Maritime Law Exemption: Exemption Provides Limited Competitive Advantage, but Barriers to Further Entry under U.S. Flag Remain
Published: 2004-02-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: No large U.S.-flagged cruise ships (ships registered in the U.S. that are U.S.-built, U.S.-owned, and U.S. crewed) are in operation. Foreignflagged vessels cruising to foreign ports serve most of the U.S. demand for cruises. However, Norwegian Cruise Line (NCL) recently obtained an exemption from U.S. maritime law to operate three foreign-built ships under the U.S. flag in Hawaii. Cruise lines and others have raised concerns over the advantage the exemption might confer to NCL, since foreign-flagged competitors are unable to offer the same itineraries due to the Passenger Vessel Services Act (PVSA), which prevents foreign vessels from transporting passengers solely between U.S. ports. Concerns have also been raised over the effect this exemption might have on future attempts to grow the U.S.-flag cruise vessel fleet, since potential U.S.-flag competitors would need to build ships in the United States, presumably at higher cost. GAO was asked to (1) review the original intent of the PVSA and rulings and decisions regarding it, (2) determine if the exemption will affect the implementation of the PVSA or other maritime laws, (3) assess the potential effects of the exemption on competition and entry into the U.S. domestic cruise market, and (4) assess the potential economic effects of granting other cruise lines similar exemptions. The Departments of Homeland Security and Transportation generally agreed with the findings in this report.
section_title: What GAO Found
paragraphs: The original intent of the PVSA, enacted in 1886, was to protect the U.S. maritime industry from foreign competition by penalizing foreign vessels that transport passengers solely between U.S. ports. However, several rulings and decisions interpreting the PVSA have allowed itineraries for foreign cruise vessels between U.S. ports that were previously restricted. For example, voyages by foreign vessels between two U.S. ports that include a distant foreign port, and round trip voyages from U.S. ports that include a nearby foreign port and other U.S. ports, do not violate the PVSA. NCL's exemption will likely have little impact on how the PVSA or other maritime laws are administered or interpreted because it is specific to three NCL vessels and cannot be applied to any other vessels in any other areas. The exemption effectively gives NCL a monopoly on interisland Hawaiian cruises--providing consumers with itineraries that were previously unavailable. However, NCL will likely have little power to raise prices on these itineraries because of competition from other vacation options. Because NCL is able to operate foreign-built ships in Hawaii, the exemption provides an additional obstacle for any potential U.S.-flag competitor to enter that market, since that competitor would need to build the ship in the United States at a higher cost. However, independent of the exemption, there were and still are other substantial obstacles for any potential U.S.-flag cruise vessel due to the higher capital and operating costs (e.g., labor costs) associated with the U.S. flag, as compared with existing foreign-flag cruise vessels offering itineraries through a foreign port. Granting additional exemptions to ease entry into the domestic trade could lead to benefits for port cities, U.S. seamen, and consumers; however, it is unclear how many cruise lines would choose to enter even if they were permitted to operate foreign-built ships under the U.S. flag, because of the higher operating costs associated with a U.S.-flag carrier operating in domestic itineraries and because of uncertain market conditions.

section_title: Letter
paragraphs: All of the passengers embarking on large cruise vessels from United  States ports, about 6.5 million in 2002, went aboard foreign cruise vessels.  The three major carriers in the cruise industry, Carnival Cruise Lines, Royal  Caribbean Cruises, Ltd., and Norwegian Cruise Line (NCL) are all foreign  corporations operating foreign-built vessels, registered under foreign flags  with predominantly foreign crews. Because trips from and between U.S.  ports that do not include a stop at a foreign port are prohibited for foreign- flag vessels, these vessels must include at least one foreign port in their  itineraries to serve consumers out of U.S. ports.
Wholly domestic itineraries are reserved for U.S. vessels by the Passenger  Vessel Services Act (PVSA) and U.S. vessel documentation laws. For  example, ferries providing transportation in U.S. ports and steamboats  providing service along the Mississippi are U.S.-built vessels, registered  under the U.S. flag. The PVSA penalizes foreign vessels that provide  transportation between U.S. ports, at $300 per passenger transported. U.S.  vessel documentation laws have established the requirements vessels must  meet in order to operate under the U.S. flag and operate in domestic trade.  These laws require that U.S.-flag vessels providing transportation between  two U.S. points must be U.S.-built, owned by U.S. citizens, and operated  with U.S. crews. However, no large U.S.-flag, overnight, ocean-going cruise  vessels are currently in operation, and no large passenger liners have been  built in the United States since 1958. American Classic Voyages, which filed  for bankruptcy in 2001, was the last company to operate large overnight  cruise ships under the U.S. flag, offering itineraries among the Hawaiian  Islands since the late 1970’s.
NCL was recently granted a legislative exemption from the U.S.-built  requirement of U.S. vessel documentation law to operate three foreign-built  cruise ships in limited domestic itineraries under the U.S. flag. These ships  must meet all other requirements to operate under the U.S. flag, including  U.S. ownership requirements and operating with a U.S. crew. NCL has  created a U.S. subsidiary, NCL America, to meet the U.S. ownership  requirements to operate U.S.-flag vessels in domestic trade. Because the  U.S.-built requirement is waived and the vessels will be operating under the  U.S. flag, these ships will be considered qualified to operate in the domestic  trade. These ships are therefore unaffected by the restrictions of the PVSA.  However, the exemption limits the markets these ships may serve. NCL is  required to keep the ships in “regular service” in Hawaii and is restricted  from using the exempted vessels for transporting passengers to ports in the  Caribbean, the Gulf of Mexico, or Alaska. NCL is scheduled to begin  service in Hawaii in July 2004.
Cruise line officials and others have raised concerns over the exemption.  The exemption potentially confers a market advantage to NCL, since other  foreign-flag competitors are unable to offer the same itineraries as NCL.  This exemption may also affect any future attempts to grow the U.S.-flag  cruise vessel fleet. As you requested, this report discusses (1) the original  intent of the PVSA and how rulings and decisions regarding the act relate to  its original purposes; (2) how the exemption provided to NCL may affect  the future implementation of the PVSA, U.S. vessel documentation laws, or  the Jones Act; (3) the potential effects of the exemption on competition in  the passenger cruise industry and entry into the U.S. domestic cruise  market under the U.S. flag, and the exemption’s broader economic effects;  and (4) the potential economic effects of granting other cruise lines similar  exemptions.
To address the original intent of the PVSA, rulings and decisions regarding  the act, and how the exemption might affect the future implementation of  the PVSA or other cabotage laws, we reviewed and analyzed the PVSA, its  amendments and legislative history, U.S. vessel documentation laws, the  exemption given to NCL, and other related laws, regulations,  administrative rulings, and judicial decisions. We also interviewed officials  from the Maritime Administration (MARAD), Customs and Border  Protection (CBP), and the U.S. Coast Guard responsible for implementing  and interpreting these laws and regulations. To address the potential  economic effects of the exemption on competition and entry, and the  potential effects of additional exemptions, we reviewed existing studies  examining competition and the economic impacts of the cruise industry;  and we also interviewed officials from cruise lines, cruise industry  associations, union organizations, and ports; representatives from the  shipbuilding industry; and other stakeholders. In addition, we analyzed  available data on capital and operating cost differentials between U.S.-flag  and foreign-flag cruise vessels to determine the extent to which foreign-flag  vessels have a cost advantage. Since most of these data are proprietary, we  were unable to independently verify them because we have no authority to  require access to the underlying data. However, we applied logical tests to  the data and found no obvious errors of completion or accuracy. Along  with our use of corroborating evidence, we believe that the data are  sufficiently reliable for our use. We conducted our work from August 2003  through February 2004 in accordance with generally accepted government  auditing standards. Appendix I contains more information about our scope  and methodology.
subsections: section_title: Background
paragraphs: Over time, cruising has developed into a highly concentrated industry with  three primary carriers. At the end of September 2003, two companies,  Carnival Cruises Lines and Royal Caribbean Cruises, Ltd., controlled 86.4  percent of the market in North America, with NCL being the next largest  cruise provider, holding a little less than 9 percent of the North American  market. (See fig. 1.)
