If there is one thing I have learned in almost 23 years of covering communications and media regulation it is this: No matter how well-intentioned, regulation often has unintended consequences that hurt the very consumers the rules are meant to protect. Case in point: “universal service” mandates that require a company to serve an entire area as a condition of offering service at all. The intention is noble: Get service out to everyone in the community, preferably at a very cheap rate. Alas, the result of mandating that result is clear: You get less competition, less investment, less innovation, and less consumer choice. And often you don’t even get everyone served.

Consider this Wall Street Journal article today, “Google Fiber Is Fast, but Is It Fair? The Company Provides Neighborhoods With Faster and Cheaper Service, but Are Some Being Left Behind?” In the story, Alistair Barr notes that:

U.S. policy long favored extending service to all. AT&T touted its “universal service” in advertisements more than a century ago. The concept was codified in a 1934 law requiring nationwide “wire and radio services” to reach everyone at “reasonable charges.” In exchange for wiring a community, telecommunications providers often gained a monopoly. Cities made similar deals with cable-TV providers beginning in the 1960s.

The problem, of course, is that while this model allowed for the slow spread of service to most communities, it came at a very steep cost: Monopoly and plain vanilla service. I documented this in a 1994 essay entitled, “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly.” As well-intentioned regulatory mandates started piling up, competition slowly disappeared. And a devil’s deal was eventually cut between regulators and AT&T to adopt the company’s advertising motto — “One Policy, One System, Universal Service” — as the de facto law of the land.

It took us almost a century to dig ourselves out of that mess and move towards telecommunications competition. Alas, we’re still living with the vestiges of this old regulatory mentality. Cities and counties across America still impose a wide variety of “universal service” regulatory mandates. Again, their intention is noble: They want everyone in their community served. You can’t blame them for that. But the result is still the same: Limited facilities-based competition and investment.

And so we return to today’s Wall Street Journal story about Google Fiber, which explains how local officials are finally starting to understand these realities. The story notes:

In 2011, Google struck a deal with authorities in both Kansas City, Kan., and Kansas City, Mo., to build the service based on customer demand. City officials say they didn’t push hard for universal coverage because they thought faster Internet service would boost the local economy and they were competing against so many other cities. “The main point was to win and bring that infrastructure to our city,” said Rick Usher, assistant city manager of Kansas City, Mo. As phone and cable companies slowed their own expansion plans, more cities allowed the selective approach.

Google’s ‘build-to-demand’ model is catching on because it produces results: More infrastructure investment, innovation, and competition. Traditional telecom and broadband operators are prepared to step up investment, too, when the incentives are right:

Verizon was required by cities and some state laws to build and offer its FiOS service widely across cities. It stopped expanding to new cities in 2010; to date, it has spent more than $23 billion on the FiOS rollout. Chief Financial Officer Fran Shammo said in March that the company wouldn’t expand to additional markets until FiOS had “finally returned its cost of capital.” If Verizon resumes expansion, the company would consider Google’s build-to-demand model because it has the potential to be more profitable, said Chris Levendos, a Verizon executive overseeing the FiOS build-out in Manhattan. Others are doing just that. AT&T said in April it would offer Internet speeds of up to one gigabit in as many as 100 cities. It is building to demand and working with local authorities to reduce construction costs, the company said. Tuesday, it said it would bring the high-speed service to Cupertino, Calif., close to Google’s headquarters. This approach “starts to make this business model look quite attractive,” John Stankey, AT&T’s chief strategy officer, said at an investor conference on Aug. 13.

Again, when you get the incentives right and give investors and innovators a green light, they will seize the opportunity. And that’s even true — actually, it is especially true — for high fixed-cost investments like fiber networks.

But wait, aren’t there some pockets of the population that will fall through the cracks under this alternative arrangement? In the short-term, potentially yes. But the right answer to that “digital divide” problem is never to restrict short-term investment and innovation opportunities just because you think you have a better, more “well intentioned” plan. That is the crucial mistake policymakers made in the past. Their desire to get everyone served at the exact same time with the exact same plain vanilla service meant we got sub-optimal technologies and stagnant markets with little hope of any new innovation or investment over the long-haul.

This is how “universal service” consistently fails us. Universal service sells us short. It sells human ingenuity short. The logic that motivates universal service regulation is that: ‘Well, this is about the best we can do. Let’s just get everyone some basic level of service and that will be just and good.’  Can you imagine if we would have applied this logic to other major markets and technologies?!

But what about the under-served communities? First, when you allow new innovation in networks, you never know how or where they might spread next. If you have more competitors offering unique networks architectures and services, there is a very good chance that entrepreneurial minds will figure out how to push out the boundaries of what is possible, especially in terms of how the service is delivered.

Consider this: Back in the old days, did it really make sense to try to stretch a thin copper wire way, way out into the middle of every valley, desert, farm field, and mountain? The myopic universal service mindset says: ‘Well, that’s all we had at the time.’ Perhaps for a time it really was. But how much quicker might we have seen some sort of alternative system if we hadn’t locked in those old assumptions as policy requirements? Is it impossible to believe that wireless technologies might have developed much more quickly if the incentives would have been right? Again, there was no reason for any innovators or investors to even consider the idea at a time when policymakers were mandating copper wires be stretched to every corner of the land, and as they were showering favored companies with subsidies to achieve that goal. That’s not something a new innovator could compete with, and so no one did. It would have been like policymakers saying we needed a “universal service” policy for cheap hamburgers for the masses and then showering McDonald’s with subsidies since they were the first one in many local markets who could deliver on that promise. Had we had such a universal cheap hamburger policy, do you think any other fast food places would have ever come to town and tried to compete against those subsidized burgers? Not likely.

The lesson for today’s policymakers is clear: Open up markets, relax regulatory burdens, eliminate discriminatory taxes and subsidies, and clear away other barriers to investment. Then see what happens. As the Google Fiber experience suggests, innovative minds can and will emerge to offer constructive solutions and slowly spread new networks and technologies.

OK, but won’t there still be some communities that are underserved, even with all that new innovation and investment. It’s certainly possible. And where those communities exist, some government action may be necessary to incentivize the spread of some sort of network to them, or even have the government build it for the community. I’m not opposed to that. (Have you ever driven through the hills of West Virginia or the mountains of rural Western states? Hard places to get wired networks out to!) I’m not very optimistic local governments will do a very good job of building sophisticated networks because they already have a horrible track record in this regard. But, again, I don’t oppose local action on this front if no other alternatives appear after a certain period of time.

But, again, the answer here is not crazy national and state-based universal service mandates that regulate everyone in every community as if they had the same problem. Let competition and innovation work its magic where it can and do not mess that up. Where it proves much harder for that network competition and innovation to take root, use smart incentives to get companies to build out their networks further, or offer alternative wireless infrastructure of some sort, or just have the government build the networks themselves. But we should always give competition and innovation the benefit of the doubt and see what happens first.

So, let me perfectly clear what I am saying here: GOOD INTENTIONS ARE NEVER ENOUGH! [And yes, I am using all caps because I am shouting!] The next time somebody starts mouthing something about how they have the moral high ground in these debates because their intentions are supposedly pure as the driven snow, ask them to show you results. Tell them you want evidence that their intentions have actually produced something concrete and positive for society. If their answer is, in essence, ‘Well, with our regulatory mandates we can at least get everybody some basic level of really crappy monopoly service,’ then tell them that they can take their good intentions and shove them. We can do better.

If broadband Internet infrastructure had been built to the same extent as public water-supply systems , more than twice as many Americans would lack fixed broadband Internet access.

After abandoning the “information superhighway” analogy for the Internet, net neutrality advocates began analogizing the Internet to waterworks. I’ve previously discussed the fundamental difference between infrastructure that distributes commodities (e.g., water) and the Internet, which distributes speech protected by the First Amendment – a difference that is alone sufficient to reject any notion that governments should own and control the infrastructure of the Internet. For those who remain unconvinced that the means of disseminating mass communications (e.g., Internet infrastructure) is protected by the First Amendment, however, there is another flaw in the waterworks analogy: If broadband Internet infrastructure had been built to the same extent as public water-supply systems, more than twice as many Americans would lack fixed broadband Internet access.

Advocates who would prefer that the government (whether local, state, or federal) own and operate the Internet often use the lack of broadband access in rural America as a justification. They point to an FCC report finding that 19 million Americans (6% of the population) lack access to a fixed broadband network and that less than 1% of Americans lack access to a mobile broadband network. Government broadband advocates fail to acknowledge, however, that more than twice as many Americans lack access to public water-supply systems. According to the most recent report from the US Geological Survey,* 43 million Americans (14% of the population) lack access to public water-supply systems and instead must self-supply their own water (e.g., they have to drill a well on their property).

