Reforming the system of heavy subsidies for rural telephone service, which dates back to the Great Depression, has long been a topic of discussion for telecom policy wonks. The Universal Service program is proof-positive that subsidies grow like weeds. Universal Service has spawned a constituency of more than 1,000 small telephone companies who’ve waged a Jihad to preserve their entitlement.
Politicians have always found it expedient to look the other way. This may be changing. In recent years, wireless companies have set up shop in rural areas. Although their costs are generally far less than those of the incumbent wireline providers, one of the FCC’s brilliant “pro-competitive” policies bestows a subsidy for wireless service which is identical to the subsidy for wireline service that’s more expensive to provide. Cable companies who provide telephone service are also entitled to identical support. So guess what? As competing providers have demanded their fair share, the overall cost of Universal Service has exploded. Even some politicians are finding the size of the fund harder to ignore.
If it ever went to court, there could be a problem. Universal Service is really a tax, although it’s still officially classified as a user fee. The distinction is critical. Agencies can’t levy taxes. They must originate in the House of Representatives – and tax legislation is referred to the House Ways & Means Committee, which has never played an active role in telecom policy. (Note: To influence the Ways & Means Committee, you would need a different set of lobbyists – a scary prospect for many.)
FCC Chairman Kevin Martin has long advocated taking action, and now the FCC has issued three notices of proposed rulemaking for reforming this mess.
Identical Support
The Identical Support NPRM seeks public comment on basing every carrier’s subsidy on their own costs. Obviously, a good idea. Anna-Maria Kovacs, one of the best regulatory analysts, claims the idea appears to have the support of all five FCC commissioners. Unfortunately, the FCC may have torpedoed this initiative by loading the NPRM with questions about how to determine support. Actual costs? Forward-looking costs? There’s a rich history of telecom companies exaggerating their costs and regulators choosing to ignore legitimate costs for the purpose of reducing rates or limiting increases. This NPRM will be a slugfest.
Reverse Auctions
The Reverse Auction NPRM seeks comment on the idea of letting competing providers bid for the subsidy. The low bidder could get the entire subsidy for a particular serving-area. Wireline providers fear that wireless providers, with their inherent cost advantage, would capture the subsidy and put them out of business. They will write to their members of Congress.
There’s an obvious solution here: Wireless and cable telephony, excellent though they are, still don’t quite match the reliability of wireline service. In a power outage, for example, your wireline phone service still works because it’s powered out of the central office which has batteries and even generators. So let reverse auctions kick in as soon as competitors match the reliability of wireline service.
A third NPRM deals with other issues. One is to broaden the base of contributors. Right now, the FCC manages only the taxation of interstate services. Some would like it to be able to tax intrastate services, as well. (Never mind that intrastate services are already heavily taxed at the state level.) One fear I and others have is that “broadening the base” could lead to the taxation of Internet traffic. Another is to step up FCC audits so as to reduce waste, fraud and abuse. You might wonder: Don’t they do that already (what do we have the FCC for if it isn’t to conduct audits)? But FCC oversight, while successful on occasion, has been a farce overall.
The Federal Communications Commission is looking into a scam involving the attempt by local phone carriers in rural areas to collect more access fees from the major long-distance providers by increasing the number of calls from “adult” chat lines.
Rural carriers have long received fees (up to 5 cents per minute) from long-distance carriers for every call they connect. The original intent behind this, of course, was to ensure that rural citizens have (subsidized) phone access. So when you make a call from New York City to your grandparents in North Dakota, Verizon pays an access fee to your grandparents’ local carrier for the connection. And the smaller you grandparents' local carrier is, the higher the per-minute fee it gets to collect. So, unsurprisingly, some small local carriers figured out that they more calls they connect, they more money they will collect.
