to its economy and financial condition. In the early 2000s, the City began a program of economic development and in December of 2003 initiated the use of Act 47 Pennsylvania’s municipal recovery plan process for financially distressed municipalities.
- Pittsburgh in 2003 was downgraded by Standard & Poor’s (“S&P”) five levels from A- to BB and other rating agencies took similar action. (Pittsburgh was AA in the 1960s and 1970s and dropped to A in 1981 and the A- in 1994.) This was the lowest rating of any major city at that time.
- In the 2000’s Pittsburgh began a campaign to increase job creation and employment in Pittsburgh. As a result, between 2004 to September 2013, Pittsburgh increased employment by 56,220 in such areas as technology, high tech, med tech and energy.
- In October 2013, S&P, after analysis of the City of Pittsburgh and efforts of stimulating its economy and creating new jobs, raised its rating on Pittsburgh debt from BBB to A, an increase three levels from the 2006 rating upgrade from BBB- to BBB.