Self-supplied water systems are common in rural areas and neighborhoods that lie outside the jurisdictional boundaries of a municipality. The Virginia Department of Health notes that the “majority of households in 60 of Virginia’s 95 counties rely on private water supply systems” and that in “52 counties, the number of households using private wells is increasing faster than the number of households connecting to public water supply systems.” For example, my neighborhood in northern Virginia, which is served by two fixed broadband providers and several mobile broadband providers, has no access to a public water-supply system. In my neighborhood, every homeowner must drill their own well (at a cost ranging from $3,500 to over $50,000 depending on geological conditions and local regulations).

The jurisdictional limitations of municipal water-supply systems can be overcome by self-supply in most areas of the United States because the value of a water system to a particular household is not directly increased by interconnecting it with another water system. In contrast, the Internet is a network of networks (the term “Internet” was shortened from internetwork) that exhibits both positive and negative direct network effects – i.e., its value for all users is affected by the addition of new users or content to the internetwork. By definition, an individual homeowner cannot self-supply Internet access without interconnecting with at least one other network.

This fundamental difference between waterworks and the Internet is critical to understanding why state legislatures often treat municipal waterworks differently than municipal broadband networks. In addition to the First Amendment issues that are involved when local governments own and control the primary means of mass communications, many states have recognized the potential for municipal broadband networks to result in a form of “cherry picking.” If every municipality built its own broadband network, substantial portions of most states would still lack access to broadband, but the ability of private broadband network operators to profitably serve those areas would likely be reduced. As noted above, public water-supply systems cover significantly less population than private broadband networks.

Of course, advocates who would prefer that the government own and operate the Internet typically don’t mention the jurisdictional limitations of municipalities or the potential impact of municipal broadband networks on citizens who don’t live in a municipality. Some of these advocates actually imply that cronyism must be the primary motivation for state legislation governing municipal broadband networks. Fortunately, state legislators representing citizens who lack access to municipal services have a better understanding of the needs of their citizens than some urban lobbyists and bureaucrats living in Washington.

*                      *                      *

*Note that the broadband data in the FCC report is current through mid-2011, and the public water-supply data in the US Geological Survey report is current only through 2005. The US Geological Survey releases its water use reports every five years, but does not intend to release its 2010 water use report until fiscal year 2014. Based on previous trends, however, it is unlikely that the percentage of Americans who have access to public water-supply systems has increased significantly in the last six years, if at all. The percentage of Americans that self-supplied their water dropped only three percentage points in the twenty-year period from 1985 (17%) to 2005 (14%).

In an important essay this week entitled “Silicon Valley’s ‘Suicide Impulse’,” Wall Street Journal columnist L. Gordon Crovitz warns that “Silicon Valley has long prided itself on avoiding the lumbering relationship between big government and most industries, but somehow it has become one of the top lobbyists in Washington.” Crovitz is worried that Internet and technology companies are falling prey to what Milton Friedman labeled “The Business Community’s Suicidal Impulse”: the persistent propensity to persecute one’s competitors using regulation or the threat thereof. “Rather than lobby government to go after one another,” Crovitz argues, “Silicon Valley lobbyists should unite to go after overreaching government. Instead of the ‘suicide impulse’ of lobbying for more regulation, Silicon Valley should seek deregulation and a long-overdue freedom to return to its entrepreneurial roots.”

Crovitz’s essay touches upon a dangerous trend I have written about here and elsewhere in the past: the increasing politicization of the Internet and information technology sectors and the gradual rise of rent-seeking (i.e., favor-seeking) over time. I’ve written about this problem in essays like:

• “The Sad State of Cyber-Politics” (Cato, 2010)
• “The Troubling Growth of High-Tech Regulation, Lobbying, and Rent-Seeking” (Dec. 2, 2012)
• “On Facebook ‘Normalizing Relations’ with Washington” (March 29, 2011)
• “DC’s LivingSocial Cronyism Experiment Already Going off the Rails” (Nov. 29, 2012)

These essays have documented how tech companies are increasingly vying for the attention of legislators and regulators in Washington, statehouses, and international capitals across the globe.

Why should we care about the increasing politicization of the information technology sector? In a forthcoming Mercatus Center working paper entitled, “A History of Cronyism & Capture in the Information Technology Sector,” Brent Skorup and I explain how “time and resources spent focusing on influencing politicians and capturing regulators represent time and resources that could better be spent competing and innovating in the marketplace. This can negatively impact consumer welfare in two ways: Not only are consumers denied more and better products and services, but they also may pay higher prices or higher taxes extracted by the corporate-government agreement.”

We document how rent-seeking and cronyism have had a corrupting influence on older information sectors and technologies, especially broadcasting and communications. We develop lengthy case studies from each sector to illustrate the costs that rent-seeking imposes on consumers, competitors, and ongoing innovation.

It’s a miserable history but one that is essential to recount if we hope to avoid it for newer sectors and technologies. That’s why Brent and I devote the closing section of our paper to a list of “Strategies to Limit Cronyism” in the Internet world before things get as bad as they have in the communications and media sectors. We argue that it is essential that we use a combination of institutional safeguards and market/social norms if we hope to head-off incessant rent-seeking and avoid the ‘suicidal impulse’ problem that Milton Friedman and Gordon Crovtiz identified.

Generally speaking, we must begin by acknowledging that, as economist David Henderson correctly notes, “There is only one way to end, or at least to reduce, the amount of cronyism, and that is to reduce government power.” Special interest rent-seeking and the chronic cronyism problems of modern America are fundamentally tied up with the constantly expanding horizons of government power. As Mancur Olson taught us in his 1965 book, The Logic of Collective Action, when benefits are concentrated and costs are dispersed (across all taxpayers or ratepayers, for example), we can expect groups to form to take advantage of those benefits. Those groups have a powerful motivation to create, preserve, and perpetuate government programs that favor their narrow interests at the expense of others, while those bearing the true costs of those policies or programs do not have the same incentive (or resources) to lobby government to reduce or end those burdens.

This leads to what economist Gordon Tullock called the “transitional gains trap”: once a policy or program is put in place to favor a certain interest, most of their gains come upfront and are factored into future earnings. Those benefiting from the policies would face large transitional losses if reform is undertaken, even if these policies impose large deadweight costs on society as a whole. This “trap” can frustrate beneficial reform efforts because the interest benefiting from the cronyist policies and programs will fight to the death to preserve them, no matter how costly or inefficient they may be for society as a whole.

There are several steps we can take if we hope to overcome the collective action problem in the tech sector and avoid Tullock’s transitional gains trap.

First, we must limit the scope of technology regulation whenever possible, and where existing rules open the door to cronyism, streamline or eliminate as many of them as possible. When policymakers deregulated other sectors in past—airlines, railroads, trucking, etc.—it helped eliminate the legal levers that industry could capture or influence. Consequently, deregulation forced companies to spend more time satisfying consumers as opposed to lawmakers and regulators.

Second, whenever possible we should rely on auctions and property rights to ensure that resources are being allocated according to market demand instead of political influence. The ugly history of spectrum cronyism is rooted in the misguided reliance upon the so-called “public interest” theory of regulation, which claimed that supposedly enlightened and benevolent regulators would steer resources and markets in more pro-consumer directions. The reality was just the opposite: the “public interest” became synonymous with the private interest of regulated entities, who largely “gamed” the system for their own ends. It was only when policymakers finally embraced the logic of auctions to allocate spectrum that America began to see cronyism dissipate in this sector. Auctions ensured faster allocation and more efficient distribution and development of this important resource. While full-blown spectrum property rights have not yet taken hold, the gradual movement in that direction helps minimize cronyism opportunities.

Third, the use of vouchers can help limit corporate gaming of social programs that are deemed essential. For example, America’s universal service program, which subsidizes phone and now broadband service, is a permanent fixture of communications policy. Unfortunately, cronyism is a permanent fixture of the system as well. Because the universal service system delivers assistance to end-users indirectly through favored local providers, it limits the potential for new entry and undermines competition. A means-tested voucher could have targeted assistance to those who needed it without creating an inefficient, unsustainable hidden tax or undermining competition.

Fourth, sunsetting provisions for new and existing laws and regulations can greatly limit cronyism opportunities. All new technology proposals should include a provision sunsetting the law or regulation within a few years of enactment and existing technology laws and regulations should be reopened and reassessed on a regular timetable as well to ensure they are not being abused. (Here’s a Forbes column I wrote last year with details about how to do so.)

Fifth, we need serious limits on congressional delegations of power to regulatory bodies and executive branch agencies. Too often, lawmakers “pass the buck” on to agencies and expect them to figure out how to interpret and administer arcane technology policy statutes. The result is abuse both by over-zealous regulators and interests looking to game the system. Congress should be more accountable and, at a minimum, must make their regulatory intent and standards clearer before delegating authority.