These companies are foreign-owned and operate foreign-built vessels.  Carnival Cruise Lines is incorporated in Panama with its North American  ships flying the Bahamian or Panamanian flag. Royal Caribbean is a  Liberian corporation, with ships flying the Bahamian or Norwegian flag.  NCL is a subsidiary of Star Cruises, a Bermuda corporation headquartered  in Hong Kong, with its ships in North America flying the Bahamian flag.
While there are several U.S. companies in the cruise industry, such as  Disney and Radisson Seven Seas, these companies also elect to operate  foreign-built vessels under a foreign flag in order to operate under the same  capital and operating cost structure as their foreign competitors. Currently,  there are no large U.S.-flag cruise ships in operation, and no large new  cruise ships have been built in the United States since 1958. This use of  foreign-built ships is largely due to the higher costs anticipated when  building a ship in the United States, rather than in shipyards in Italy, Germany, and elsewhere that have the infrastructure, expertise, and  economies of scale for this segment of the market.
Over the past decade, several bills have been introduced into the U.S.  Congress with the objective of stimulating the development of a U.S.-flag  fleet and growth in the domestic cruise ship trade, the travel industry, and  port cities, although none have been enacted. Generally, these bills would  have allowed foreign ships either to operate in the domestic trade or to be  reflagged with the U.S. flag under certain specified conditions. For  example, the U.S. Cruise Vessel Act (S. 127), introduced in 2001, would  have allowed U.S.-owned, foreign-built cruise ships to enter the domestic  market for a limited time if the operators agreed to build replacement  vessels in the United States. This law was designed to allow new  companies to enter the domestic market with existing vessels and  immediately increase the size of the U.S. commercial fleet, thus providing  new jobs for merchant mariners. Under the proposal, these foreign-built  cruise ships would have been required to fully comply with all applicable  U.S. laws, regulations, and tax obligations.
Many federal agencies oversee U.S. maritime policy. For example, in the  Department of Transportation, the Maritime Administration’s (MARAD)  primary mission is to strengthen the U.S. maritime transportation system— including infrastructure, industry, and labor—to meet the economic and  security needs of the nation. MARAD also seeks to ensure that the United  States maintains adequate shipbuilding and repair services, efficient ports,  and effective intermodal water and land transportation systems. MARAD  programs are designed to promote the development and maintenance of an  adequate, well-balanced, U.S. merchant marine. MARAD originally  financed two of the ships that NCL will be operating in the Hawaiian  Islands through MARAD’s Title XI loan guarantee program under a project  known as “Project America,” that provided loan guarantees to help  construct two new cruise vessels for American Classic Voyages in a U.S.  shipyard for use in the Hawaiian Islands. Congress also granted American  Classic Voyages a monopoly in the Hawaiian market for the life of the  vessels. However, American Classic Voyages filed for bankruptcy in 2001,  and the partially completed hull of one ship and parts for the other were  purchased by NCL for $29 million. Subsequent to the purchase, NCL  obtained the exemption, allowing them to complete these ships in a foreign  shipyard and still operate them in Hawaii under the U.S. flag.
The Coast Guard and Customs and Border Protection (CBP), within the  Department of Homeland Security, are generally responsible for  administering and enforcing maritime laws and U.S.-flag requirements,  including the PVSA and U.S. vessel documentation laws, as well as the  Jones Act. The Coast Guard handles documentation requirements for  U.S.-flag ships—such as determining whether vessels meet the U.S.- ownership and crewing requirements in order to operate under the U.S.  flag—and U.S.-built requirements in order to operate in domestic trade.  Through this process the Coast Guard provides endorsements to vessels  defining the type of trade in which they are allowed to engage, e.g., foreign  trade, domestic trade, or fishing. The Coast Guard also conducts quarterly  inspections on all vessels embarking passengers at U.S. ports. CBP also has  a role in administering the PVSA, such as publishing rulings on the legality  of proposed itineraries. CBP also has civil enforcement authority under the  PVSA, with the ability to levy penalties on any passenger vessel operators  engaging in service in the domestic market without the relevant Coast  Guard endorsements. The current penalty that can be levied against a ship  operator for a violation of the PVSA is $300 per passenger.
The Federal Trade Commission (FTC) is responsible for ensuring that the  nation’s markets are vigorous, efficient, and free of restrictions that harm  consumers. The FTC exists to protect consumers by enforcing federal  consumer protection laws and conducting economic research and analysis  to inform all levels of government. In this regard, FTC conducted an  analysis of competition in the cruise market and the potential competitive  affects of a merger between two of the largest cruise lines and issued its report in October 2002. After FTC’s study of the cruise market, in April  2003, Carnival Corporation acquired P&O Princess Cruises. Prior to the  acquisition, Carnival Corporation was already the world's largest cruise  company; after the acquisition, Carnival Corporation became even larger,  with 13 separate brands, 66 cruise ships and 17 more on order, and  combined annual revenues of $6.9 billion.
section_title: Intent of PVSA Was to Protect U.S. Maritime Transportation Industry, but Rulings and Decisions Have Expanded Itineraries for Foreign Cruise Ships
paragraphs: In 1886, Congress passed the PVSA to protect the U.S. domestic maritime  transportation industry from foreign competition. To provide this  protection, it penalizes foreign vessels that transport passengers solely  between U.S. ports. Many cruises provided by foreign vessels are to  international destinations and, therefore, are not affected by the PVSA;  however, several rulings and decisions interpreting the PVSA have  expanded possible itineraries for foreign cruise vessels between U.S. ports  that were once restricted. For example, rulings and decisions have found  circumstances where voyages between two U.S. ports by foreign vessels do  not violate the PVSA when the primary purpose of the voyage is to visit  foreign ports. In addition, rulings and decisions have allowed foreign  vessels to visit several U.S. ports on an itinerary, so long as a foreign port is  included and the vessel disembarks its passengers at the port of  embarkation. In these circumstances, the voyages in question are not  considered to be domestic transportation between two U.S. points.
subsections: section_title: Original Intent of the PVSA Was to Preserve and Protect the U.S. Domestic Maritime Industry
paragraphs: The PVSA was originally designed to prevent U.S.-based vessels from  facing strong competition in the domestic transportation market from  maritime nations, such as Great Britain and Canada. Specifically, there was  a concern about competition from Canadian vessels that were transporting  passengers across the Great Lakes. The PVSA originally stated “no foreign  vessel shall transport passengers between ports or places in the United  States, either directly or by way of a foreign port, under a penalty of $2 for  each passenger so transported and landed.”  Congress originally thought  that the $2 penalty per passenger would discourage this practice.
