12/17/99 Statement of Commissioner Harold Furchtgott-Roth on 1998 Biennial Regulatory Review: Review of Depreciation Requirements for Incumbent Local Exchange Carriers, United States Telephone Association's Petition for Forbearance from Depreciation Regulation of Price Cap Local Exchange Carriers, Report and Order in CC Docket 98-137, Memorandum Opinion and Order in ASD 98-91.

December 17, 1999

PRESS STATEMENT OF
COMMISSIONER FURCHTGOTT-ROTH

Re: 1998 Biennial Regulatory Review: Review of Depreciation Requirements for Incumbent Local Exchange Carriers, United States Telephone Association's Petition for Forbearance from Depreciation Regulation of Price Cap Local Exchange Carriers, Report and Order in CC Docket 98-137, Memorandum Opinion and Order in ASD 98-91.

I find it encouraging that the Commission has streamlined some of the costly and burdensome depreciation prescription requirements that are currently imposed on the large incumbent local exchange carriers. I would have gone a good deal further, however. Because I believe that the Commission's depreciation requirements no longer serve a useful purpose, and because I believe that the requirements of section 10 have been satisfied, I would have granted USTA's petition for regulatory forbearance.

Background. Depreciation expenses were at one time a significant part of the regulatory equation. Under rate-of-return regulation, which the Commission abandoned for large carriers in 1990, a carrier's interexchange access prices were calculated based on its costs, including its depreciation expenses. Although I certainly do not endorse rate-of- return price regulation, I accept the proposition that if an agency employs that approach, it needs to monitor the costs of the companies it regulates.

The Commission no longer sets prices for large local exchange carriers' services based on costs. Beginning in 1990, it adopted the fundamentally different price-cap methodology, which directly governs a carrier's access charges, and the carrier retains whatever profit it is able to make. From 1990-1997, the Commission took something of a hybrid approach to rate regulation, since carriers were required to "share" all or some portion of their earnings over a specified rate of return. In addition, the Commission's methodology included a "low-end adjustment" mechanism, which guaranteed that a local exchange carrier would not be forced to charge unreasonably low prices. Again, although I do not endorse either the "sharing" or "low-end adjustment" mechanisms indeed, they are nonsensical from an economic standpoint, since they both limit the efficiency gains of price-cap regulation I understand that depreciation expenses were relevant to this hybrid regulatory approach.

The Low-End Adjustment Does Not Support the Retention of the Depreciation Requirements. In 1997, however, the Commission eliminated the "sharing" mechanism altogether, finding that it blunted the efficiency incentives of price-cap regulation. At this point, with respect to rate regulation, carriers' depreciation expenses continued to be relevant only to the "low-end adjustment" mechanism. But I do not think that the low-end adjustment is an essential component of price-cap regulation, and I would support eliminating it entirely. Without the low-end adjustment, there would no longer be any legitimate reason for continuing to regulate incumbent carriers' depreciation expenses.

The Commission has traditionally reasoned that the "low-end adjustment" is necessary to avoid unconstitutional takings problems. I do not think this theory is a sufficient basis for retaining the low-end adjustment, particularly since it means retaining the Commission's burdensome and costly depreciation requirements. To prevail on such a claim, carriers would have to make the very difficult showing that the Commission's price- cap requirements had threatened their "financial integrity" or "otherwise impeded[d] their ability to attract capital," Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254, 1263 (1993). In any event, the carriers themselves have indicated that they are ready to give up the low- end adjustment as part of a regulatory adaptation to increased competition. And if the Commission thinks it necessary to guard against the possibility of a regulatory taking, I think there are alternatives to the low-end adjustment that would not require incumbent carriers to continue to comply with its depreciation regulations.

The Commission's Other Justifications for its Depreciation Requirements Do Not Withstand Scrutiny. The Commission also justifies its refusal to forbear from depreciation regulation on the ground that, if carriers were allowed to set their own depreciation expenses, incumbent carriers might request exogenous treatment of past reserve deficiencies, or make above-cap filings based on past reserve deficiencies. In the first place, I think it extremely unlikely that incumbent carriers could succeed on either of these theories. The Commission has consistently refused to permit carriers to treat changes in depreciation expenses as exogenous costs, and there is no basis for thinking that policy is unsound. Nor is there any reason to think that carriers could make the showing that they are entitled to the "extraordinary remedy" of an above-cap filing.

More important, however, I do not think that the possibility that, if the depreciation requirements were lifted, carriers might take positions adverse to the Commission is any basis for declining to forbear from depreciation regulation. What the Commission seems to be saying is that, if lifting its regulations would somehow enable carriers to challenge the effects that those requirements have had, it must continue to impose those requirements whether or not the regulations continue to serve any other, useful purpose. This reasoning is quite simply indefensible. An administrative agency has a fundamental obligation to engage in reasoned decisionmaking, which in turn means that the agency must be prepared to explain and defend its regulations. If carriers can legitimately claim that the Commission's past requirements would support a low-end adjustment or an above-cap filing, it is in the public interest for the Commission fairly to address those claims. It is most certainly not in the public interest for the Commission to continue to impose meaningless requirements on incumbent carriers simply because it is afraid it might have to defend those regulations.

Nor do I believe the other reasons the Commission has raised for refusing to forbear from its depreciation regulation withstand scrutiny. The Commission contends that State commissions have used Commission-prescribed depreciation rates in setting prices for interconnection and unbundled network elements, and forbearance would deprive State commissions of this information. I question whether it is appropriate to continue to require incumbent carriers to comply with burdensome federal depreciation regulations simply to provide State commissions with information that they could themselves gather from many other sources. Nor do I agree with the Commission that its requirements are necessary for it to determine which depreciation inputs it should use in the universal service high-cost support model. To the extent such inputs are needed for what has always been described as a forward-looking model, the Commission could easily come up with many simpler ways of setting the values of those inputs.

Conclusion. In my opinion, there is no valid reason for continuing to require the large incumbent local exchange carriers to comply with the Commission's burdensome and anachronistic depreciation regulations. In light of this conclusion, I believe that USTA's forbearance petition should have been granted, and I do not believe the Commission possesses the authority to require carriers to comply with the waiver conditions that it has devised.