Finally, we need to encourage better norms inside the tech industry itself and encourage them to hold themselves to a higher standard. We should ask them to promise not to exploit government power that would discourage innovation or crush competition. Better yet, we should ask them to consider “strategic disengagement” with Washington and politics in general. Yes, I understand that sounds like a pipe dream since where power exists interests will likely look to exploit it. And, again, that’s the best reason for serious deregulation and strong limits on government power to begin with. But social pressure and market norms can also help in the absence of more sweeping reforms. Some firms already adopt the right approach. For example, Apple and Sony have largely shunned political engagement and instead focused on satisfying their customers in the marketplace. While their hands aren’t entirely clean, we should encourage more tech innovators to follow their general lead of not sending small armies of lobbyists to Washington and state capitals.

In the end, there is no silver-bullet solution that can forever cure cronyism. It would be foolish to pretend that we’ll be able to significantly curtail the scope of government powers in the short-term. Nonetheless, there are many sensible institutional reforms and marketplace norms that can help us keep cronyism in check before it begins running rampant in this important sector of our economy.

(Brent and I have just sent our paper on this topic off for peer review from some academic experts in this field, but we welcome thoughts from others about strategies to limit and reduce cronyism in this arena. We hope to publish this paper in a law review or poly sci journal later this Summer or Fall.)

Yesterday it was my privilege to speak at a Free State Foundation (FSF) event on “Ideas for Communications Law and Policy Reform in 2013.” It was moderated by my friend and former colleague Randy May, who is president of FSF, and the event featured opening remarks from the always-excellent FCC Commissioner Robert McDowell.

During the panel discussing that followed, I offered my thoughts about the problem America continues to face in cleaning up communications and media law and proposed a few ideas to get reform done right once and for all. I don’t have time to formally write-up my remarks, but I thought I would just post the speech notes that I used yesterday and include links to the relevant supporting materials. (I’ve been using a canned version of this same speech at countless events over the past 15 years. Hopefully lawmakers will take up some of these reforms some time soon so I’m not using this same set of remarks in 2027!)

I) The fundamental problem we face in the world of communications and media policy today is easy and diagnose and, at least in theory, easy to remedy.

The Problem= asymmetrical regulation / “unlevel playing field”

• Policymakers are imposing different regulatory policies on different layers of the modern information ecosystem. (This is sometimes referred to as the “regulatory silos” problem.)
• Regulatory silos and unlevel playing fields create 3 additional problems. They:

1. are unfair to those players who suffer under more onerous rules;
2. threaten to roll the old onerous rules on newer and less regulated speech and communications platforms and technologies; and,
3. create uncertainty and threatens investment and innovations.

The Solution (again, simple in theory but not in political reality) = level the playing field by deregulating down to achieve parity instead of regulating up

II) Let’s get more concrete about how to accomplish that sort of liberalization and level the playing field. Three simple reform ideas can help:

1. “MFN clause for communications and media policy”: To the extent Congress continues to place ground rules on the information sector at all, it should consider borrowing a page from trade law by adopting the equivalent of a “Most Favored Nation” (MFN) clause for communications and media policy. In a nutshell, this policy would state that: “Any operator seeking to offer a new service or entering a new line of business, should be regulated no more stringently than its least regulated competitor.” Such a MFN for communications would ensure that regulatory parity exists within this arena as the lines between existing technologies and industry sectors continue to blur. Placing everyone on the same deregulated level playing field should be at the heart of telecommunications policy to ensure non-discriminatory regulatory treatment of competing providers and technologies at all levels of government. In other words, to level the proverbial playing field properly, we should “deregulate down” instead of regulating up to place everyone on equal footing.
2. “Moore’s Law” for information technology laws and regulations: With information markets evolving at the speed of Moore’s Law, public policy must as well. Toward that end, every new technology proposal should include a provision sunsetting the law or regulation 18 months to 2 years after enactment. And this principle should apply retroactively so that old rules are sunset on a rapid timetable. If Congress deems them vital, they can always be reauthorized. [See my Forbes column on this proposal.]
3. Comprehensive FCC reform, downsizing & defunding: You can’t truly deregulate communications and media markets if the primary regulator (the FCC  in this case) remains large and is constantly growing its budget and responsibilities. Regulators exist to regulate! Only by downsizing and defunding them can we truly deregulate these markets. (Alfred Kahn and the Democrats taught us that in the late 1970s when the comprehensively deregulated airline and transportation markets and then moved to abolish the agencies that oversaw those sectors as well. They understood that the very existence of those agencies was a major contributing factor to economic inefficiency and crony capitalism.)

III) If wasn’t that long ago that this sort of an approach was considered the model for how to move forward

Following the lead of the Democrats who deregulated airlines and transportation sectors in the late 1970s, a number of scholars in the 1990s and 2000s devised comprehensive reform proposals for communications and media markets. (Two old PFF projects built on this):

• “The Telecom Revolution”: May 1995 proposal from @ a dozen different free-market think tank analysts to replace the FCC with a much smaller agency.
• “Digital Age Communications Act” project (“DACA”): a 2005-06 set of proposals from over 50 non partisan academics to make the FCC behave more like the FTC. [See this paper by Ray Gifford for a concise summary of the project and all the proposals).

Generally speaking, both projects focused on same 5 reform objectives:

1. Replacing the amorphous “public interest” standard with a consumer welfare standard, which is more well-established in field of antitrust law
2. Eliminate regulatory silos and level the playing field through deregulation
3. Comprehensively reform spectrum not just through more auctioning but through clear property rights
4. Reform universal service by either voucherizing it or devolving it to the States and let them run their own telecom welfare programs
5. Significantly reforming & downsizing the scope of the FCC’s power of the modern information economy

• If we can get those 5 things done, we will have accomplished true deregulation of America’s information marketplace.  What we don’t want is another fiasco like the Telecommunications Act of 1996, which represented an effort at managed competition. That law intentionally avoided providing clear deregulatory guidance and instead delegated broad and remarkably ambiguous authority to the FCC. This left the most important deregulatory decisions to the FCC and, not surprisingly, the agency did a very poor job of following through with a serious liberalization agenda.
• Again, regulators generally don’t deregulate themselves! It is against their self-interest. Congress must impose restraint on the agency and limit (or, better yet, end) its powers.

IV) Some will say communications & media markets are too important to deregulate. But the exact opposite is true.

• America’s Founders thought media was important enough that they made sure that the First Amendment clearly stated that “Congress shall make no law” as it pertains to freedom of speech and the press. They got it exactly right.
• We need to return to that Constitutional prime directive for information markets and start removing the layers of unjust and unnecessary regulation that have encumbered these markets for the past 100 years. America’s communications and media policy should once again be the First Amendment, not the Communications Act of 1934 or the Telecom Act of 1996.
• What we need, to borrow the title of Richard Epstein’s book of the same title, is “simple rules for a complex world.”  Those simple rules include: the law of contract, torts and common law, anti-fraud statutes, etc.
• Such simple rules can govern our complex information ecosystem the same way they govern every other sector of our capitalist economy. We don’t need a sector-specific regulator or body of regulation for communications, media, and the Internet.

[Video clip of my remarks from the FSF panel follows.]

Those of you who spend a lot of time thinking about public choice economics and the problem of cronyism more generally might appreciate this little blurb I found today about the Universal Service Fund (USF).

It goes without saying that America’s “universal service” (telephone subsidy) system is a cesspool of cronyism, favoring some companies over others and grotesquely distorting economic incentives in the process. And the costs just keep growing without any end in sight. Just go to any FCC meeting or congressional hearing about universal service policy and listen to all the companies insisting that they need the subsidy gravy trail to keep on rolling and you’ll understand why that is the case. But plenty of policymakers (especially rural lawmakers) love the system, too, since it allows them to dispense targeted favors.

Anyway, I was flipping through the latest copy of “The RCA Voice” which is the quarterly newsletter of what used to be called the Rural Cellular Association, but now just goes by RCA.  RCA represents rural wireless carriers who, among other things, would like increased government subsidies for–you guessed it–rural wireless services. Their latest newsletter includes an interview with Rep. Don Young (R-AK) who was applauded by RCA for launching the Congressional Universal Service Fund Caucus, whose members basically want to steer even more money into the USF system (and their congressional districts). Here’s the relevant part of the Q&A with Rep. Young:

RCA VOICE: “How important is it for carriers serving rural areas to be engaged with their members of Congress on USF issues?”

REP. DON YOUNG (R-AK): “The more carriers engage with both their Representatives and Senators, the better. While the early bird may get the worm, the bird that doesn’t even try definitely won’t get any worms. The same applies to Congress.”

Well, you gotta admire chutzpah like that! It pretty much perfectly sums up why universal service has always been a textbook case study of public choice dynamics in action. Sadly, it also explains why there isn’t a snowball’s chance in hell that this racket will be cleaned up any time soon.