Some industry associations and U.S. courts view the PVSA, U.S. vessel  documentation laws, and the Jones Act, as serving other purposes,  including providing a ready fleet in times of national defense, sustaining a  U.S. merchant marine, and supporting the U.S. shipbuilding industry. U.S.  courts have said that the PVSA and the Jones Act have helped to secure the  national defense by maintaining, “a merchant marine of the best equipped  and most suitable types of vessels sufficient…to serve…in time of war or  national emergency.” Because vessels in the domestic trade must be U.S.- crewed, labor groups view the laws as protecting jobs for the U.S.  merchant marine. According to data supplied by MARAD, over 1,000  passenger vessels are operating under the U.S. flag, employing U.S.  seamen, including ferries, steamboats, and small cruise vessels; however,  the last large U.S.-flag overnight cruise vessels ceased operations when  American Classic Voyages declared bankruptcy in October of 2001. In  addition, because the PVSA and the Jones Act protect the domestic  maritime transportation market for U.S.-built ships, they also support U.S.  shipyards. While several U.S. shipyards routinely build passenger vessels  for U.S.-flag operators such as ferry operators and steamship operators,  U.S. shipyards have not built large overnight, ocean-going cruise ships, and  the last large passenger liner built in the United States was completed in  1958.
section_title: Legal and Administrative Rulings and Decisions Have Expanded Itineraries Foreign Vessels Can Operate
paragraphs: Several administrative rulings and judicial decisions have identified limited  exceptions to the PVSA that allow certain vessel operations between U.S.  ports by foreign passenger vessels. One significant decision—which has  allowed passenger travel between U.S. ports by foreign vessels as long as a  distant foreign port is included—was a 1910 Attorney General opinion. This  opinion states that an around-the-world cruise that started in New York and  touched numerous foreign destinations and ended in San Francisco did not  violate the PVSA because the voyage could not be considered domestic  trade. The Attorney General made this determination on the supposition  that the purpose of the trip was not to travel from one U.S. port (New York)  to another (San Francisco), but to travel to different locations around the  world. In 1940, a federal court also found that the transportation of  passengers on a foreign vessel from New York to Philadelphia that stopped  in a foreign port was not “detrimental to the coast wise monopoly sought to  be assured to U.S. vessels.” The court said this was not a violation of the  PVSA because the vessel, which was originally scheduled to return to New  York, was forced to dock at the Philadelphia port because it was carrying  perishable cargo, requiring passengers to disembark in Philadelphia. The  court found that it was not the purpose of the trip to transport passengers  from New York to Philadelphia.
Two regulations and rulings by CBP have also contributed to expansion of  the number and variety of itineraries in which foreign-flag vessels can  engage, from and between U.S. ports. First, based on the 1910 Attorney  General Opinion, CBP, in its regulations, interprets the PVSA to allow a  foreign vessel to embark passengers at one U.S. port and disembark  passengers at a different U.S. port, so long as the vessel makes a port of call  at what the regulations define as a “distant foreign port,” such as Aruba or  Curacao. Second, a 1985 CBP regulation allows round-trip cruises from a  U.S. port, that touch on a “nearby foreign port”—defined by the regulation  as such places as Canada, Mexico, or Bermuda—to visit other U.S. ports  and allow passengers to go ashore temporarily, as long as they return to the  ship. For example, foreign vessels can embark passengers in New York,  make a quick stop in Canada or Bermuda, then cruise to several other U.S.  ports and return to New York without violating the PVSA. CBP’s decision to  allow these types of itineraries was based on the supposition that the PVSA  put some U.S. ports at a disadvantage in competition for tourist business.  In its response to opposing comments, CBP stated that it is “of paramount  importance in this area to consider the primary object of passengers in  taking a voyage,” citing both the 1910 Attorney General Opinion and the  1940 court case as the authority for doing so. Table 1 summarizes these key  rulings and decisions regarding the PVSA.
section_title: Interpretation and Enforcement of the Exemption Will Likely Have Little Impact on the Implementation of the PVSA and Other Related Laws
paragraphs: The exemption granted to NCL to be able to operate in Hawaii will likely  have little impact on how the PVSA, U.S. vessel documentation laws, or the  Jones Act are implemented by CBP and the Coast Guard. NCL’s exemption  is from the U.S.-built requirement of U.S. vessel documentation laws, which  allows NCL to operate foreign-built ships under the U.S. flag in limited  domestic itineraries. Therefore, the PVSA will not apply to these vessels, as  the PVSA only penalizes foreign vessels carrying passengers between U.S.  ports. In addition, the Coast Guard deals with vessels on a case-by-case  basis; and this exemption is specific to NCL’s three vessels and cannot be  applied to any other vessels in any other trades. Furthermore, although  Congress has enacted several specific exemptions to the PVSA, allowing  foreign vessels to serve particular regions of the United States; no previous  exemption has had an impact on the implementation of any other related  laws. Exemptions have also been allowed under the Jones Act with no  corresponding impact on the PVSA.
subsections: section_title: The NCL Exemption Did Not Amend the PVSA but Is an Exemption from the U.S.- Built Requirement of Vessel Documentation Laws
paragraphs: In 2003, Congress effectively gave NCL an exemption from U.S. vessel  documentation laws in order to operate certain foreign-built passenger  vessels in a limited domestic area. Specifically, NCL is allowed to operate  the two Project America vessels completed in a foreign shipyard and to  reflag one additional foreign-built ship under the U.S. flag, in “regular  service” in Hawaii. These ships are not required to meet the U.S.-built  requirement in order to provide service in these limited domestic  itineraries and are considered qualified for this purpose; therefore, they are  not subject to penalties under the PVSA, since the PVSA only applies to  foreign vessels carrying passengers between U.S. ports.
The exemption requires that NCL operate these ships in regular service, as  defined in the exemption as the “primary service in which the ship is  engaged on an annual basis,” between the islands of Hawaii and specifically  prohibits NCL from transporting paying passengers to ports in Alaska, the  Gulf of Mexico, or the Caribbean. There may be some ambiguity on what  NCL’s obligations are for providing regular service to the Hawaiian Islands,  as the exemption was silent on service to the East and West coasts, and  therefore NCL is not prohibited by the exemption from providing some  service to these destinations, as long as the regular service requirement is  met. CBP officials declined to speculate on how the regular service  provision might be enforced if there is a challenge to the itineraries that  NCL operates. Several maritime lawyers we spoke with suggested this  requirement might be interpreted to mean that at least 51 percent of the  individual vessel’s operations must be conducted in Hawaii. NCL officials  told us, however, that their current plans are to use these vessels in the  Hawaiian Islands year round.
section_title: The NCL Exemption Should Not Affect Future Implementation of the PVSA, U.S. Vessel Documentation Laws, or the Jones Act
paragraphs: All of the allowances and restrictions of the exemption are specific to the  two Project America vessels and the additional vessel to be reflagged by  NCL and do not amend the PVSA or U.S. vessel documentation laws. Coast  Guard officials stated that they have already confirmed that the vessel NCL  has under construction, and the second vessel NCL intends to construct  abroad, are the vessels referred to in the exemption; and NCL has already  identified the vessel to be reflagged; therefore, the allowances of the  exemption apply only to the three vessels. Coast Guard and CBP rulings  regarding these laws are made on a case-by-case basis; and because the  exemption is unique to the identified vessels, it should create no precedent  on the implementation of these laws regarding other vessels. NCL’s  exemption does not allow for further exemptions for other foreign cruise  lines to be able to operate foreign-built vessels in Hawaii or anywhere else  in the domestic trade. Additional legislation would be required to allow for  any further domestic operations by foreign-built vessels.
