Phone fund rip-off

October 24, 2006|By Thomas W. Hazlett

ARLINGTON, Va. -- Programs are given funny names in Washington. Take the Universal Service Fund, which spends $7 billion annually to extend telephone service to low-income households in high-cost areas. In truth, it has never delivered "universal" phone service or significantly expanded the reach of networks. What it does is shower subsidies on grossly inefficient rural phone companies while imposing stiff taxes on the very folks it aims to help. And policymakers are today casting about for new revenues to feed the beast.

Many consumers are alarmed that taxes are being raised on other network activities to keep the subsidies flowing. As detailed in my study commissioned by the Seniors Coalition, rural telephone companies bag as much as $13,345 per year, per line, in federal payments.

To fund the Universal Service Fund's corporate largess, U.S. long-distance calls are taxed. This hurts phone users, particularly those with limited incomes, and puts a drag on the expansion of communication networks - precisely the reverse of what is intended by "universal service."

The fund has surged to more than $7 billion annually, up from less than $4 billion in 1998; consequently, the tax rate skyrocketed from 2.1 percent in 1997 to 10.9 percent in 2006. Eighty-five percent of the increase in the fund since 1999 consists of subsidies to phone carriers via "cost plus" accounting that encourages inefficiency by increasing payments to companies that have higher expenses.

Company handouts mushroomed from $1.7 billion in 1998 to $3.7 billion in 2005. Carriers have organized around these federal payments, which reward small systems with extremely high costs. While there are about 90 local phone companies serving suburban and urban markets, there are nearly 900 serving rural markets. Many receive federal payments in excess of $1,000 a year per telephone line.

Even the most remote households can now be served by efficient alternatives to traditional fixed-line networks. Satellite phone service, for instance, is pretty expensive at $800 per year - but it's an absolute bargain compared with the Universal Service Fund-subsidized option. Taxpayers could save at least $1 billion each year by simply giving away - at full retail cost - satellite or cellular phone service to the few remaining Americans who do not have access to wire-line systems.

While the goal of universal service is uncontroversial, Americans are ditching old-fashioned phone networks. In 2004, the latest year for which government data are available, just 89 percent of U.S. homes had a traditional fixed line, down from 94 percent a few years ago. The decline was more than offset by mobile phones. But the Universal Service Fund swims against this natural transition by bailing out yesterday's technology with today's tax dollars.

Rural telephone companies are now so flush with subsidies that many of them pay out more in dividends to their owners than they charge for phone service. More than 100 rural telephone companies incur more than $500 per line in annual administrative expenses - what a typical mobile customer pays in total charges. These are corporate overhead costs not driven by expenses associated with providing service in low-density markets.

"Long distance" revenues have gone the way of the eight-track tape deck, replaced by e-mail, buckets of wireless minutes and Voice over Internet Protocol (VoIP). So now, to finance the Universal Service Fund, tax rates are rising for fixed and wireless phone subscribers and being newly imposed on VoIP customers.

Advocates of rural phone subsidies fiercely resist the idea that $1,000 per line in annual subsidies is excessive. In fact, they deny that the taxes levied to pay for the $7 billion fund are even taxes at all. An industry consulting paper stated that "USF structure is simply a pricing strategy, employed by public policy makers over the years, to enable local exchange carriers to earn a reasonable return on their investment."

What a pleasant way to think about it. Americans, it is true, might be much happier if they would just think of the taxes withheld from their paychecks as "simply a pricing strategy, employed by public policy makers" - and not really taxes at all.

But if obfuscation fails to ease the pain, a more realistic solution would be to cap the mushrooming Universal Service Fund and then reduce it year by year. A means to this end would be to adopt "reverse auctions" to assign universal service obligations. Here, the government specifies high-cost service areas and then takes bids from rival firms offering to serve that area as the "provider of last resort." The lowest-priced bid wins.

Reform would not prove popular with rural carriers that now wolf down $4 billion in annual subsidies, but it would make excellent economic sense. And the American taxpayer would likely find it a more palatable solution than pretending that taxes aren't taxes.

Thomas W. Hazlett is a professor of law and economics at the George Mason University School of Law. His e-mail is

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