The FCC’s universal service tax is officially out of control. The agency announced yesterday that the “universal service contribution factor” for the 1st quarter of 2012 will go up to 17.9%.  This “contribution factor” is a tax imposed on telecom companies that is adjusted on a quarterly basis to accommodate universal service programs. The FCC doesn’t like people calling it a tax, but that’s exactly what it is. And it just keeps growing and growing. In fact, as the chart below reveals, it has been exploding in recent years. It was in single digits just a few years ago but is now heading toward 20%. And not only is this tax growing more burdensome, but it is completely unsustainable. As the taxable base (traditional interstate telephony) is eroded by new means of communicating, the tax rate will have to grow exponentially or the base will have to be broadened to cover new technologies and services. We should have junked the current carrier-delivered universal service subsidy system years ago and gone with a straight-forward voucher system. A means-tested voucher could have targeted assistance to those who needed it without creating an inefficient, unsustainable hidden tax like we have now. For all the ugly details, I recommend reading all of Jerry Ellig’s research on the issue.

Freelance journalist Laurence Cruz was kind enough to call me recently looking for comment on whether broadband should be considered a human right. Well, actually, he probably didn’t have many options. If you do a quick search on the topic, you’ll find an endless stream of essays in favor of the proposition.  Then, somewhere in the mix, you’ll find a few dissenting rants I’ve penned here in the past. So I’m getting used to playing the baddie in this drama.

Cruz’s essay is now up over at “The Network,” which is Cisco’s technology news site. Here’s what I had to say in opposition to the proposition:

Not everyone is so ready to jump aboard this particular broadband bandwagon. “I don’t think there is any such thing as a human right to free, unlimited broadband service,” says Adam Thierer, a senior research fellow at the Mercatus Center, a market-oriented academic research institution at George Mason University in Arlington, Va. “The entitlement or rights mentality in America today is completely out of control.”

Thierer says he’s a firm believer in such fundamental human rights as freedom of speech, expression, movement and association—so-called “negative rights” that don’t require any assertion of government authority or demand payment from anybody. But he says any proposed right to broadband access is a different animal altogether—one likely to come at taxpayers’ expense and to have all manner of unintended consequences, from squelching competition to providing a poor level of service.

Thierer says the universal telephone service provided in America in the early 20th century by the original AT&T should serve as a cautionary tale against governments stepping in to provide universal broadband. He says the government-sanctioned Bell System monopoly provided mediocre telephone service to 93 percent of the U.S. population at best—whereas TV and radio hit 98 percent and 99 percent respectively, even though neither was subsidized or regulated. And what of the Bell System’s cheap prices? “We have no idea if it could have been much cheaper because competition was not allowed to develop,” Thierer says.

To clarify that last point… I’m certainly aware that broadcast TV and radio were regulated in various ways. In fact, I’ve spent a lifetime writing about it. But policymakers did not regulate broadcasting as aggressively as telephony in an attempt to achieve universal service. Indeed, “universal service” was the driving force behind communications monopolization in this country, but it had horrific consequences for consumers as I noted in my 1994 history of how communications competition was destroyed in the U.S. (See:  “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly.”)

But here’s the critical point: We live in a world of trade-offs and there is no free lunch. One doesn’t just mandate broadband for all and then expect there won’t be any costs — both direct and indirect. The direct cost is the cost to taxpayers or ratepayers in form of higher taxes or bills. The indirect costs usually arrive in the form of diminished competition, limited innovation, lackluster options, and the various problems associated with the regulatory capture that will ensue.

We must never forget that the best universal service policy is market competition. When we get the basic framework right — low taxes, property rights, contractual enforcement, anti-fraud standards, etc. — competition takes care of the rest.

For example, last week we learned that the number of wireless phone subscribers in the U.S. is now greater than the nation’s population: 327.6 million wireless subscriptions compared to a total population of 315.5 million people. That’s a penetration rate of nearly 104%. Of course, some of this is due to multiple subscription households. Even so, this is a rather astonishing development, and no one doubts that more Americans of every demographic group today have available to them an unprecedented array of wireless phones and plans. Prepaid plans are currently the hottest growth segment, in fact.

This amazing “universal service” story didn’t happen because of regulation or subsidies. It was vigorous competition and incessant innovation that spurred the spread of better, faster, and cheaper phones and service. We should remember that lesson next time anyone starts calling broadband–or other technological services–an inalienable human right.

Federal Communications Chairman Genachowski previewed the universal service reform plan the commissioners are discussing in a speech today.

The speech offers a masterful summary of the myriad inefficiencies created by the current universal service subsidies and intercarrier compensation payments. Most of the examples highlight plain old-fashioned waste. The universal service program collects billions of dollars from telephone subscribers, then simply wastes a goodly portion of it by subsidizing telephone competition in places where unsubsidized service from cable or satellite already exists, subsidizing multiple mobile wireless competitors, and subsidizing local phone companies that have little incentive for cost containment because they are still subject to rate-of-return regulation. The intercarrier compensation system uses per-minute charges to collect billions of dollars from telephone subscribers and hands it to phone companies that sometimes charge as little as $8 a month for phone service. There’s also a race to game this system as the companies that benefit seek new ways to inflate the regulated charges they collect, and the companies that pay seek clever ways to avoid paying.

It’s a powerful brief for reform. Never thought I’d live to see the day whan an FCC chairman would say so many things that are substantiated by economic research.

Nevertheless, a few parts of the speech give me cause for concern about the solutions the FCC commissioners may be discussing.

First, the chairman claims that 18 million Americans live in areas without access to broadband — up from the 14 million estimated in the National Broadband Plan.  The size of this figure suggests to me that the FCC is still over-estimating the number of people without access by defining “broadband” as a speed fast enough to exclude 3G wireless, many small rural Wireless Internet Service Providers, and satellite. Absent an adjustment in the definition of broadband, the subsidy program will be larger than it needs to be, and so telephone consumers will pay excessive universal service charges.

Second, the FCC still seems bent on subsidizing at least two broadband competitors in rural areas through the Connect America Fund and a separate Mobility Fund. This essentially presumes that fixed wireless service  and 4G mobile are, and always will be, separate services, and every rural customer is entitled to both. If the goal is basic broadband connectivity in places that allegedly have no broadband at all, why not make all technologies compete for a single subsidy in these places before proceeding to subsidize two?

Third, there’s a certain amount of technological favoritism.  Wireless subsidies will be awarded based on competitive bidding from the outset.  Subsidies for (fixed) service to homes and businesses will transition from current payments to competitive bidding — faster for phone companies subject to price caps, slower for phone companies under rate-of-return regulation. Satellite is mentioned just once — in a sentence discussing how service will be extended to the most remote areas. This continues the pattern set in the National Broadband Plan, which viewed satellite as a special-purpose technology suitable only for remote areas. For reasons unexplained, the plan assumed that wired and wireless broadband could expand capacity in response to subsidies, but satellite could not.

In summary: The speech gave a great diagnosis of the problem and sketched out solutions that will surely improve things compared to the way they are now.  But given that opportunities to actually achieve universal service reform (as opposed to just talking about it) come around rarely, there’s still room for improvement.

A couple days before Congress announced a debt deal, half a dozen telecommunications companies filed a plan on July 29 with the Federal Communications Commission that attempts to resolve a much longer-running set of negotiations over big bucks.  The “America’s Broadband Connectivity” Plan seeks to replace Universal Service Fund subsidies for telephone service in rural areas with subsidies for broadband in rural areas.

Like the federal budget negotiations, the never-ending negotiations over USF get bogged down in arguments over distribution: who gets what.  Indeed, it’s almost exclusively an argument over which companies get what. But federal telecommunications policy is supposed to advance the overall public interest, not just haggle over what corporate interest gets what piece of my pie. Here is a quick take on the biggest strengths and weaknesses of the plan in terms of advancing overall consumer welfare. By “consumer welfare,” I mean not just the welfare of the folks receiving subsidized services, but also the welfare of the majority who are paying a 15 percent charge on interstate phone services to fund the USF.

BIGGEST STRENGTHS

Fixed-term commitment: Rural phone subsidies have become a perpetual entitlement with no definition of when the subsidies can end because the problem is considered solved.  The ABC plan proposes a 10-year commitment to rural broadband subsidies.  By 2022 the FCC should assess whether any further high-cost universal service program is needed. This idea remedies a significant deficiency in the current high-cost subsidy program, which doesn’t even have outcome goals or measures. (That’s why I like to sing the final verse from “And the Money Kept Rolling In” from Evita when I talk about universal service.  Free State Foundation President Randy May asked me for an encore of this at the end of the foundation’s July 13 program on universal service, available here.)