In addition, this exemption will likely not have any legal impact on the  Jones Act and its restrictions on shipping cargo between U.S. points.  Although interest groups and labor organizations link the PVSA and the  Jones Act philosophically, as being parallel laws for passengers and cargo,  respectively, numerous amendments and changes have been made to each  law that have not affected the other. For example, in 1920, the PVSA was  modified to allow permits to be issued for the transport of passengers by  foreign vessels to or from Hawaii, which lasted for 2 years. Furthermore,  an exception to the PVSA was made in 1938 to allow for the transport of  passengers by Canadian vessels between the New York ports of Rochester  and Alexandria Bay. More recently, Congress passed the Puerto Rico  Passenger Ship Act, which allows vessels not qualified to engage in the  domestic trade to carry passengers between U.S. ports and Puerto Rico and  between Puerto Rico ports. None of these exemptions has had an impact  on transporting cargo, which would fall under the jurisdiction of the Jones  Act, or on justifying the transportation of passengers outside the specific  scope of the exemption. Furthermore, the rulings and decisions discussed  earlier that have allowed foreign-flag vessels to transport passengers from  and between U.S. ports, if a foreign port is visited, do not extend to freight  transportation. For example, a foreign ship can pick up passengers in New  York, travel to Paris and pick up passengers there, and return to Boston to  disembark the passengers without violating the PVSA; however, the same  ship cannot take freight cargo from New York, pick up additional cargo in  Paris, and drop off the cargo in Boston without violating the Jones Act.
section_title: Exemption Allows NCL to Offer Exclusive Domestic Itineraries and Creates an Additional Barrier to U.S.-Flag Entry, but It Could Generate Economic Benefits
paragraphs: The exemption allows NCL to offer exclusive all-domestic itineraries in  Hawaii because no other large U.S.-flag passenger ships currently offer  such service, and no other foreign-built ships can offer all-domestic  itineraries. However, despite this advantage, NCL will likely have limited  ability to exert pricing power on its exclusive itinerary because it will still  have to compete with other vacation options. In addition, NCL’s exclusive  right to operate foreign-built ships in U.S. domestic trade creates an  additional obstacle for any large cruise lines attempting to compete in the  domestic market under the U.S. flag. NCL is able to complete building the  ships abroad at a lower cost than they could be completed in the United  States, while any would-be entrant into the domestic market would have to  build a ship in the United States and would therefore face a higher capital  cost structure than NCL. However, prior to the exemption there were  already substantial barriers to U.S.-flag entrants into domestic trade due  not only to higher capital costs, but also to higher operating costs  associated with the U.S. flag. Potential economic benefits from the  exemption include expanded choice of cruise itineraries for consumers,  enhanced sustainability of competition in the industry, employment  growth, and generation of tax revenues. These benefits are contingent on  NCL’s continued U.S.-flag operations, which analysts speculate might not  be able to compete successfully with lower-cost, foreign-flag operations.
subsections: section_title: Exemption Gives NCL Exclusive Hawaiian Itineraries but Confers Limited Pricing Power
paragraphs: As previously mentioned, the exemption allows NCL the exclusive right to  operate certain foreign-built, U.S.-flag ships on wholly domestic Hawaiian  itineraries. No other large U.S.-flag passenger vessels currently operate in  domestic trade; and foreign-flag, foreign-crewed cruise ships cannot offer  wholly domestic itineraries because of the PVSA. Therefore, although the  exemption does not explicitly exclude any carriers from offering these  itineraries, no other carriers are able to offer the same itineraries. In  addition, prior to obtaining the exemption and prior to the bankruptcy of  American Classic Voyages, NCL already had an exclusive itinerary stopping  at Fanning Island, in the Republic of Kiribati, the closest foreign port to  Hawaii. NCL’s agreement with Fanning Island for exclusive access, which  lasts for a limited period, already gave NCL the ability to offer 7-day  Hawaiian cruises, not feasible for other cruise lines that must include a  farther foreign port, like Vancouver, Canada, or Ensenada, Mexico, which  are 4 to 6 days sailing time to Hawaii. Figure 2 compares NCL’s exclusive 7- day domestic itinerary, scheduled to be available in the summer of 2004,  with Hawaiian itineraries of foreign-flag vessels.
Because NCL has the ability to offer unique Hawaiian Island itineraries  without including foreign ports, NCL’s interisland cruises on its exempted  ships will allow cruisers to spend more daytime hours in ports than other  existing Hawaiian Island cruises. NCL’s proposed itinerary for wholly  domestic Hawaiian cruises includes 59 daytime hours in port; however,  NCL’s current 7-day cruise, which includes a stop at Fanning Island, offers  only 28 daytime hours in ports. In general, the greater number of hours in  port is seen as more appealing to consumers.
While NCL can operate exclusive itineraries, the exemption likely conveys  only limited pricing power to NCL, even in the absence of another cruise  line offering identical itineraries. According to a comprehensive cruise  market analysis conducted by the FTC in 2002, a single cruise itinerary  does not constitute a market; rather, competitive conditions should be  assessed in the context of a market that includes all vacation options or,  minimally, all other cruise options. Therefore, although no cruise lines will  compete directly on the domestic itineraries, NCL will continue to face  competition from comparable vacation options, such as land vacations and  similar cruises in different geographic areas. NCL will also compete with  foreign-flag vessels that operate with lower costs on other itineraries that  include Hawaii. Those foreign-flag vessels could offer a lower price than  NCL, which would make any theoretical attempt at a price increase by NCL  unsustainable.
One of the reasons for FTC’s broad market definition is its finding that  cruise passengers are highly sensitive to price changes. In other words, an  attempt by a cruise line to raise prices above competitive levels likely  results in significantly fewer bookings. NCL anecdotally confirmed this  finding, citing a decline in its bookings following an attempt to raise prices  by about 3 to 4 percent on its 2003 Norwegian Star, 7-day Hawaiian-Fanning  Island itineraries—which had no competition from any other cruise line on  the same itinerary—after showing strong sales during 2002. From the  outset, over a year from sailing dates, sales were slower than in 2002 for the  same cruise, and NCL was forced to reduce its prices to fill the ship,  resulting in approximately 8 percent lower revenue yields by the sailing  date on the 2003 cruises compared with the 2002 cruises.
section_title: Exemption Adds to Existing Barriers for Potential U.S.- Flag Market Entry
paragraphs: NCL has a large capital cost advantage over potential competitors, who  might attempt to build ships entirely in the United States for operation  under the U.S. flag because the exemption permits NCL to complete  construction of its U.S.-flag ships in a foreign shipyard at a lower cost than  a comparable ship built in a U.S. shipyard. Unless they also receive an  exemption from the U.S.-built requirement, cruise lines entering the  domestic market would have to build their ships in U.S. shipyards or  refurbish an existing U.S. built vessel overseas. Such building costs, based  on estimates from Project America, compared with contract costs for  foreign-built ships, would likely be much higher. For example, we  compared the contract cost to construct the first Project America ship with  the total projected cost for NCL’s Pride of America, built from the partially  U.S.-built hull of the first Project America ship now being completed  overseas. The Project America contract cost was between 35 and 54  percent, or $140 to $190 million, higher than total cost projections to  complete the Pride of America in a German shipyard, as shown in figure 3.  The disparity is likely even larger because the actual costs of the Project  America ships were expected to exceed the contract costs. Incorporating  adjustments to the Project America contract costs, the cost differential  ranges from 71 to 95 percent higher, or $284 to $334 million higher.
