October 22, 1998

Re:	Forward-Looking Mechanism for High Cost Support for Non-Rural LECs; (CC Docket Nos. 96-45, 97-160) .

I want to express my appreciation to the staff who have worked so diligently to produce this internal model. I agree that this model has many benefits over either of the two industry submitted models, and I congratulate those involved for creatively incorporating the best aspects of both proposals.

Today, the Commission takes the next step in its plan to determine, from here in Washington, D.C., the total cost of providing service to every high cost resident in the country and then use that estimate to determine the total amount of high cost universal service support that should be needed to ensure service to everyone. I question whether the Commission can use such a hypothetical model to determine the cost -- whether actual or forward-looking -- of providing service to every individual, including those located in the remotest regions of our country. Moreover, I object to using a model to determine the total federal universal subsidy that is now needed or to distribute that subsidy among the states. Using a model for either of these purposes, as the Commission seems intent on doing, conflicts with the Telecommunication Act's mandate that we "preserve and advance" universal service and contradicts the Commission's promise to Congress last spring to the hold the States harmless -- i.e. guarantee that the adoption of a new federal universal service subsidy scheme would not result in any state receiving "less total interstate universal service support than is currently provided through aggregate implicit and explicit federal subsidies."⁽¹⁾ For these reasons, I dissent in part from today's Order.

I question, however, not that the model adopted today is superior to either model originally proposed, but the Commission's purpose in adopting a model at all. Indeed, as one fellow economist explained to me the other day, "but the model is good at evaluating relative costs" -- i.e. whether it costs more to provide service to residents of rural Montana than to residents of Minneapolis or even downtown Missoula -- "even if the model is not as good at determining absolute costs" -- i.e. how much it actually costs to provide service to a resident in either rural Montana or downtown Missoula. The problem is that it is the latter purpose -- determining an absolute cost of providing service to these areas and basing federal support on some percentage of that amount -- for which this agency seems intent on using the models.

I am also concerned about adopting this model before the Joint Board has made its final recommendation. The issues related to the use of explicit federal universal service support to reduce implicit federal support was raised in a request by the state Joint Board members and has been referred back to the Joint Board for further consideration. That issue seems necessarily to implicate the adoption of any model.

I fear that we are being requested to focus on the minute details of one possible solution without stepping back to consider the simple outlines of a broad range of possible solutions. In particular, I fear that we are now focusing narrowly on how to apply a specific model to determine the total high-cost support needed for non-rural telcos and how to allocate that amount between carriers or States when we have not even addressed the simple question of whether any model at all is necessary, or indeed even advantageous. Moreover, we seem to be focusing on how to improve the existing allocation of funds by giving more to some firms in some States and less to others thereby creating "winners" and "losers" when we could be making practically all consumers a "winner" by changing the way by which we raise funds. My reflections on these issues lead me to some tentative conclusions:

1. We do not need a federal model either to size or to allocate a fund for non-rural high-cost carriers, nor is one advantageous;

2. We should place the federal model in the public domain to allow the States to incorporate State-specific data and to use it as they see fit; and

3. We may be better able to improve consumer welfare by focusing on how we collect high-cost support than on how to reallocate support among existing users.

I. The Commission does not need to adopt a federal model.

A. The Commission should not adopt a model to distribute the current universal service support dedicated to non-rural carriers in high-cost areas. Current federal universal service support for non-rural carriers in high-cost areas is relatively small by national standards. For the Fourth Quarter of 1998, these funds are projected to be $253 million on an annualized basis, of which $140 million are for Puerto Rico. Twenty-two States plus the District of Columbia, Guam, and the Virgin Islands receive no support. Of the twenty-eight States that receive support, only two -- Alabama and North Carolina -- receive more than $10 million, and average support is much less than $5 million annually. Too much time and resources have been spent on the development of an extremely complicated model if the intent is only to use it to distribute this current amount of high-cost support.

Moreover, if the size of the federal non-rural high-cost support fund is to remain the same or shrink, a model can only divide an ever-dwindling pie. Any gain from any possible economic efficiency from reallocation -- and I am skeptical that there are any such gains to be made -- would likely be substantially outweighed by the political costs associated with a fight between new "winners" -- States and carriers that would receive more money than before -- and new "losers" -- States and carriers that would receive less money than before.