Intercarrier compensation: “Intercarrier compensation” refers to the per-minute charges communications companies pay when they hand off phone traffic to each other. The plan proposes to ramp down all intercarrier charges to a uniform rate of $0.0007/minute.  Economists who study telecommunications have pointed out for decades that high per-minute charges reduce consumer welfare by discouraging consumers from communicating as much as they otherwise would.  MIT economist Jerry Hausman, in a paper prepared for the filing, estimates that low, uniform intercarrier charges would increase consumer welfare by about  $9 billion annually.

Legacy obligations: Public utility regulation traditionally forced regulated companies to offer certain services or serve certain markets at a loss, then charge profitable customers higher prices to cover the losses. Judge Richard Posner referred to this opaque practice as “Taxation by Regulation“: the customers paying inflated prices get “taxed” to accomplish a public purpose, but they don’t know it.  Some of these obligations continue today as federal requirements applied to “Eligible Telecommunications Carriers” or state “Carrier of Last Resort” obligations.  The plan would remove these obligations for companies that are not receiving USF subsidies.

BIGGEST WEAKNESSES

Definition of broadband: The plan would continue to inflate the cost of rural broadband subsidies by defining “broadband” as 4 megabytes per second download and 768 kilobytes per second upload.  This means 3G wireless, satellite, and some wireless Internet service providers do not count as “broadband.” This decision more than doubles the number of households considered “unserved” and rules out some lower-cost technologies.  Jerry Brito and I have written extensively about both the economics and the legality of this.  Interestingly, the ABC coalition’s legal white paper arguing that the commission has legal authority to adopt the plan makes no effort to show that the commission has authority to subsidize 4 mbps broadband; it only shows the commission has authority to subsidize some form of broadband.

Alternative cost technology threshold: The plan includes an “alternative cost technology” threshold that allows substitution of satellite broadband for customers who would cost more than $256/month to serve.  Inclusion of a threshold is actually a strength. But the $256/month figure is way too high.  Satellite broadband with speeds of 1-2 mbps is now available for $60 – $110 per month.  Consumers who pay a 15 percent surcharge on their local phone bills to fund USF should not be expected to provide a subsidy of more than $200 per month.

Mobility: The plan appears to advocate subsidies for mobile broadband service in places where it is not currently available.  So now the rural entitlement expands to include not just basic broadband service in the home to stay connected, but also a mobile service that a lot of Americans don’t even buy unless their employers pay for it! I question whether mobile broadband satisfies the 1996 Telecommunications Act’s criteria for universal service subsidies, such as “essential” (not just nice) for education or public safety, or subscribed to by a “substantial majority” of households. These questions should be thoroughly examined before anyone receives subsidies for mobile broadband. At a minimum, households should be eligible for only one broadband subsidy — wireline or mobile — but not both.

While most folks have been obsessing over their income taxes the past few weeks, Jerry Brito and I have been obsessing about a non-tax: the universal service assessments on our phone bills.

More specifically, the Federal Communications Commission has asked for comments on its plan to gradually turn the current phone subsidy program in high-cost rural areas into a broadband subsidy program in high-cost rural areas. This opens up a big tangled can of worms.  Comments are due Monday.  We deal with two issues in our comment:

Definition of broadband: Thankfully, the FCC is asking for comments on its proposal to define broadband as 4 Mbps download/1 Mbps upload. This is an important decision with a big effect on the size of the program. The 4 Mbps definition more than doubles the number of households considered “unserved,” because it doesn’t count 3G wireless or slower DSL or slower satellite broadband as broadband. It also raises the cost of the subsidies by requiring more expensive forms of broadband.

The definition fails to fit the factors the 1996 Telecom Act says the FCC is supposed to consider when determining what communications services qualify for universal service subsidies.  A download speed of 4 Mbps is not “essential” for online education; most online education providers say any broadband speed or even dialup is satisfactory. Nor is that speed “essential” for public safety; the biggest barrier to public safety broadband deployment is creation of an interoperable public safety network, which has nothing to do with USF subsidies. And the proposed speed is not subscribed to by a “substantial majority” of US households.  The most recent FCC statistics indicate that the fastest broadband download speed subscribed to by a “substantial majority” of US households is probably 768 kbps.

Definition of performance measures: Fifteen years after passage of the legislation that authorized the high cost universal service subsidies, the FCC has proposed to measure the program’s outcomes.  Actually, the FCC wants to measure intermediate outcomes like deployment, subscribership, and urban-rural rate comparability — not ultimate outcomes like expanded economic and social opportunities for people in rural areas.  But it’s a start …  provided that the FCC actually figures out how the subsidies have affected these intermediate outcomes, rather than just measuring trends and claiming the universal service subsidies caused any positive trends observed.  We have some suggestions on how to do this.  

Our full comment is available here.

In previous posts, I’ve criticized the Federal Communications Commission for arbitrarily jacking up the speed in its definition of broadband (to 4 mbps download/1mbps upload) so that third generation wireless does not count as broadband. This makes broadband markets appear less competitive.  It also expands the “need” for universal service subsidies for broadband, since places that have 3G wireless but not wired broadband get counted as not having broadband.

The FCC’s definition is based on the speed necessary to support streaming video.  I rarely watch video on my computer. But tonight I had a chance to test the wisdom of the FCC’s definition.  I’m in rural southern Delaware with broadband access only via a 3G modem. I wanted to watch more State of the Union coverage than the broadcast channels out here carried. So, I fired up the old PC and watched things on CNN.com.  The video showed up fine and smooth, and it didn’t even burp when I opened another window to start working on this post.

So now I have not just analysis that questions the FCC’s definition of broadband, but that most precious of commodities in Washington regulatory debates: AN ANECDOTE!!!

The folks at the Pew Research Center’s Internet & American Life Project came out with another installment of their “Home Broadband” survey yesterday. This one, Home Broadband 2010, finds that “adoption of broadband Internet access slowed dramatically over the last year.” “Most demographic groups experienced flat-to-modest broadband adoption growth over the last year,” it reports, although there was 22% growth in broadband adoption by African-Americans.  But the takeaway from the survey that is getting the most attention is the finding that:

By a 53%-41% margin, Americans say they do not believe that the spread of affordable broadband should be a major government priority. Contrary to what some might suspect, non-internet users are less likely than current users to say the government should place a high priority on the spread of high-speed connections.

This has a number of Washington tech policy pundits scratching their heads since it seems to cut against the conventional wisdom.  Cecilia Kang of The Washington Post penned a story about this today (“Support for Broadband Loses Speed as Nationwide Growth Slows“) and was kind enough to call me for comment about what might be going on here.

I suggested that there might be a number of reasons that respondents downplayed the importance of government actions to spur broadband diffusion, including that: (1) many folks are quite content with the Internet service they get today; (2) others might get their online fix at work or other places and not feel the need for it at home; and (3) some may not care two bits (excuse the pun) about broadband at all.  More generally, I noted that, with all the other issues out there to consider, broadband policy just isn’t that important to most folks in the larger scheme of things. As I told Kang, “Let’s face it, when the average family of four is sitting around the dinner table, to the extent they talk about U.S. politics, broadband is not on the list of topics.”

I also noted that many Americans are getting increasingly fed up with the scope of government power and the sort of wasteful spending that is increasingly bankrupting our nation and future generations.  More specifically, to the extent people know about them, existing universal service schemes for telephone service are massively inefficient and a prime example of why many Americans don’t trust their government to deliver on such grandiose tech-entitlement promises. One government report after another lambastes the waste, fraud, and abuse that runs rampant today our universal service system, and yet, those programs just keep growing and growing, year after year.

That’s why I told Kang that extending the same kind of federal aid to broadband providers is not likely to be any more efficient. “My skepticism comes from a poor government track record on tech funding,” I told her.  And I suspect that many people are equally skeptical for such reasons, and that might be influencing their answers when responding to Pew or other surveys.

Finally, I bet there are some folks out there who believe that, to the extent government should have a role in the “spread of affordable broadband” at all, that role should be focused on (1) clearing the deck of unnecessary regulatory burdens that prevent quicker rollout of privately-funded networks, and (2) limiting any subsidies that may be needed after that to targeted state and local programs for the truly neediest, not grandiose federal tech-pork barrel schemes.  Indeed, that’s my own position.

Of course, as I’ve noted here many times before, liberty is a loser these days and the natural progression of history is for Big Government to just grow and grow and grow.  So, I am prepared to get in line for my own tech handouts, as I noted in my essay last October, “Broadband as a Human Right (and a short list of other things I am entitled to on your dime).”

In a 3-2 vote, the Federal Communications Commission recently decided to jack up its official definition of “broadband” from 200 kbps download to the 4 mbps dpwnload/1 mbps upload used as a benchmark in Our Big Fat National Broadband Plan. The three commissioners in the majority also declared that the definition of broadband will continue to evolve as consumers purchase faster connections to utilize new applications.