Hence, some rural carriers decided to sell local area codes to adult chat lines. That way every time someone calls the adult line, the rural carriers get a connection fee. Revealing how out of control all of this has gotten, one Senate staffer said recently:
To illustrate the success this program has had, consider this: in July 2005, the rural phone company in Wayland, Iowa showed 40,000 minutes of long-distance calls received; in December 2006, they showed 10 million minutes. Of those calls, half were to the same four phone numbers, all adult chat lines.
Family advocacy groups are upset, because such calls to regular area codes can not be automatically blocked. At least with the old 1-900 numbers, parents could automatically block such calls.
We hardly needed one more example of the unintended consequences of regulation. But here it is anyway.
The FCC received public comments on the concept of using auctions to determine
who gets Universal Service support to provide subsidized phone service in rural areas. The leading trade association representing rural local exchange carriers (the Organization for the Promotion and Advancement of Small Telecommunications Companies) predictably claimed that “[s]electing winners based solely on price would surely be a ‘race to the bottom.’” According to OPASTCO, “[q]uality of service, service capabilities, and existing service area coverage should all be included in the criteria for evaluating carriers bidding for a rural service area, and those criteria should be given at least equal weight as the bidding price.”
OPASTCO’s premise is surely correct. The trick is to balance quality, reliability and price in a way that creates maximum value for everyone – including the taxpayers, er, ratepayers – and doesn’t create insurmountable hurdles for newer, more efficient and potentially more useful technologies in the earlier stages of development.
Continue reading "Interesting ideas for designing auctions to reduce USF subsidies" »
FCC Chairman Kevin Martin
A few weeks ago, the FCC courageously requested public comment on the merits of using auctions to determine who gets Universal Service support to provide subsidized phone service in rural areas. One difficulty with a reverse auction is what, if anything, to do about stranded investment. What are the legitimate investment expectations that the incumbent provider deserves to recover?
Under the current system, the incumbent rural phone companies will be subsidized in perpetuity. Yet, cable VoIP service and wireless systems have been built in many rural areas without Universal Service support. Many of the competitors are now seeking their fair share. Chairman Kevin Martin noted yesterday at a Senate hearing that these competitors received $1 million when he came to the commission but get $1 billion now.
Martin stood up for reforming Universal Service so it supports the best and most efficient new technologies, and he took a beating from Senate Commerce Chairman Ted Stevens (R-AK) – an ally of the incumbent rural phone companies – who, like most politicians, focused on who would be the winners and losers:
Continue reading ""Continuity and community presence" in Universal Service" »
The telecom reform proposal under consideration in the Senate Commerce Committee would create a $500 million account as part of the Universal Service Fund to subsidize broadband deployment in rural areas. The anecdotal evidence for some time has been that rural areas actually are not far behind urban areas as it is. Part of the reason that there is not much of a lag is small rural telcos have been able to finance broadband upgrades with USF.
In a paper released Friday, the Congressional Budget Office sheds some much-needed light on the rumors. CBO claims that broadband is in fact permeating rural areas at a "rapid pace," and cites a finding from the Pew Internet and American Life Project that "rural areas are only about two years behind urban areas in their broadband subscription rates." (See "Factors That May Increase Future Spending from the Universal Service Fund," Jun. 2006.)
CBO confirms that USF is in fact already subsidizing broadband deployment, since current telephone equipment eligible for the subsidies is capable of providing voice and data services.
The proposal in the Senate to expand USF may be bad for innovation, since new technology could be forced to subsidize obsolete technology. The CBO study provides evidence that the popular notion of a rural broadband divide is actually a myth, and not a justification for expanding USF.
Sen. Ted Stevens (R-AK) rightly worries that current universal service mechanisms are unsustainable as consumers migrate to Internet phone services that are lightly taxed and regulated (these services clearly should contribute their fair share). Stevens and others also believe that rural America won't get broadband services without subsidies (we can't know this for sure, because we have never tried the alternative approach of removing all of the barriers to competition and investment).