Cruise officials and shipbuilders state that U.S. construction costs are  higher than foreign construction costs because U.S. shipyards have not  developed technical capability, a reliable supply chain, and economies of  scale to build cruise ships competitively. According to one shipbuilder we  spoke with, while U.S. shipyards are experienced at building complex  cargo and military vessels, cruise ships require wholly different  construction techniques; and U.S. shipyards have not developed certain  technical capabilities. One official asserted that U.S. shipyards might  become competitive if they partner with foreign shipyards to learn the  latest technology. In addition, officials from the American Shipbuilders  Association acknowledge that, while U.S. shipyards currently have the  ability to build the hull and superstructure of a cruise ship, unlike  European shipbuilders, U.S. shipbuilders do not have established and  reliable supply chains for certain materials and other structures on a  cruiseship, which are critical to efficient and timely completion of  cruiseships. These officials said that they expect that the capital cost  differential would be negligible if the U.S. shipbuilding industry grew and  realized economies of scale; however, such growth seems unlikely given  the current lack of demand for U.S.-built cruise ships and concerns about  technical capabilities and undeveloped supply chains. Moreover, ships  must be built in order for economies of scale to be realized, so the first  ships that would have to be built for any would-be U.S.-flag operation will  likely have higher capital costs than NCL’s vessels.
While the exemption affords NCL a capital cost advantage over would-be  entrants, acquiring financing for U.S. ship construction may not be any  more difficult because of the exemption. In theory, financiers would be less  willing to provide financing for capital costs to an operator who will  compete in a market with an existing competitor who has a lower capital  cost structure. However, industry financial analysts we spoke with said that  acquiring financing was equally difficult prior to the exemption because of  the presence of competing lower-cost, foreign-flag cruise lines and would  not necessarily be more difficult once NCL begins providing U.S.-flag  service in the Hawaiian Islands. Furthermore, an official from the Office of  Ship Financing within MARAD said that, while theoretically the NCL  presence in the U.S. domestic market could affect decisions about  applications for new vessels, they have not seen and do not expect to see  any impact from the NCL exemption. They said that they receive so few  applications for large cruise ships that they are unable to determine if the  number of applications has declined because of the NCL exemption.  Furthermore, no applications for financing of large cruise ships have been  denied or withdrawn because of the NCL exemption or NCL’s expected  presence in the U.S. domestic market.
Prior to the NCL exemption, cruises offered by lower cost foreign-flag  vessels already limited the likelihood of cruise lines entering the domestic  market. With the possible exception of Hawaii, the close proximity of  foreign ports-of-call in Canada, Mexico, Bermuda, and the Caribbean  allows foreign-flag ships to serve U.S. cruise demand without meeting the  requirements of operating under the U.S. flag and adding significant time or  fuel costs to the voyages. Figure 4 shows examples of cruise itineraries  between U.S. ports that foreign-flag vessels can offer. The availability of  foreign-flag service on U.S. itineraries that include a foreign port-of-call  reduces the likelihood that potential U.S.-flag carriers can offer competitive  prices because U.S.-flag ships have higher capital and operating costs than  foreign-flag ships. In addition to higher ship construction costs discussed  earlier, according to an industry trade organization, wage costs on U.S.-flag  ships could range between 30 and 100 percent higher than wage costs for a  similar foreign-flag ship due to compliance with U.S. labor laws that require  minimum wage, overtime compensation, payment of social security tax,  and protection and indemnity coverage, which do not apply to foreign-flag  vessels. According to NCL officials, wage costs for their U.S.-flag  operations will be 100 to 150 percent higher than wage costs for their  foreign-flag operations. Cruise officials also stated that due to regulations  pertaining to overtime and labor requirements for U.S. seafarers, they  would likely have to hire more U.S. workers at higher wages to serve the  same number of passengers. Finally, U.S.-flag ships are liable for corporate  income taxes, while foreign-flag ships typically incorporate in countries  where their income is tax-exempt, resulting in an additional cost advantage  for foreign vessels. See appendix II for additional information on laws that  apply to U.S.-flag ships.
section_title: Potential Economic Benefits May Result from the Exemption
paragraphs: Several economic benefits might be generated as a result of NCL’s  exemption. These benefits include expanded consumer choice, continued  competition in the industry, employment growth and generation of tax  revenues.
subsections: section_title: Exemption Generates New Cruise Itineraries for Consumers
paragraphs: The exemption expands consumer choice by allowing NCL to offer  previously unavailable cruise itineraries. Hawaiian interisland cruises  without a foreign port-of-call have not been available to potential cruisers  since 2001, when American Classic Voyages filed for bankruptcy. As  previously noted, following the exemption, NCL will operate exclusive  interisland Hawaiian cruises on certain U.S.-flag ships. These new  interisland cruises will be provided by cruise ships offering many of the  amenities previously available only on foreign-flag ships.
section_title: Exemption Could Improve NCL’s Competitive Position in the Highly Concentrated Cruise Industry
paragraphs: The exemption could improve NCL’s position relative to its competitors in  the highly concentrated North American cruise market. According to  MARAD data from July to September of 2003, Carnival and Royal  Caribbean control a combined 86.4 percent of the North American cruise  market, while NCL is the third largest firm with 8.8 percent of the market.   NCL’s ability to offer unique domestic itineraries, primarily in Hawaii,  affords NCL an opportunity to further differentiate itself from its primary  competitors. NCL’s differentiation is important because it provides travel  agents with an incentive to sell NCL’s products. Officials from the American  Society of Travel Agents and cruise lines agree that recommendations by  travel agents play a significant role in determining which cruises customers  choose to buy. While the share of airline and land vacation purchases made  through travel agents has declined in recent years, travel agents still sell  approximately 90 percent of all cruises. If NCL only offered the same  itineraries as Carnival and Royal Caribbean, travel agents may have an  incentive to discontinue sales of NCL products, because travel agents are  paid commissions that often increase with the number of cruises sold on a  particular cruise line. Without travel agents endorsing its products, NCL  could have difficulty competing with Carnival and Royal Caribbean.  However, the unique Hawaiian cruise products that NCL can now offer help  NCL to continue to be the third major firm in the market. If there are only  two major players in a market, there is a much higher probability of the two  firms coordinating higher prices, thus hurting consumers. The recent  acquisition of P&O Princess Cruises by Carnival Corporation resulted in a  reduction from four major competitors to three. The FTC’s decision to not  challenge the merger stated that a reduction from three to two major  competitors would likely be more problematic for consumers.
section_title: Other Potential Effects of the Exemption Include Employment Growth and Tax Revenues
paragraphs: NCL’s operations resulting from the exemption will create jobs on the  exempted ships and where it offers itineraries, and they will likely increase  tax revenue. According to NCL’s analysis of the Hawaiian market, its  expanded operations will generate about 2,400 full-time shipboard jobs and  additional shoreside employment in Hawaii. This estimate seems  reasonable, because NCL must hire at least 800 U.S. employees per ship for  three ships, as well as additional land-based employees. Some of these jobs  might be transfers of jobs from other states to Hawaii and, thus, would not  represent new benefits to the U.S. economy. An NCL consultant estimates  total annual tax revenues from the exemption operations to be $126.5  million, including employee income taxes and social security taxes, airfare  taxes, and customs, immigration and ship passenger taxes. In addition,  NCL’s U.S. subsidiary, NCL America—which will operate the exempted  ships in order to meet the U.S.-ownership requirements needed to register  the vessels under the U.S. flag—will be liable for corporate income taxes  on any profits it earns; and it will be subject to the payment of employer  payroll taxes in Hawaii.