Several months earlier, the FCC launched a proceeding to figure out how to convert universal service subsidies for rural telephone service into universal service subsidies for rural broadband service.  Put these two decisions together, and it looks like the majority on the FCC is hell-bent on establishing rural broadband subsidies as a perpetual entitlement program that will never “solve” the rural availability problem because the goalposts will keep moving.

The current USF program taxes price-sensitive services (long distance and wireless) to subsidize a service that is not very price sensitive (local phone connections).  If the FCC takes a further step on the funding side and starts collecting universal service assessments from broadband, it will diminish broadband subscribership by taxing a service that is even more price sensitive: broadband connections. (I explained this a few months ago here.)

It’s time to get off this merry-go-round. The solution was suggested by MIT economist Jerry Hausman back when the FCC first started creating the current universal service programs in response to the Telecom Act of 1996: use revenues from spectrum auctions. 

Instead of having the FCC perpetually collect assessments from broadband or telephone services to subsidize broadband buildout in rural areas, Congress should earmark revenues from the next spectrum auction for one-time buildout grants in high-cost areas. The grants should be awarded via a competitive procurement auction that would force subsidy-seekers in different locations to compete with each other for the federal dollars. And Congress should explicitly wind down the universal service telephone subsidies in high cost areas and prohibit the FCC from using universal service assessments to fund broadband deployment in these places.

Using revenues from spectrum auctions would avoid the distortions and perverse consequences caused by ongoing universal service assessments on broadband or telephone services. One-shot deployment grants would ensure that the availability problem gets solved, so the federal government can declare victory and get out of the perpetual subsidy business.

Of course, some locations in the US are so expensive to serve that the potential revenues might not even cover the operating costs of broadband. But it does not follow that operators in these places need an ongoing stream of subsidies. When preparing their subsidy bids, they will have to calculate how large the one-shot payment needs to be to induce them to take on the capital costs and the ongoing operating costs. In other words, they can bank some of the one-shot subsidy and use it to cover the difference between revenues and operating costs.

This modest proposal does not address all aspects of the universal service fund. But it would achieve a clear objective — bringing broadband to rural areas — while allowing the FCC to extricate itself from the business of distributing $4.6 billion a year in subsidies. Let’s see a timetable for withdrawal!

The Federal Communications Commission has an open proceeding in which it seeks advice on how to repurpose universal service subsidies for phone service in high cost areas to subsidize broadband instead. The FCC apparently wants to subsidize broadband with a minimum download speed of 4 megabytes per second (mbps) and upload speed of 1 mbps. These are the goals proposed in the commission’s National Broadband Plan.

I’m no lawyer, but I wonder if the FCC can do this legally. Section 254 of the Telecommunications Act of 1996 lays out criteria the FCC is supposed to consider when it decides whether to provide universal service subsidies for new services in addition to phone service. One of the criteria is that the new service must be subscribed to by a “substantial majority” of residential consumers.

Sixty-five percent of Americans have broadband at home. (National Broadband Plan, p. 167)  But a minority of residential customers subscribe to broadband that meets the FCC’s 4 mbps/1 mbps definition. According to the FCC’s Omnibus Broadband Initiative technical report on the “Availability Gap” (p. 43), 48 million subscribers have download speeds of 4 mbps or higher. More subscribers – 53 million – have broadband download speeds of 3 mbps or lower. And 35 percent of Americans have no broadband at all. These figures imply that a “substantial majority” of Americans have not subscribed to broadband that meets the National Broadband Plan’s proposed definition.

Based on figures in the technical report, I calculated that approximately 59 percent of Americans subscribe to broadband with a download speed of 768 kbps or higher. Perhaps this figure qualifies as a “substantial majority,” but surely the 4 mbps/1 mbps definition does not.

A reasonable person might also question whether even 59 percent counts as a “substantial majority” for the purpose of declaring broadband a service eligible for subsidy. Surely Section 254 requires a “substantial majority” in part to ensure that consumers who have chosen not to subscribe to a service do not bear the injustice of having to subsidize the provision of that service to others. It is clear from the FCC’s figures that most of the 35 percent of American households without broadband have it available but choose not to subscribe. Therefore, subsidizing even 768 kbps broadband would force many consumers to pay universal service assessments to provide others with a subsidized service that they themselves have decided is not worth the cost.

Wait and see how the FCC addresses this issue once it starts creating a universal service program for broadband.

We all pay “universal service” assessments on our phone bills.  It’s even broken out separately; go look. It’s probably just a matter of time before the Federal Communications Commission proposes to slap universal service assessments on broadband service to help pay for universal service subsidies for broadband service. The national broadband plan, after all, calls for “broadening” the universal service funding base.

If the commission reclassifies broadband as a “Title II” telecommunications service, this will be virtually automatic because the Telecommunications Act of 1996 says telecommunications providers must contribute toward the FCC’s universal service fund. If the commission doesn’t reclassify broadband, it could still require contributions — just like it imposed universal service assessments on VOIP without classifying VOIP as telecommunications.

After the FCC starts using universal service funds to subsidize broadband for poor people and rural households, the logic will be seductively compelling: “Broadband receives subsidies, so it’s only fair that broadband pays into the fund.”

Forget the ensuing howls about “taxing the Internet.”  I want to talk about another aspect of this.  Would imposing universal service assessments on broadband actually further the FCC’s goals in its national broadband plan?

Photo by nawtydawg.

The FCC wants to make broadband available to all Americans, regardless of where they live. Ideally, the FCC would like us all to subscribe, regardless of our income or where we live. The problem with imposing universal service assessments on broadband is that this would increase the price, leading subscribership to be lower than it would otherwise be.

This effect might be big or it might be little. But before making a decision about imposing universal service assessments on broadband, the FCC ought to know the size of the effect and how it compares to the increase in subscribership that would result from the subsidies.

To figure out how universal service assessments might affect broadband subscribership, we need to know how responsive broadband subscription is to changes in price. Economists call this the “price elasticity of demand.” The most recent study I’ve seen — and the only one cited in the FCC’s technical paper underlying the national broadband plan — estimates the elasticity of broadband demand was about -0.69 in 2008. That means a 1 percent increase in price would lead to a 0.69 percent decrease in subscribership. Other, earlier studies find much higher demand elasticities. But to be conservative, let’s use -0.69.

Current universal service assessments on interstate telecommunications are about 15 percent.  About 66.6 million households had broadband in 2008. A 15 percent increase in the price of broadband would reduce subscribership by about 6.9 million households (15% times -0.69 times 66.6 million.)

If the FCC imposed universal service assessments on broadband, it might be able to lower the rate since it would be collecting assessments from a broader base than just telephone service. Suppose the FCC could lower the assessment to 10 percent, more in line with the historical norm.  A 10 percent increase in the price of broadband would reduce subscribership by 4.6 million households (10% times -0.69 times 66.6 million).

So we’re going to reduce broadband subscribership by 4.6-6.9 million households in order to provide subsidies to increase broadband subscribership.  If the funds currently spent to subsidize phone service in rural areas were spent on broadband, that would be enough money to close the “funding gap” and make broadband available to the 7 million homes the FCC  says currently are unserved or under-served. 

Not all of them will susbcribe, so we can’t assume these subsidies will increase subscribership by 7 million.  About 65 percent of Americans currently have broadband at home.  If 65 percent of unserved or underserved households choose to subscribe once broadband becomes available, that would be  4.55 million new subscribers.

In short, it looks like subjecting all broadband to universal service assessments to pay for rural broadband subsidies would either be a wash or reduce subscribership on net. Paying for universal broadband service with assessments on broadband service will give the FCC a lot to do, but it won’t advance the subscribership goals of the national broadband plan. 

There are other ways to raise the money without this perverse effect. Historically, local telephone subscription has been very insensitive to price, so one option would be for the FCC to simply impose a universal service charge per phone number instead of the current percentage fee.  (Low-income households who have “Lifeline” service or use low-cost prepaid wireless plans could be charged a lower fee without sacrificing much revenue.)

Another option would be for Congress to earmark some revenues from upcoming spectrum auctions to fund universal broadband service, and reduce the universal service assessments on our phone bills accordingly.

Reasonable people can differ on whether, or by how much, the federal government should subsidize broadband where it is not currently available. But if we’re gonna do it, there’s no sense in funding it with a mechanism that reduces broadband subscription elsewhere.

Back on St. Paddy’s Day, I offered a few comments on the “funding gap” identified in the FCC’s just-released national broadband plan. Since then, the FCC has put out a notice of proposed rulemaking and notice of inquiry seeking public comment on reforms that would allow its universal service fund to subsidize broadband. The FCC has also released a 137-page technical paper that details how the staff calculated the broadband “availability gap” and funding gap.

