Fixing universal service

Congress is unlikely to scrap high-cost universal service subsidies. Many lawmakers in predominantly rural states consider continued support for rural telephone service essential to the social and economic welfare of their constituents.

Rural telephone and cellular carriers have an obvious financial stake in the continuation of high-cost payments. Some consumer groups also oppose changing the system, on the grounds that residential and especially low-income phone users would suffer.

Nevertheless, the Federal Communications Commission, state utility regulators and various think tanks have proposed measures intended to curb rising costs and put the universal service fund on a firmer financial footing. Reform proposals floated in recent years include the following:

• Auctioning off subsidies to cut costs. FCC Chairman Kevin Martin has endorsed the idea, explored at various times in the past decade, of holding "reverse" auctions to allocate universal service funds. The FCC would specify high-cost service areas and then take bids from rival telecom firms willing to serve each area as the provider of last resort. The company bidding the lowest per-subscriber subsidy wins. By forcing providers to reveal their true costs and become more efficient, "technology neutral" reverse auctions would inexorably drive down high-cost outlays. Auction systems have been employed in Latin America to provide Internet access and pay phone service. But in this country rural telcos have objected that low bidding would foster inferior service.

• Making states responsible for distributing universal service funds. A group of economists associated with the Privacy & Freedom Foundation, a Washington, D.C., think tank, has suggested capping the high-cost and low-income programs and giving the money to each state in the form of a performance-based block grant. State administrators could distribute USF subsidies in any way they see fit, and states that hit FCC performance targets would be allowed to spend excess funds on "nonbasic" communications services such as broadband deployment. Pitting states against each other for limited grant funds would encourage state administrators to strive for efficiency and prioritize USF spending, the economists say. States could save money, for example, by confining support to very remote areas, or low-income households. Rural telephone companies have lambasted this plan.

• Collecting from all telecom providers. Only about 34 percent of total telecommunications revenues are subject to USF fees. Why not broaden the contribution base to encompass all telecom revenues, including those derived from intrastate traffic, high-speed Internet access and Internet telephony? The FCC took a step in that direction last summer, requiring Voice over Internet Protocol companies to contribute 10.5 percent of their long-distance sales to the USF for calls that touch the public-switched telephone network. The FCC also increased the USF levy on cellular service and long-distance calling cards, but for now intrastate telecommunications and Internet access provided over cable modems remain exempt from USF contribution requirements.

• Levying fees on all telephone numbers. Martin has said that he is "committed to adopting and implementing a numbers-based contribution system"—USF fees assessed not on long-distance usage but on all assigned telephone numbers. Charging by the numbers would tap into a huge, swelling revenue base; roughly 565 million working phone numbers exist in the United States, according to the FCC, and that total is growing about 2 percent annually. By imposing a flat per-number fee on all carriers—wireline and cellular phone companies, cable firms, VoIP providers—this proposal spreads the universal service burden evenly across the entire industry and captures intrastate revenues to boot. Opponents, including some small rural telcos and the Consumers Union, argue that shifting the contribution burden from businesses (which make more long-distance calls) to residences would penalize low-income households.

• Funding the USF from general taxes. Some analysts have suggested that U.S. taxpayers support universal service, as they do most federal programs. On purely economic grounds, raising general tax dollars to fund the USF makes more sense than charging industry-specific fees, which tend to distort prices and consumer choice. The universal service fee on long-distance use is particularly distorting and inefficient because increasing the price of long-distance induces subscribers to cut back on their minutes or switch to flat-rate calling plans. Jerry Hausman of the Massachusetts Institute of Technology calculated in a 1998 paper that USF fees cost the economy at least an additional $1.05 for every dollar in revenue they produced—more than twice the efficiency cost of raising money from general taxes. But paying for universal service with general revenue may require raising taxes—anathema to many lawmakers.

In order to fix universal service, regulators and the telecom industry must grapple with another contentious issue—intercarrier compensation, a complex set of rules governing who gets paid what for handling voice and data traffic. National and regional carriers pay access charges to local telephone companies that originate and terminate long-distance calls. Because access charges levied by small rural carriers usually exceed the actual cost of completing calls, ICC is an implicit subsidy that supplements USF high-cost payments. But growth in wireless-to-wireless calls and free VoIP services (both of which bypass interstate and intrastate access charges) together with proliferating "phantom" or disguised traffic threaten to choke off this steady revenue stream.

Telecom firms are unlikely to agree to overhaul universal service without revamping ICC as well, said Tony Clark, chairman of the North Dakota Public Service Commission. "Intercarrier comp is, for a lot of rural companies, probably as big if not bigger an issue than universal service," he said. "They are joined at the hip, and everybody recognizes that."

One stab at a new ICC regime is the FCC's Missoula Plan, named for the Montana city where the National Association of Regulatory Utility Commissioners and industry representatives hammered out the details last year. An attempt to level the regulatory playing field for different telecommunications technologies and classes of carriers, the plan would reduce and unify ICC charges while allowing telecom firms to recover some of their lost revenues from increased line charges paid by subscribers.

Like reform proposals for universal service, the Missoula Plan has supporters and detractors, with rural telephone companies and other wireline carriers generally backing it and cable and wireless providers opposing it. As of March the FCC was still reviewing proposed amendments to the plan.