B. Unless the Commission breaks its promise to hold the states harmless at their current levels of "aggregate implicit and explicit support," the adoption of a model would only create a larger total amount of federal support. There is ample reason to believe that the overall size of the federal non-rural high-cost support fund cannot easily shrink. Last April, the Commission indicated to Congress that, under new universal programs, we would hold carriers harmless. Specifically, the Commission indicated:

[W]e note that the pre-may 1997 regulatory scheme created a de facto allocation of responsibility between the Commission and state commissions with respect t support for service to rural and high cost areas. The allocation of responsibility was defined by the separations rules, which placed 25 percent of booked loop costs in the interstate jurisdiction for most of the loop plant used by the non-rural LECs. . . . [W]e conclude that a strict, across the board rule that provides 25% of unseparated high cost support to the larger LECs might provide some states with less total interstate universal service support than is currently provided through aggregate implicit and explicit federal subsidies. The Commission will work to ensure that states do not receive less funding as we implement the high cost mechanisms under the 1996 Act. We find that no state should receive less federal high cost assistance than it currently receives.⁽²⁾

The plain language of this promise indicates that the Commission would ensure that States did not receive less in federal support than they do currently through explicit universal service funding and implicit support embedded in access charges. Thus, additionally allocating support using the model would allow States to choose the greater of what they would get under the model, or what they previously received through federal explicit and implicit support.

Some here at the Commission argue that all that was promised last spring was to hold the States harmless as to the current explicit fund. The language quoted above, however, indicates that the Commission's commitment to hold the States harmless goes farther. Apparently, whether this hold-harmless promise extends just to current explicit federal non-rural, high-cost universal support but not to all implicit federal subsidies will be the subject of semantic games. My impression is that many carriers and States -- and indeed many Members of Congress -- believe that universal service programs promulgated by the Commission will hold both carriers and States harmless. Indeed, the statute itself speaks of the "preservation" of universal service, not its reallocation.

Stated slightly differently, in the minds of many, high-cost support can only grow but not shrink. A related result is that if the relative allocation of high-cost support changes as the result of a cost model, total support can only grow because of the hold-harmless provisions.

If high-cost support is to increase, I am skeptical that a model that applies only to non-rural carriers is practical. If universal service support is to increase, why should it increase only for non-rural, high-cost carriers? Why not rural telcos as well? Or why not low-income households?

In the end, other than the current allocation, I can see no viable allocation of non-rural, high-cost support that does not raise more troubling questions than answers. Thus, I see no reason to use any cost model if the current allocation will ultimately be used. I fear, however, that the Commission may try to limit its hold harmless commitment to the current explicit universal service support, thereby reducing the total amount of federal universal support -- at least to some states. I cannot support such an attempt to reduce support when the statute mandates that the Commission "preserve and advance" universal service.⁽³⁾

C. Neither is this cost model the right tool for access charge reform. Some observers have suggested that a cost model may be useful for access charge reform. I fear that the same logical traps that apply to altering the allocation of non-rural high-cost funds apply here as well. There will likely be substantial political consequences if carriers and States are not held harmless relative to current receipts and current expectations of reductions in those receipts -- based on expectations of future productivity factors. Thus, reallocation of access charges based on a cost model would only result in an expansion of those funds relative to current levels. Again, any proposed expansion of high-cost support begs the question of why not expand other segments of universal service instead, such as low-income households. In sum, the only viable allocation in the near term will be the current allocation.

II. What should the Commission do with these cost models?

As I have explained above, I don't believe that the cost models should be used to either size the universal service fund or to distribute money from the fund among the States. Fundamentally, what this Commission must decide is whether it believes that the current level of federal support (both explicit and implicit -- including access charges) is sufficient to support universal service. Even if the models can play a helpful role in determining relative costs between high cost and low cost areas, I am concerned that it is an inappropriate tool for determining the absolute cost of service to any particular area. Consequently, I question whether the models can determine the ultimate universal service subsidy needed. At present, I am not convinced that the total federal outlay is in excess of what is necessary; rather, I believe the Commission should hold the States harmless as to the amount that carriers currently receive. Thus, I do not support using the models to determine the size of universal service support.

I do believe, however, that the models can play a valuable role in the debate on universal service. The models are a valuable tool that could be use at the State level to distribute universal service support to carriers within a State. I would support the Commission releasing this model to the public, explicitly acknowledging the possible benefits of this model over both of the other proposals. States would then be free to use the federal model platform, modified as they see fit and with as many State-specific inputs as any State feels is appropriate, to distribute universal service funds within a State.

Along those lines, I also object to this agencies continued efforts to perfect and maintain control of this model at the federal level. As I have described, I am unclear as to what purpose we in the federal jurisdiction can put this tool. While we may have provided a valuable service to states in developing this for their use, we cannot afford to continue to expend the time and resources necessary to further develop and maintain this tool. Especially since its most useful purpose is at the state level with state specific inputs. We should expeditiously seek to provide the model to the States and allow them to perform whatever additional work is necessary to use it as they see fit.

III. It is more important for the Commission to act to improve consumer welfare by ensuring that the universal service burden is not imposed through usage-sensitive fees.

Up until now, most of the Commission's efforts seem to be focused on either sizing or reallocating universal service support. I believe that the first step in universal service reform should focus on the collection of the universal service subsidy. Some consumers will win and some will lose if we develop new mechanisms to reallocate universal service, but practically all consumers may benefit if we move to a more rational form of collecting universal service fees.