Anyway, while Internet content and conduit providers obsess over net neutrality, something equally harmful is lurking in the shadows. A little noticed provision in the Senate's "staff working draft" designed to expand the universal service funding base could have profound consequences.
Currently, consumers of "telecommunications" services contribute billions of dollars to subsidize telephone service in rural areas. "Telecommunications" include telephone, cell phone and, for the moment, DSL services. DSL has been deregulated, and the requirement that it contribute to universal service is temporary. VoIP contributes a small amount, but nothing like a fair share. The Senate staff draft expands the category of contributors and ensures that they all pay equally. Its true that the Internet backbone would not contribute to universal service, but so what? Everything that travels to or from the public Internet would pay.
Here's how this looks:
‘‘(1) CONTRIBUTION MECHANISM.—
‘‘(A) IN GENERAL.—Each communications service provider shall contribute as provided in this subsection to support universal service."
‘‘COMMUNICATIONS SERVICE.—The term ‘communications service’ means telecommunications service, broadband service, or IP-enabled voice service (whether offered separately or as part of a bundle of services)."
‘‘(A) BROADBAND SERVICE.—The term ‘broadband service’ means any service used for transmission of information of a user’s choosing with a transmission speed of at least 200 kilobits per second in at least 1 direction, regardless of the transmission medium or technology employed, that connects to the public Internet for a fee directly—
‘‘(i) to the public; or
‘‘(ii) to such classes of users as to be effectively available directly to the public."
Setting aside the issue of VoIP -- whose free ride should clearly end -- advocates of expanding the funding base sound like tax collectors when they argue that spreading the burden will lower the individual contributions. Contributions that are set low initially are, of course, much easier to raise in the future. And that will happpen, because there are no limits on the growth of most of the universal service funding mechanisms.
This week Senate Commerce Chairman Ted Stevens (R-AK) introduced comprehensive telecom reform legislation which, as Adam Thierer notes, is a 135-page monster, represents a counterproductive obsession on the part of some policymakers over the smallest details of communications policy and doesn't tear down any of the old regulatory paradigms that it sould.
That said, the proposal would move the country in a positive direction in several respects.
- Net Neutrality
-- Unlike the House bill, which grants the FCC specific new authority to enforce the commission's net neutrality principles -- and which is guaranteed to lead to questionable enforcement proceedings and perhaps litigation between grasping and delusional competitors -- the Stevens bill wisely requires the FCC to merely keep a watchful eye on industry practices and issue annual reports for 5 years. The reports may contain recommendations, but the commission may not recommend new rulemaking authority for itself. Unfortunately, the commission shall report on peering and other business arrangements that are appropriate objects for antitrust -- if egregious -- but not for an agency which is not governed by a clear and principled competition standard which emphasizes consumer welfare, as Randy May and the Regulatory Framework Working Group have outlined. It is unnecessary to include any provision regarding net neutrality in telecom reform legislation, as I have argued here, for example. However, Senator Stevens has the best net neutrality proposal so far.
- Video Franchising -- The proposal encourages negotiations between cities and competitive entrants, but establishes a 30-day shot clock and eliminates the ability of the cities to extort in-kind contributions (beyond 1% of gross revenues for Public, Educational and Governmental channels) or set anticompetitive buildout requirements. It also ensures comparable treatment for cable operators who face competition from a new entrant. Unfortunately, the proposal preserves almost all of the existing video regulations -- such as must-carry, PEG and I-Nets -- even though the market is competitive and all vendors need to be able to raise vast sums of capital to deliver broadband speeds of 50 mbps to 100 mbps.
- Universal Service -- On the distribution side, the bill would require periodic audits of universal service recipients and would set up a review process to prevent waste, fraud and abuse. That Senator Stevens, one of the strongest defenders of universal service, acknowledges the potential for waste, fraud and abuse in what is nothing more or less than an entitlement program is welcome and significant. Although this is a great start, ways must be found to ensure that the size of the fund declines as technology reduces the cost of services. One way to do this is to mandate price caps on all recipients. Another way is to auction the loans and/or subsidies for broadband services to the providers and the technologies that can offer the service at the lowest cost.