So, now there’s more to chew on, and another round of online mastication would be timely given the open FCC proceeding.  Here are three big issues:

1. Definition of broadband

The plan announced a goal of making broadband with actual download speeds of 4 mbps available to all Americans.  In the plan, this goal appeared to be based on the actual average speed of broadband service (4 mbps), even though the median speed is just 3.1 mbps (p. 21). The technical paper, however, also projects that, based on past growth rates in broadband speed, “the median will likely be higher than 4 mbps by the end of 2010.” (p. 43)  Contrary to what I thought back in March, it appears the FCC is justifying the 4 mbps goal based on the median speed, not the average. 

The technical report also argues that 4 mbps is necessary to run high-speed video, which a “growing portion of subscribers” (not including me) apparently use. (p. 43) So, if the broadband plan achieves its goals, every Amercian will have the opportunity to subscribe to Internet access capable of delivering high-quality porn! Fortunately, the technical report uses a different and more productive example — streamed classroom lectures. 

Reasonable people could still question whether the median is the appropriate benchmark to guide government actions intended to equalize broadband access opportunities.  The technical report includes a helpful graphic that shows the most common broadband speed users actually buy is 2 mbps, and 38 percent of all subscribers have speeds of 2 mbps or less. (p. 43) The FCC staff’s model calculates that if the goal were set at 1.5 mbps, the number of “unserved” households would fall from 7 million to 6.3 million, and the required subsidy would fall from $18.6 billion to $15.3 billion. (p. 45) 

If almost half of broadband subscribers have decided that something less than 4 mbps is perfectly adequate, that suggests 4 mbps may go far beyond what is necessary to ensure that all Americans have access to basic broadband service. So, that 4 mbps goal is still questionable.

2. Omission of 3G wireless

The 4 mbps goal allowed the FCC to ignore third generation wireless when it estimated the “availability gap.” The technical paper shows that 95 percent of households have 4 mbps broadband available. About 3 percent of households have no broadband available, while 2 percent have broadband available at speeds ranging from 384 kbps – 3 mbps. (p. 17)  That 2 percent probably includes households with slow DSL and 3G wireless.

The technical paper also revealed that it did not include service from fixed Wireless Internet Service Providers due to data availability. (p. 25) These serve 2 million subscribers in rural areas (p. 66), so the omission potentially accounts for a large chunk of the households considered “unserved.” No telling how many, since apparently the data aren’t available.

Back in March, I guesstimated that the 7 million household “availability gap” might overstate the size of the problem by more than half, simply because 3G wireless is available to 98 percent of American households. Looks like my guesstimate is pretty much in line with the more detailed figures in the FCC technical paper.

 3. Role of satellite

The broadband plan did not count satellite broadband when assessing availability. The technical paper (pp. 89-94)provides a much more detailed explanation of the capacity constraints the FCC staff believes will prevent satellite broadband from serving more than a couple million subscribers.   (The current satellite subscriber base is approximately 900,000.)

The technical paper pointed out that satellites are expensive and take three years to build. (p. 92) To put the time frame in perspective, that’s about as long as the FCC and the Federal-State Joint Board on Universal Service have been discussing universal service subsidies for broadband. Lord knows we shouldn’t make consumers wait that long!

There is, however, something a little asymmetrical about the way the FCC staff treated satellite and other forms of broadband. The point of estimating the broadband availability gap was to determine how much of a subsidy would be required to induce the private sector to build the infrastructure to close the gap. But while the study assumed that the subsidies would call forth the requisite cable, DSL, and wireless infrastructure within some unnamed but acceptable time frame, it decided that three years is just too long to wait for satellite infrastructure to expand. So, satellite plays a minimal role in the FCC’s plan.

Yet even this minimal role has a big impact. To its credit, the technical paper calculated how satellite broadband could dramatically slash the cost of serving the most expensive 250,000 homes. It estimated (pp. 91-92) that the net present value of subsidies required to serve these homes with satellite would range between $800 million and $2 billion — compared to a $13.4 billion subsidy required to serve these homes with terrestrial broadband. (This implies an annual subsidy of $105-255 million, which is pretty close to my March 17 guesstimate of $100-200 million.)

So, satellite broadband could help prevent costs from skyrocketing, even assuming it plays only the limited role envisioned in the FCC staff’s analysis.

… in receiving support from the Federal Communications Commission’s Universal Service Fund.

In case you missed it, on December 31 the Federal-State Joint Board on Universal Service issued its 2009 Universal Service Monitoring Report. This 568 page report compiles a massive number of statistics on the Federal Communications Commission’s $7.6 billion Universal Service Fund.  This fund subsidizes phone service in high-cost areas, phone subscriptions for low-income households, Internet service for schools and libraries, and Internet connections for rural health care facilities. About 60 percent of the money — $4.4 billion — goes to “high cost” (usually rural) phone companies.

The money comes from the universal service charge on your wired, wireline, or VOIP phone bill. (That’s why the phone companies put the FCC’s phone number on the bill, so you can call the FCC if you have questions about this charge. Isn’t that thoughtful!)

Virtually every table in the Monitoring Report is fascinating. But check out some of the statistics to the right, which came from Table 1.12.  After substracting the universal service charges paid by its citizens, Mississippi received the highest net amount from the Universal Service Fund — $258 million. Alaska, Puerto Rico, Kansas, and Oklahoma round out the top five net recipients.

Some states are net payers. Florida paid $304 million more into the Universal Service Fund than its phone companies, low-income consumers, schools, libraries, and rural health facilities received back. Not surprisingly, other big, high-income states with large urban areas are also big net payers.

Some states receive close to what they pay in. Although Texas is a big Universal Service Fund recipient ($511 million in 2008), Texas telephone customers also pay a lot into the fund ($508 million in 2008). Thus, Texas received a net $3 million from the Universal Service Fund. Other states close to breakeven are Arizona, Missouri, Oregon, and South Carolina.

For 2008, I counted 22 states that are net recipients of $15 million or more, and 23 states that are net payers of $23 million or more.

And you thought you had fun on New Year’s Eve!

In a speech yesterday, FCC Chairman Julius Genachowski pledged to revisit the Federal Communications Commission’s universal service programs for telecommunications as part of the National Broadband Plan: 

 The key points for today are these: USF is a multi-billion dollar annual fund that continues to support yesterday’s communications infrastructure. The goal of universality is as important as ever — and to meet our country’s innovation goals, we need to reorient the fund to support broadband communications. This is a thorny issue, with no shortage of practical and statutory challenges. We need to wring savings out of the system, protect consumers, avoid flashcuts, while ultimately moving USF in the direction it needs to go to support our 21st century platform for innovation. 

The USF program spends approximately $7 billion annually. Most of the money goes to subsidize phone service in “high cost” areas. Eeuww – phone service.  So twentieth century! All of us who have not yet shifted 100% of our personal communications to Facebook and Twitter pay for the universal service fund via surcharges of about 12 percent on our wireless and  wireline phone bills, including VOIP. (Dirty little secret: you also pay for universal telephone service if you use a wireless broadband card, because each card is assigned a phone number.) 

Genachowski’s comment follows some rather interestingly-timed announcements from the FCC’s broadband task force. On November 13, the task force asked for public comment on the role the universal service fund and “intercarrier compensation” (another, more opaque set of transfers from consumers in general to rural phone companies) should play in the national broadband plan. Comments are due December 7. Five days after soliciting comments, on November 18, the FCC announced that the structure of the universal service fund is one of the “critical gaps” in the path to universal broadband.

I doubt the FCC has telepathically determined what the parties will say in the comments they file on December 7, but there’s no need to. The FCC has ground through so many rounds of comments on universal service reform that the problems and potential solutions are well-known. At a conference on universal service about five years ago, I recall one speaker commented, “Everything that can be said about universal service has already been said, but not everyone’s had a chance to say it, so that’s why we still have conferences on it.” About a year ago, the FCC almost used a court-imposed deadline as an opportunity to actually reform universal service and intercarrier compensation, but the commissioners failed to reach consensus.

Here are some major problems with the universal service fund, in no particular order:

• It subsidizes voice phone service with built-in incentives for inefficiency on the part of providers.
• It subsidizes wireless voice service without limiting the subsidy to one essential connection per household, so it has effectively created an entitlement to both wired and mobile phone service in rural areas.
• The FCC does not measure or track the outcomes produced by the subsidies to see what they actually accomplish for the public. (Section 201 of the draft Boucher-Terry USF reform bill would require the FCC to adopt outcome-oriented performance measures.)
• The contribution mechanism acts like a percentage tax that discourages use of price-sensitive services like long-distance, wireless voice, and wireless broadband.
• The “death of distance” has slashed long-distance phone charges, which means wireless bears a growing percentage of the burden and the funding mechanism may well be unsustainable.

(For more detail on these issues, read the assortment comments on USF reform by various Mercatus Center colleagues and me here, here, here, here, here, here, here, here, here, and here. BTW, did I mention this issue has been beaten to death?)

So is the FCC jumping the gun, rushing to judgment on universal service before the comments are in?  Heck no. It’s about time.