NCL estimates passenger expenditures will bring an additional $355 million  annually to the regions where NCL operates. This value assumes that all  vessels operate at full capacity. These passenger expenditures represent a  net benefit to the U.S. economy only when these passengers choose the  domestic NCL cruise over a foreign vacation or other foreign spending. To  the extent that the passengers’ alternatives were a different U.S. vacation  or other discretionary spending in the United States, then this expenditure  figure only represents a transfer of revenues to the region where the cruise  is operating from other U.S. regions.
section_title: Realization of Economic Benefits Is Largely Contingent on NCL’s Continued U.S.-Flag Operations
paragraphs: Most of the benefits described above will materialize only if NCL continues  to operate cruise ships under the U.S. flag. However, as noted above,  industry analysts question NCL’s ability to operate the interisland Hawaiian  cruises profitably. Analysts speculate that these cruises might not be  profitable since they will still have to compete with foreign-flag cruises  with significantly lower operating costs than NCL, though on different  itineraries. Analysts also expressed concern that NCL is deploying too  much capacity for the uncertain Hawaiian market demand. According to  Cruise Lines International Association, Hawaiian cruises generated only  about 3 percent of the business in the North American cruise market in  2002. NCL plans to grow the Hawaiian market by 23 percent each year for  the next 5 years, resulting in Hawaiian destinations comprising 6 percent of  the North American cruise market by 2007. This plan is quite aggressive,  considering that industry trade groups expect the cruise market in general  to grow 10 percent each year. If NCL is not profitable operating the  exempted vessels in the United States, analysts speculate that NCL will  seek government approval to reflag the vessels and operate them in foreign  trades. NCL could continue to serve the Hawaiian market with the  reflagged vessels, if the itinerary included a stop at Fanning Island or  another foreign port. In this case, the exclusive interisland cruise options  for consumers would no longer be offered, jobs for U.S. crew and the  associated tax revenue would be lost, and NCL would not be liable for U.S.  corporate income tax. In addition, if NCL is unable to operate successfully  under the U.S. flag in Hawaii, possibly the most desirable market protected  under the PVSA, there will be further disincentive for any other cruise line  to attempt to operate under the U.S. flag, thus limiting the potential  development of the U.S.-flag cruise vessel fleet.
section_title: Unclear if Granting Other Cruise Lines Similar Exemptions Would Lead to Entry by Other Cruise Lines and Resulting Economic Benefits
paragraphs: Granting similar exemption to ease entry into the domestic trade could lead  to additional benefits for ports and port cities, the merchant marine and  consumers; however, it is unclear how many cruise lines would choose to  enter if they were permitted to operate foreign-built ships under the U.S.  flag. For certain unique itineraries, where foreign vessels cannot easily  operate with a nearby foreign port, such as in Hawaii, one-way cruises in  Alaska, or short 3 to 4-day itineraries on the east or west coasts, some  potential exists for U.S.-flag ships to enter the market. However, there are  substantial disincentives to operating under the U.S. flag due to (1)  operating cost differentials between the would-be U.S.-flag entrant and  foreign-flag ships that still offer somewhat similar itineraries, but include a  foreign port, (2) labor conditions and ship requirements, and (3) uncertain  market conditions. Moreover, entry from additional ships exempt from the  U.S.-built requirement could have a negative impact on the U.S.  shipbuilding industry and small U.S.-flag cruise ships, though these impacts  are likely to be minimal if the U.S.-built requirement is waived only for large  cruise ships.
subsections: section_title: Additional Benefits Could Result from More Entry into the Domestic Markets
paragraphs: Ports and port cities, the merchant marine, and consumers could benefit if  additional exemptions to the U.S.-built requirement led to new entrants  providing U.S.-flag cruise service. Additional domestic cruises could create  more activity for the ports and result in more jobs and increased spending  in port cities. U.S.-flag ships also would employ U.S. seamen, adding to the  base of trained maritime employees who could serve the country in a time  of emergency. Moreover, potential entrants could offer more cruise options  and new itineraries to consumers. For example, a 1997 study conducted for  the California State Tourism Board found that with similar exemptions to  operate foreign-built vessels under the U.S. flag, cruise lines could offer  cruise itineraries on the California coast to smaller ports, such as Santa  Barbara and Monterey, resulting in more tourist dollars in those areas.  However, if new domestic cruises primarily replaced existing foreign-flag  service, with minor itinerary changes caused by eliminating foreign ports- of-call, the benefits to ports, port cities and consumers might be minimal.  On the east coast, for example, Carnival currently offers cruises on a  foreign-flag ship—round-trip from New York including stops in Boston,  Massachusetts; Portland, Maine; and Canada. If U.S.-flag vessels replaced  the foreign-flag vessels offering east coast cruises and had itineraries  running from New York to Portland without the stop in Canada—but  including the same ports-of-call as the former Carnival cruise—ports, port  cities and consumers would experience very little additional benefit from  these cruises. Additional cruises to U.S. ports that foreign-flag vessels  continue to serve and cruises to different U.S. ports than foreign-flag  vessels currently serve are the only source of benefits to ports, port cities,  and consumers.
section_title: Even with Exemptions from the U.S.-Built Requirement, Other Substantial Barriers to Entry Might Limit the Number of Potential Entrants into the Domestic Cruising Market
paragraphs: While some potential benefits exist, industry officials said that most cruise  lines are not likely to enter the domestic market, even if they could build  ships outside of the United States because of operating cost differentials,  different ship standards, and uncertain market conditions. As previously  noted, U.S.-flag operating costs are significantly higher than foreign-flag  operating costs. The wage differential is so great that an official from one  cruise line stated that the cruise line would prefer to employ foreign  workers for any non-U.S. domestic itineraries offered on a U.S.-flag ship.
The official noted that it would be difficult to hire a separate seasonal U.S.  crew to work on a U.S.-flag ship, which may operate domestic itineraries  only at certain times of the year. U.S.-flag cruise ships also must meet U.S.  building standards, which sometimes conflict with international standards.  For example, an industry official cited different wiring configurations  required on U.S. ships. One cruise line official stated that the cruise line he  represents would not specially build a ship to comply with U.S. standards  only to be able to operate the ship in domestic trade, given the existing  operating cost differentials. Furthermore, cruise officials and industry  analysts question whether U.S.-flag operations can be profitable since  lower cost foreign-flag ships can serve similar itineraries and demand is  unknown for domestic destinations.