On the contribution side, the bill would authorize the FCC to expand the contribution base in virtually any conceivable way and would hide everything from the Congressional budget process. Sinces taxes and regulation go hand-in-hand, Senator Stevens' proposal raises the worrisome possibility that not only taxes but also regulation may be coming to the Internet. I'm not sure which is worse: that taxes and regulation could ruin the Internet, or that the Internet might provide potentially limitless opportunities for taxes and regulation to stifle everything else. At a minimum, Congress should cap the fund if its going to give the FCC virtually unlimited authority to collect "fees."
- Video and Audio Flag -- The bill would preserve the brodcasting business model by withholding content from the Internet. This is protectionist and anti-consumer. Congress should not pick winners and losers.
- Sports Freedom -- The bill would outlaw exclusive contracts with programming vendors for sporting events. In a free market, exclusive contracts can benefit producers and consumers. Government, as a general matter, should not interfere with private contractual arrangements. On the other hand, these particular arrangements are not the product of a competitive marketplace and have the potential to retard competitive entry. A permanent prohibition is heavy-handed and could be damaging, but some kind of transitional relief seems appropriate.
Professor Vernon L. Smith provides a helpful analytical tool which explains why the cost of health care has doubled in the past decade and generally outpaces inflation and also demonstrates why Universal Service is inherently flawed and ultimately unsustainable (see "Trust the Customer!" in the Wall Street Journal).
Continue reading "Universal Service suffers same defect as health care system" »
A first-rate report describing the shortcomings of Universal Service and suggesting several options for reform has been issued by the Progress & Freedom Foundation. The report is timely because a lot of service providers support a "numbers-based" contribution mechanism designed to spread the cost of Universal Service to include any service that connects to the telephone network and uses an assigned number.
Overall, the report confirmed by own impression that Universal Service is a classic example of "regulatory capture," the theory that regulation can be manipulated by regulated firms to bring them unwarranted profits and thus actually harm the consumers (through artificially higher prices) that it purports to serve. The report doesn't state this conclusion quite so candidly, though. It diplomatically notes that smaller rural telephone companies receive subsidies based upon "rate-of-return" regulation, which can "distort the regulated firm’s choice of inputs, so the regulated firm fails to produce at minimum cost." Regulators, the people we all assume are there to protect us, have "little incentive ... to scrutinize the use of universal service funds" and "few incentives ... to reduce expenditures." The report cites comments that were filed in 2004 by Western Wireless, subsequently acquired by AllTel, that "no comprehensive audit of the regulatory accounts of rural ILECs has been conducted in the past decade, either by the FCC, NECA, USAC, or independent auditors retained by the ILECs themselves.”
The report does recommend a "numbers-based tax," which is one way to reduce the inequitable burden that the current system imposes on legacy service providers. But it would be throwing money at a problem which is, in effect, subsidizing the problem and only making it worse. That is not the aim of the report, which contains many useful ideas for reducing costs.
Need for audits
One idea is a requirement that the FCC conduct periodic audits. This is an obvious starting point, and it is truly appalling that Congress may be forced to enact fundamental reforms without the benefit of extensive audit findings. The Congressional committees of jurisdiction ought to put an immediate end to this dereliction of duty by regulators. My friend John Dillard, who owns and operates a smaller rural telephone company in Oregon recommends "First, effective audit oversight of all recipients by NECA and USAC acting for the FCC. The current USAC audits do not meet that requirement and are ineffective, worthless even. NECA and USAC need to question and deny claims for USF support. The companies must justify their costs to the overseers. If a company doesn't want that level of oversight, they do not need to apply for the USF support."