A recent study by Jerry Hausman⁽⁴⁾ illustrates the enormous penalty that consumers pay when universal service is supported by taxes and fees on a usage-sensitive basis. For example, for every dollar collected on fees assessed on long-distance service, such as access charges, consumers lose more than two dollars in welfare.

The solution is not to broaden the tax base because a broadened tax base, no matter how defined, will still impose usage-sensitive fees. Instead, consumer would be much better off with a fixed assessment, such as a per-line charge. This assessment could distinguish between business and residential customers.

There is ample legal precedent for a federal per-line charge. The current SLC and PICC are assessed per line. There are several other reasons to use a per-line charge, which I outline below.

A. Fees must be in exchange for service. The FCC has the authority to levee fees, not taxes. For a payment to be a fee, there should be something tangible received in exchange. We should therefore define precisely those services and conditions that telecommunications carriers (as the direct contributors to universal service) and consumers (as the indirect contributors to universal service) receive from the federal government and the FCC in particular.

I believe that carriers and consumers do receive something from the FCC. In particular, the FCC administers or is responsible for:

a. Numbering system or addressability of telecommunications;

b. Ensuring access to an interstate telecommunications network;

c. Ensuring access to an interstate telecommunications network with nodes that have been expanded as the result of universal service (to high-cost areas and low-income households); and

d. For carriers, a centralized system for the determination of payments.

There may be other services that the FCC performs, but any service that the FCC provides, I believe, is fixed in cost and is not usage sensitive. That is, the service that the FCC provides a carrier or a customer is the same whether a customer is making a one-minute or a one-hour interstate call. Consequently, any fee structure that the FCC might consider for universal service should be fixed for the sake of consistency with the fixity of the service provided. Moreover, any usage-sensitive charge from the FCC, to the extent services provided are not usage sensitive, runs the risk of being a tax.

B. Federal fees should be consistent with the law. The federal government and the FCC cannot tax intrastate services. Moreover, the FCC has little or no authority to place universal service fees on entities that do not provide telecommunications services. Primary responsibility rests with telecommunications carriers, the same population that may become eligible carriers.

C. Fees should be consistent with technology. A rational universal service fee must not only avoid being a tax, but it should also avoid being inconsistent with technology and market developments. Telecommunications markets are evolving rapidly with multiple services available to consumers. Some of these services are provided by telecommunications carriers subject to universal service fees; some services are available from other services. Consumers have opportunities to avoid usage-sensitive fees by selecting service providers that are not technically telecommunications carriers. To the extent a universal service fee structure is inefficient, it will artificially accelerate the migration of traffic away from telecommunications carriers.

Future technologies are even more incongruent with usage- sensitive access fees. Telecommunications networks may well develop into predominantly packet-switched networks in which line access is not a particularly relevant concept. Within these packet-switched networks, determining what is interstate and what is not, and determining the identity and purpose of traffic, are impossible tasks.

D. A federal per line fee would ease the universal service burden over time and allow for an easier transition. The number of lines has been growing rapidly in recent years. Thus, a flat per line universal service fee would produce increasing revenues every year. If we held the amount of federal universal service subsidy fixed at current levels, the burden that each subscriber carries would decrease each year. In addition, the Commission could consider phasing in the flat fee to take advantage of the growth in the number of lines. Moreover, a flat fee should reduce usage rates, thereby expanding demand for usage-sensitive services, increasing carrier revenues, and ultimately reducing requirements for universal service support.

IV. Conclusion

The need to adopt a federal model necessarily means that the Commission is heading down one of three paths, none of which I could support.

First, the Commission might not use the model to size or to distribute universal service funding. This is the path I would recommend, and to which I would ask then why do we need to officially adopt a model today and maintain it in the future. This exercise would be an unfortunate use of the Commissions time and resources.

Second, the Commission could use the model to size and distribute the universal service funds but also fulfill its commitment to hold the states harmless. Such actions, however, would thereby create a larger total federal universal service subsidy. Then I would ask why the rural carriers have not also had the opportunity to gain a larger share of support.

Third, and most likely, the Commission will limit its hold-harmless promise to the current explicit universal service fund, using the model to size and distribute the new high cost fund and to justify a net reduction in the current federal subsidy flow. In light of this agency's statutory mandate to preserve existing universal service and its own promise to Congress that it would hold the states harmless, I would object to such an attempt.

Ultimately, today's Commission action only begs the greater question of the allocation of universal service support between the federal and state jurisdictions, raising more questions about the Commission's direction than it provides answers.

4. Jerry Hausman, Taxation by Telecommunications Regulation: The Economics of the E-Rate, (Washington, D.C. AEI Press, 1998).