Despite all the expected difficulties and disadvantages, representatives of  two cruise lines said they would explore entry into some domestic markets  if they were given exemption from the U.S.-built requirement. According to  these representatives, they would consider testing the Alaskan and  Hawaiian markets, and short coastal cruises because of their unique  attributes. In Alaska, one-way cruises are popular and currently cannot be  offered from a U.S. port, such as Seattle, due to the PVSA. In Hawaii, the  nearest foreign port adds at least 2 days of sailing time to the itinerary.  Short coastal cruises on the east or west coasts are attractive because  including a foreign port would lengthen the cruise.
However, even these attractive markets have factors deterring U.S.-flag  operations. Foreign-flag ships currently serve the one-way Alaskan trade  embarking in Vancouver. These operators would still have a competitive  advantage over U.S.-flag operators granted an exemption from the U.S.- built requirement and operating out of Seattle. While consumers might face  an added land transportation cost to depart from Vancouver rather than  Seattle, foreign-flag operators would continue to have a significant  operating cost advantage over U.S.-flag ships and thus might offer lower  prices. The price advantage of the foreign-flag ships is likely to offset the  cost disadvantage to consumers of departing from Vancouver. Moreover,  according to one industry analyst, the Port of Vancouver might respond to  potential competition from the Port of Seattle by lowering its port fees to  retain firms operating less costly foreign-flag ships.
Hawaii’s long distance from most foreign ports creates an especially  attractive opportunity for entry under the U.S.-flag, but potential  competitors would have to compete with an established operator, NCL, for  unknown demand. In addition to NCL’s ability to offer wholly domestic  cruises in Hawaii with the exemption, it has had an exclusive arrangement  for its ships to stop at Fanning Island, the closest foreign port to Hawaii.  With this exclusive agreement NCL has been able to garner the largest  market share of the Hawaiian trade. NCL intends to run three U.S.-flag  ships and one foreign-flag ship regularly in Hawaiian itineraries. As noted  previously, some industry analysts do not think consumers in the Hawaiian  market can support NCL’s capacity increase; therefore, success might be  difficult for any additional companies entering the market. In fact, one  cruise line we spoke with is uncertain about continued operations, given  the sales performance of its initial entry into the Hawaiian market.
Finally, while short 3- or 4-day cruises along the east or west coasts of the  United States may hold some attraction for would-be entrants, these  cruises could still face lower cost competition from foreign vessels offering  similar itineraries with a foreign port included. In addition, while there are  some smaller U.S. passenger vessels offering short coastal cruises, the  potential demand for these cruises may not be substantial enough to  sustain large cruise ships.
section_title: Similar Exemptions Could Negatively Affect U.S. Shipbuilding Industry and Small Passenger Vessels
paragraphs: Granting other cruise lines exemptions to the U.S.-built requirement  without strict tonnage requirements could negatively affect the U.S.  shipbuilding industry. If exemptions were granted only for large, overnight  cruise vessels, the U.S. shipbuilding industry would face little, if any,  impact given that no such ship has been completed in the United States  since 1958. However, if the exemptions were broader, including small  passenger ships, U.S.-flag operators of small cruise ships might purchase  less expensive ships from foreign shipyards, exposing U.S. shipyards to  foreign competition that is not subject to the same laws, regulations, and  taxes.
Another potential adverse effect of similar exemptions is the shift of  passengers away from small U.S.-flag cruise lines to domestic cruises on  larger U.S.-flag ships built in foreign shipyards. Small U.S.-flag vessels are  built in the United States and operate under all U.S. laws. A major shift in  their customer base could disrupt this segment of the cruise industry and  negatively affect the shipyards that build these small vessels. However,  industry analysts suggest that there is a very small likelihood that similar  exemptions would affect the small cruise vessels because they serve  different segments of the market. Small vessel operators view their  products as boutique cruises, as compared to mass-market cruises on large  vessels. These boutique cruises are often shorter voyages, including calls in  small ports that large cruise ships cannot access due to their size.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided the Departments of Homeland Security and Transportation  with draft copies of this report for their review and comment. Both  departments generally agreed with the findings in the report and provided  technical clarifications, which we incorporated as appropriate.
We are sending copies of this report to the appropriate congressional  committees and to the Secretaries and other appropriate officials of the  Departments of Homeland Security and Transportation. We also will make  copies available to others upon request. In addition, the report will be  available at no charge on the GAO Web site at http://www.gao.gov.
If you have any questions about this report, please contact me at  heckerj@gao.gov or at (202) 512-2834. Additional GAO contacts and  acknowledgments are listed in appendix III.
section_title: Scope and Methodology
paragraphs: To address the original intent of the Passenger Vessel Services Act (PVSA)  and how pertinent rulings and decisions have affected the implementation  of the law, we reviewed the PVSA, its amendments, and its administrative,  legislative and judicial history. We also reviewed several listings in the  Customs Rulings Online Search System to see how the PVSA is currently  interpreted and we conducted interviews with officials from Customs and  Border Protection (CBP) and the Coast Guard responsible for  documentation of U.S. vessels and for enforcing the provisions of the  PVSA, U.S. vessel documentation laws, and the Jones Act.
To ascertain how the exemption provided to NCL might affect future  rulings or interpretations on the PVSA, U.S. vessel documentation laws, or  the Jones Act, we researched the legislative history of the PVSA, its prior  amendments and exemptions, and pertinent CBP rulings to determine what  impact they had on future rulings regarding the PVSA or the Jones Act. We  also reviewed rulings regarding the PVSA to determine if any amendments  of exemptions provided for under the Jones Act had any impact on them.  Finally, we conducted interviews with agency officials about the  implementation of maritime laws.
To determine the potential effects of the exemption on competition in the  passenger cruise industry, entry into the U.S. domestic market, the  exemption’s broader economic effects, as well as the potential effects of  granting similar exemptions, we reviewed studies on the economic impact  of the cruise industry and competition in the industry and conducted  interviews with officials from several cruise lines, industry associations,  and a full range of cruise industry stakeholders, analysts, and experts. To  understand the nature of competition in the industry, we reviewed a merger  analysis conducted by the Federal Trade Commission (FTC) in 2002 that  examined, in-depth, competitive conditions in the North American cruise  industry. We also interviewed officials and reviewed internal documents  from cruise lines, including Norwegian Cruise Line, Carnival Cruise Lines,  Royal Caribbean Cruise Lines, Radisson Seven Seas Cruises, Crystal  Cruises, the former American Classic Voyages, and CruiseWest to get their  perspectives on the nature of competition in the industry, the effects of the  exemption on competition, and the potential of various domestic  itineraries. We also spoke with several port authorities, individual U.S.  shipyards, and industry financial analysts for further information on the  broader economic effects of the exemption and the potential effects of  granting similar exemptions. In addition, we gathered information on the  capital and operating costs of foreign-flag vessels as compared with U.S.- flag vessels. Since most of these data are proprietary, we were unable to  independently verify them because we have no authority to require access  to the underlying data. However, we applied logical tests to the data and  found no obvious errors of completion or accuracy. Along with our use of  corroborating evidence, we believe that the data were sufficiently reliable  for our use.