Proposal for state block grants
Another idea from the report is to allow the states to "tailor universal service solutions to meet their own needs," resulting in a "process of interstate competition that will help to identify a set of best practices." This is called a "Performance-Based Block Grant Model." As one who sympathizes with the need for universal service in some parts of the country, I fear that devolving responsibility for administering universal service to the states could jeopardize the program by making it easier politically for the federal government to reduce its commitment in the future. When Congress deregulated the airlines, the Essential Air Service block grants were supposed to ensure that smaller communities would continue to receive commercial air service, but they fell victim to budget cutting. I also question whether most states could handle this responsibility. Most state commissions struggle with very limited resources and broad jurisdictional responsibilities that cover energy, water, transportation and other distractions. State commissions have sometimes proven effective in monitoring service quality and are probably more sensitive to consumer complaints that arise locally. Sometimes a state commission in one of the larger states has blazed a trail for others to follow, but this often depends on a combination of coincidences that includes the presence of a commissioner with unusual vision and leadership abilities. Another problem with assigning significant policymaking responsibilities to state commissions is that in the process of experimenting with universal service they could unwittingly impact interstate networks and balkanize the Internet. Also, state commissioners are as susceptible to regulatory capture as the FCC. Therefore, if a state commission thinks it can build a better mouse trap, why not let them apply for a federal waiver?
Other useful suggestions
John would add the following ideas:
"The FCC needs to convene a Joint Board to bring telecommunications accounting, cost allocations and separations methodologies into GAAP compliance. The various factors need to be reviewed and recast to reflect current technologies that are being deployed. The Joint Boards will need explicit direction to do that.
"The old circuit based telephone equipment needs to be phased out in a timely but quick fashion over a specified period of time. USF surcharges for a period of time may be needed to help rural carriers do this," and
"There needs to be a date certain where state regulation is limited to quality of service issues only. The telecommunications regime is basically federalized."
The FCC took comments Friday on what to do about an enormous rate of growth in the demand for Universal Service subsidies. The High Cost Fund has almost doubled in size since 1999. Part of the growth is attributable to a variety of familiar problems. For example, support for rural carriers is still determined using a rate-of-return methodology despite the fact that price-cap regulation has proven to be far more effective in controlling costs. And rural carriers can choose to be subsidized not on the basis of their own actual costs, but according to an "average" cost incurred by many carriers. So it doesn't matter that some rural carriers contend with mountains, deserts, lakes and rivers while there are others who serve flat patchworks of farms as far as the eye can see. Well, it doesn't matter in terms of keeping the size of the fund low. It's great for the carriers serving the flat areas.
The bulk of the growth since 1999, however, is due to the availability of subsidies for competitors, such as competitive rural wireless carriers. Some incumbent phone companies argue it is inefficient to subsidize two networks serving the same area: The resulting competition is artificial because it depends on continuing government subsidies. But their proposal virtually guarantees that the availability of subsidies will be limited to the incumbents. The solution is not to outlaw competition. The real question is why should Universal Service continue to be biased in favor of wireline services when it is cheaper in most cases to deploy wireless technology in rural areas? Many rural areas have mobile services that do not require any subsidies at all. One example of this bias is the fact that the subsidies available to rural wireless carriers are set according to the cost data submitted by the incumbent wireline provider! No attempt is made to capture the benefits of lower costs for the fund.
Universal Service policy is highly political and impossible for the FCC to manage successfully. As a result, it incorrectly focuses on the needs of providers not consumers. That's one reason why larger "non-rural" carriers don't receive any support for the rural areas they serve. These carriers are forced to overcharge their urban customers, leading to arbitrage which undermines investment. This policy is a subtle but real form of "taking," which no court has figured out yet.
The cost of telecommunications is declining while the cost of Universal Service is exploding. Something is wrong. But it would be a mistake to control costs by discriminating for and against various technologies. Technology offers the best opportunity to reduce and eventually perhaps eliminate Universal Service.
|
 |