The Entertainment Consumers Association (ECA) is a group that does some good things to mobilize gamers to fight misguided regulation of video games. I greatly appreciate their tireless efforts to fight stereotypes and myths about games and gamers, and to specifically counter the hysteria about video games that we sometimes see in the press, and definitely see in political circles on a regular basis.  They’re a great ally in the fight for freedom of speech and artistic expression in this field.

That’s why I was so sorry to see the ECA launch a new campaign that encourages gamers to petition their congressional leaders and encourage them to regulate the high-tech economy more and waste more taxpayer dollars on inefficient universal service programs and subsidies:

Net Neutrality and Universal Broadband are not only great for America; they allow us to play the games we want at high speeds! … ECA believes that Universal Broadband and Net Neutrality are vital for the development of the national infrastructure, and believes that this bill is an important opportunity to let Congress know that you agree.

Sorry, but someone at the ECA will have to tell me how Net neutrality regulation will make my online Madden and Tiger Woods Golf experience move faster. If anything, such regulations would slow things down by making it more difficult for carriers and gaming networks to create more effective bandwidth management schemes and pricing plans such that my video game bits can get through faster. Is that called “discrimination”? You better believe it, and it’s a great thing. Go ask Microsoft why they signed up Limelight Networks a couple of years ago to help them make the Xbox Live experience more tolerable.  Empowering regulators to micromanage this process, by contrast, is just going to quash innovative approaches to the problem and invite more regulation of high-tech markets in general. That won’t help gamers in the long run.

Regarding the call for universal service subsidies… I suppose I could see the ECA’s logic if those schemes actually worked. But we have 70 years of experience with these pork subsidy programs and they have proven to be an abysmal failure. They are prone to extreme waste, fraud, and abuse and, worse yet, those inefficient subsidies have discouraged competition in rural areas. You’re not going to get more entry in the broadband business by subsidizing favored local operators all day long. And subsidizing risky new ventures isn’t much better since it just lets bureaucrats roll the dice with our tax dollars.  Bad idea.

Finally, there’s a more important principle matter at stake here: If you want to hold the line on future government attempts to regulate video games, it’s generally not a good idea to come to Congress asking for favors in the form of new regulation or spending. With one hand government giveth; with the other they (eventually) take away.

One of the reasons that so many of us here take issue with proposals to expand regulation of communications, broadband, and media markets is because we have studied the horrendous inefficiencies of economic regulation in practice. We oppose regulatory proposals not because of a “blind faith” in free markets, but because we understand that even when markets stumble they correct themselves quicker and more efficiently than regulatory systems do. One can profess the supposed theoretical benefits of enlightened “public interest” regulation all they want, but the facts are the facts. And the facts do not support the proposition that government regulation generally enhances consumer welfare.

In that regard, Tim Lee’s new Net neutrality report for Cato does a nice job of surveying some of the past unintended consequences of regulation. Also, even though it is now 10 years old, I highly recommend “Economic Deregulation and Customer Choice” by Jerry Ellig and Robert Crandall. It’s an outstanding overview of why economic regulation of various industries failed consumers so miserably in the past.

But if you want even more shocking proof of how horrendously inefficient communications regulation can be in practice, then you must read my PFF colleague Barbara Esbin’s two essays this week on the Universal Service Fund (USF): “The High Cost of USF Support,” and “More FCC Support Fund Follies.” In these two essays, Esbin walks the reader through various grim reports and statistics that have been released recently documenting the failures of the USF.

Her first essay notes how a recent FCC Inspector General report found that the USF “High Cost” fund is spiraling out of control. According to a FCC press release, that report found that “a program is at risk if the erroneous payment rate exceeds 2.5% and the amount of erroneous payments is greater than $10 million. The estimated erroneous payment rate for the High Cost Program (“HCP”) was 23.3%. The previous estimate was 16.6%. Total estimated erroneous payments were $ 971.2 million as compared with the previous estimate of erroneous payments of $617.8 million. Accordingly, the FCC-OIG concluded that the High Cost Fund program is “at risk” under applicable [..] criteria.”

Esbin puts these shocking results in perspective:

“At risk” is a surely a euphemism for a program that loses in “erroneous payments” nearly one out of every four dollars collected from telephone subscribers. In 2007, pursuant to FCC rules, telephone consumers were effectively taxed over $4 billion for the high-cost portion of the USF. Thus, nearly $1 billion dollars of subscriber money went out the door in “erroneous payments.” As the report makes clear, erroneous payments include both over- and underpayments, and also instances where the agency is unable to discern whether a payment was proper as a result of “lack of documentation.” The report’s conclusions state that the “rate of improper overpayments is 22.8%, and the proportion of improper overpayments out of total improper payments is 98.2%.” To be considered “erroneous,” an payment “need not be the result of fraudulent misrepresentation, or a corrupt administrative process.” “Nor does it necessarily exclude those factors as potential causes of erroneous payments.” Significantly, nor are “the erroneous payments . . . necessarily recoverable from recipients by process of law.” Fabulous. Not only has nearly $1 billion in erroneous overpayments gone missing, but even if final audits indicate where it has gone, it may not be recoverable! Among the interesting results of this preliminary report are the identified causes of erroneous payments. According to Table 2 of the report, 50% of the causes of erroneous payments can be attributed nearly equally to two factors: either “Inadequate Documentation” (25.3%) or “Inadequate Auditee Processes and/or Policies and Procedures” (24.6%). Another 10% “Disregarded FCC Rules” and 12% had “Applicant/Auditee Weak Internal Controls.” That is, roughly 75% of the erroneous overpayments can be attributed to poor bookkeeping, inadequate internal controls and “disregard” of FCC rules. This is stunning information. No wonder it made its appearance the day before Thanksgiving.

But wait, things get worse. So much worse. In Esbin’s second essay, she notes that:

On Monday, the OIG released its Semi-Annual Report to Congress, discussing the full range of audit activities conducted from April 1, 2008 to September 30, 2008. Thus we learn that in addition to the loss of nearly $1 billion in erroneous overpayments to the High Cost program, another fund the FCC is ultimately responsible for, the “Telecommunications Relay Service” (TRS) Fund, which provides funds for a variety of telephone transmission services for those with hearing and speech disabilities, also appears to be at risk for substantial overpayments due to the lack of adequate controls. Since 1993, according to the FCC’s website, the Commission’s rules have required that each common carrier providing voice transmission services provide TRS throughout its service area. All providers of interstate telecommunications services contribute to the TRS Fund, and TRS providers recover the costs of providing interstate services from the Fund on a minutes-of-use basis. Intrastate TRS funding is generally administered by the states, although some intrastate TRS offerings are supported by the interstate TRS Fund. The current TRS Fund Administrator is the National Exchange Carrier Association (NECA). Although NECA directly manages the Fund, the FCC sets the Fund size and carrier contribution factor annually and is ultimately responsible for Fund oversight. When the TRS Fund started, it disbursed about $31 million, growing to over $38 million by 1999. Since 1999, the OIG report states that the TRS Fund has increased approximately 50-80% each year, to reach $637 million for the Fund’s fiscal year from July, 2007 to June, 2008. The size of the fund for the current fiscal year is $850 million, a 26% increase over the previous fiscal year. That is, in roughly ten years the TRS Fund has ballooned from $38 million to $850 million! What, if any, other communications service has seen 50-80% growth in costs per year?

Indeed, that is a shocking degree of waste and inefficiency by just about any standard. And Esbin goes on to document specific examples of this waste and inefficiency in action within the TRS Fund. It’s shocking stuff and doesn’t make for pleasant reading if you care about good government.

Barbara is actually much more tempered and tolerant than me when it comes to what to do about all this. She recommends a lot more reform and oversight. If you ask me, however, then entire USF program should be dismantled immediately and any future support deemed necessary should be distributed directly to consumers at the state level in the form of a welfare payment. After all, at root, that’s what universal service is: a communications industry welfare program, but one in which most of the support flows to companies instead of individuals. And that makes it one of the most insanely misguided and inefficient regulatory / subsidization systems known to man. 13 years ago, in one of the very first things that PFF ever published ( The Telecom Revolution: An American Opportunity) I was advocating exactly this sort of a plan along with a dozen other think tank colleagues. (And we also set forth another, less radical reform plan than the “voucher-ize & devolve” plan I favored).

But no one listened. Business as usual continued. And so the endless waste and inefficiencies continue. Somebody will have to remind me how any of this benefits consumer welfare. I can’t see how anyone could make such a case, and I would hope the USF follies serve as a cautionary tale for how the best of intentions are meaningless when it comes to what regulation actually means in practice. Because it sure ain’t pretty.

But hey, it’ll all be different going forward right? We just need to have faith in the media reformistas and the Net neutralitistas.  If we click our heels together enough time and just wish hard enough, all our dreams can come true.

Sure.