To analyze the effects of the exemption on the potential for entry into the  U.S. domestic market, we spoke with industry financial analysts and  experts, including officials at American Marine Advisors, G.P. Wild, and J.P.  Morgan Chase to obtain perspectives on whether financing for a U.S. built  vessel would be more difficult to obtain now that the exemption has been  granted. We also spoke with officials within the Maritime Administration to  ascertain whether applications or approvals for federal loan guarantees for  building large passenger vessels had waned or would be more difficult to  obtain as a result of the exemption. We also spoke with officials from the  cruise lines and an official representing smaller U.S.-flag vessel operators  to get their perspectives on the potential for entry into the U.S. domestic  cruise market. To determine the extent of NCL’s capital cost advantage  under the exemption, we obtained estimates of the final cost to build the  first of the exempted vessels from the General Disclosure statement under  the Stock Exchange of Hong Kong of Star Cruises Limited, NCL’s parent  company. We were unable to independently verify these costs because we  have no authority to require access to the underlying data. However, we  confirmed the accuracy of these figures with officials within NCL and  through comparing the figures to publicly available data on the costs of  vessels of similar size completed for other cruise lines. We then compared  these costs to the original project costs to build the Project America vessels  in a U.S. shipyard. We converted all figures to 2003 dollars using the  producer price index for ship and boat building and repairing prepared by  the Bureau of Labor Statistics.
We also obtained additional perspectives on the potential economic effects  of the exemption and of possible additional exemptions from various  industry associations, including the International Council of Cruise Lines,  Cruise Lines International Association, the Passenger Vessel Association,  the American Shipbuilding Association, and the American Society of Travel  Agents, as well as officials from the Maritime Cabotage Task Force, the  Maritime Trades Departments of the AFL-CIO, American Maritime Officers,  and the Seafarers International Union.
We conducted our work from August 2003 through February 2004 in  accordance with generally accepted government auditing standards.
section_title: Other U.S. Laws Applicable to U.S.-Flag Vessels on Wholly Domestic Cruises
subsections: section_title: NCL’s Operations Will Subject Them to the Application of U.S. Tax, Labor, and Other Laws Unlike Other Foreign Cruise Lines that Serve the United States
paragraphs: Since NCL’s vessels will be undertaking domestic travel under the U.S. flag,  NCL will subject itself to numerous other U.S. laws in the areas of tax,  labor, immigration, environment and the Americans with Disabilities Act.  These U.S. laws do not usually apply to foreign-flag cruise lines because  their itineraries are in international waters, either because they include a  distant foreign port if they are traveling between U.S. ports, or a nearby  foreign port if the voyage is a round trip from one U.S. port, and thus  international rather than U.S. laws apply.
subsections: section_title: NCL Will Be Subject to U.S. Taxation Laws
paragraphs: Because NCL’s U.S.-flag Hawaiian operations—operated by its U.S.  subsidiary NCL America—will be involved in domestic trade, income  derived from those operations would be taxable under the U.S. tax code.  The Internal Revenue Code has special rules for “transportation income.”   If the transportation income is attributable to transportation that begins  and ends in the United States, it is treated as income derived from sources  in the United States and therefore fully taxable. If the transportation begins  or ends in the United States, but not both, 50 percent of the transportation  income is treated as income derived from sources in the United States.  However, the Internal Revenue Code, under 26 U.S.C. 883, also excludes  from the gross income of foreign corporations income derived from the  international operation of vessels if their home countries grant an  equivalent exemption from paying taxes to U.S. corporations. Therefore,  the income earned from foreign-flag vessels operated by foreign  corporations operating cruises in the United States may not be subject to  U.S. corporate income tax.
section_title: NCL Vessels under the Exemption Will Be Subject to Several U.S. Labor Requirements
paragraphs: If NCL operates vessels in domestic trade, those vessels will become  subject to U.S. labor and documentation laws, which, among other things,  require that the officers and unlicensed seamen on a U.S.-flag ship to be  U.S. citizens or documented aliens with permanent residence in the United  States, and that the crew be subject to minimum wage and collective  bargaining laws. U.S. documentation laws under 46 U.S.C. 8103(a) require  that only U.S. citizens serve as the master, chief engineer, radio officer, and  officer in charge on a U.S. documented vessel. Also, each unlicensed  seamen must be a citizen of the United States except that not more than 25  percent of that number may be aliens lawfully admitted to the United States  for permanent residence. Under the Fair Labor Standards Act, minimum  wage laws would apply to the crew, and they would be allowed to engage in  collective bargaining under the National Labor Relations Act. In addition,  where applicable, higher state minimum wage laws would apply. For  example, U.S.-flag interisland Hawaii cruise operations will be subject to  the state’s $6.25/hour minimum wage, which is $1.10 higher than under  federal law. In addition, crewmembers on U.S.-flag vessels are subject to  tax at the federal, state, and local levels.
section_title: Foreign Cruise Ships Primarily Adhere to International Construction and Safety Standards Rather than U.S. Standards
paragraphs: NCL’s U.S.-flag ships will have to adhere to U.S. Coast Guard-approved  vessel construction and safety standards. As a general rule, foreign vessels  operating in U.S. waters need only comply with international construction  and safety standards, as opposed to the often more rigorous U.S. standards.  An international treaty, the Safety of Life at Sea Convention sets forth  international construction and inspection standards. A foreign vessel from  a country that is a signatory to the Convention, would be subject to U.S.  inspection only as to the vessel’s propulsion and lifesaving equipment.  Finally, according to several industry experts and representatives, the  application of the American’s with Disabilities Act could have significant  cost implications for vessels operating in the U.S. domestic trade because  of requirements to make the vessels handicap accessible. However, NCL  executives stated that these requirements would not add significant costs  to their ships, because even their foreign-flag ships adhere to high  standards in this regard.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: The GAO staff that worked on this report dedicate it to their late colleague,  Ryan Petitte, in recognition of the valuable contributions he made. Other  key contributors include Jay Cherlow, Michelle Dresben, Sarah Eckenrod,  Colin Fallon, David Hooper, Ron Stouffer, and Andrew Von Ah.
section_title: GAO’s Mission
paragraphs: The General Accounting Office, the audit, evaluation and investigative arm of  Congress, exists to support Congress in meeting its constitutional responsibilities  and to help improve the performance and accountability of the federal government  for the American people. GAO examines the use of public funds; evaluates federal  programs and policies; and provides analyses, recommendations, and other  assistance to help Congress make informed oversight, policy, and funding  decisions. GAO’s commitment to good government is reflected in its core values of  accountability, integrity, and reliability.
section_title: Obtaining Copies of GAO Reports and Testimony
paragraphs: The fastest and easiest way to obtain copies of GAO documents at no cost is  through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full- text files of current reports and testimony and an expanding archive of older  products. The Web site features a search engine to help you locate documents  using key words and phrases. You can print these documents in their entirety,  including charts and other graphics.
Each day, GAO issues a list of newly released reports, testimony, and  correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site  daily. The list contains links to the full-text document files. To have GAO e-mail this  list to you every afternoon, go to www.gao.gov and select “Subscribe to   e-mail alerts” under the “Order GAO Products” heading.
subsections: section_title: Order by Mail or Phone
section_title: To Report Fraud, Waste, and Abuse in Federal Programs
section_title: Public Affairs