pacific research institute digital welfare the failure of the universal service system february 2009

8/14/2019 Pacific Research Institute Digital Welfare the Failure of the Universal Service System February 2009

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Digital Welfare:The Failure of the Universal Service System

By Vince Vasquez

February 2006


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Digital Welfare:The Failure of the Universal Service Syst

By Vince Vasquez

February 2006


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Digital Welfare:The Failure of the Universal Service System

By Vince Vasquez

February 2006

Pacific Research Institute

755 Sansome Street, Suite 450

San Francisco, CA 94111

Tel: 415/989-0833 | 800/276-7600

Fax: 415/989-2411

Email: [email protected]

Additional printed copies of this study may be purchased by contacting PRI at the addresses

above, or download the pdf version at www.pacificresearch.org.

Nothing contained in this briefing is to be construed as necessarily reflecting the views of

the Pacific Research Institute or as an attempt to thwart or aid passage of any legislation.

2006 Pacific Research Institute. All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted in any form or by any means, elec-

tronic, mechanical, photocopy, recording, or otherwise, without prior written consent of

the publisher.


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Table of Contents

Executive Summary .............................................................................................................. 1

Introduction .......................................................................................................................... 3

Historical Beginnings............................................................................................................ 5

The Telecommunications Act of 1996 ................................................................................ 7

The State of Universal Service Today ................................................................................. 9

USF Low Income Issues ......................................................................................... 11

USF High Cost Issues ............................................................................................ 12

USF E-Rate Issues .................................................................................................. 13

Prospects for Reform .............................................................................................. 14

Forces in Favor of the USF Status Quo ................................................................. 15

The Case of California........................................................................................................ 17

Shaking Down Advanced Technologies for Universal Service ............................ 17

USF in California .................................................................................................. 18

California Universal Service System Issues ........................................................... 19

Universal Service v. Market Competition ............................................................ 20

Whittling Away the Welfare State ......................................................................................... 21

Forging an Exit Strategy ........................................................................................................... 23

Conclusion .............................................................................................................................. 27

Endnotes .................................................................................................................................. 29

About the Author .................................................................................................................... 33

About the Pacific Research Institute ...................................................................................... 35


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Executive Summary

Universal service, a federal policy that guarantees affordable telecommunications access forevery corner of the country, has been disastrous for the interests of consumers, telephone

carriers, and industry innovators.

Due to political pressures, short-sighted universal service rules have saddled local carriers

with wasteful subsidies and deterred new entrants with economic disincentives, denying

needy communities the greater benefits of a competitive marketplace.

Telecom companies have also taken a hit, as system administrators have recklessly redis-

tributed industry revenue to pay for the thousands of corporate subsidies and millions of ser

vice discounts they approve. These unaccountable bureaucrats have quietly rubber-stamped

a massive increase in program disbursements, allowing special interest groups to raid morethan $48 billion in industry profits. A lack of adequate oversight over the universal service

system has also generated endless cases of fraud and abuse, as ravenous recipients have ex-

ploited the fund for financial profit and personal gain.

Now, as program administrators seek to solve their institutional problems by inflicting oner-

ous revenue demands and red tape upon new technologies, fearful industry innovators have

delayed broader investment in the U.S market, sinking our global standing in technologica

prowess and broadband deployment.

Unfortunately, many of the problems ailing the federal universal service system also af

flict many state-based systems, including Californias. Golden State regulators finance theirprograms by directly charging fees on the telephone bills of state consumers, to the tune o

more than $800 million a year. Like with the federal initiative, California has overseen bal

looning costs, wasteful subsidies, and has even attempted to add bureaucracy over the most

promising breakthroughs in communication services deplorably laying siege to Silicon

Valley, the birthplace of the Internet Revolution.

The level of government failure in executing universal service policies is reminiscent of the

notorious handling of the federal welfare system. As public officials now debate the next

phase for universal service, they should consider the merits of reforming the regulatory

morass with pro-competitive policies such as technology-neutral vouchers for consumers

and new rules to ensure accountability and safeguard cutting-edge innovations. When businesses are allowed to compete in open markets, and lawmakers work vigorously to protect

the public interest, consumers win.


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Introduction

For more than twenty years, the U.S. government has overseen the implementation of uni-versal service, a multi-billion dollar redistribution scheme that was originally established

to assure affordable telephone service for all Americans, regardless of income. Over time,

lawmakers slapped on additional programs and mandates, mutating the original plan into

a grab bag of service discounts for a ballooning number of recipients. This massive digita

welfare system has become severely riddled with institutional abuse, recipient waste, and

little accountability.

Now, with rising funding commitments and a shrinking revenue base, the universal service

system threatens to collapse on its own weight, prompting calls from some lawmakers for

higher taxes and consumer fees to bail out this billion-dollar disaster. As Congress and in-

dustry regulators gather to reassess the virtues of this unwieldy program, serious questionsare raised. Are consumer fees and corporate subsidies the best way to connect communities

with basic phone service? Has universal service stifled technological innovation and entre-

preneurship in areas where theyre needed the most? Can the marketplace play a bigger role

in achieving the core objectives of universal service?

This study examines the evolution of the universal service system in America, the conse-

quences of government failure, and prospects for meaningful policy reform. The authors

intent is to give a broad look at the policy in practice, and recommend constructive starting

points for eliminating its destructive effects.


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Historical Beginnings

The original concept of universal service is widely attributed to Theodore Vail, formerPresident of AT&T. In the early 20th century, many telephone service providers did not

interconnect their networks with their competitors, preventing consumers served by dif-

ferent companies from communicating via telephone. In 1907, Vail created the notion of

one policy, one system, universal service, as a way to foster a cohesive interconnection

policy in America. However, AT&Ts subsequent (and seemingly anti-competitive) buy-

outs of rival telephone companies to implement this vision ruffled the feathers of the fed-

eral government. In a letter later known as the Kingsbury Commitment, AT&T assured

the U.S. Attorney General that it would, among other things, cease purchasing additional

competitors and voluntarily provide long distance connections to independent telephone

companies. With the federal government tacitly agreeing to tolerate AT&Ts vast network

of subsidiaries known as the Bell System, the result was a government endorsed nationaltelephone monopoly, granted with the belief that a single service provider could efficiently

build out a landline telephone network to provide quality affordable service to all con-

sumers. By using the universal service doctrine to establish a non-competitive relationship

among telephone companies, Vail successfully entrenched Ma Bells dominant market posi

tion for more than half a century.1

The Communications Act of 1934 codified universal service as a national goal to provide,

so far as possible, efficient wire-based and radio communications at reasonable rates, but

did not explicitly enlist corporate subsidies to achieve it.2 AT&T instead sought private

non-compulsory solutions to pursue universal service, escaping additional regulatory require-

ments from the government. The decision paid off. Less than fifty years after the signing ofthe Communications Act, more than 90% of American households owned a telephone.

Ironically, AT&Ts success in attaining universal service was its downfall. With the completion

of a functional, national landline network, many on Capitol Hill believed that the telephone

monopoly was no longer justified. On November 20, 1974, the U.S. Department of Justice

(DOJ) filed an antitrust suit against AT&T, levying charges of anticompetitive behavior and

seeking the ultimate breakup of the Bell System. Faced with dim prospects of emerging victori-

ous from federal proceedings, AT&T agreed in 1982 to a settlement with the DOJ. Under the

Modification of Final Judgment, AT&T was allowed to retain its long distance network, but

agreed to give up 22 of its Bell Operating Companies (BOCs), which were later consolidated

into seven Regional Bell Operating Companies (RBOCs), known as the Baby Bells.

The volatility of the telephone market, spurred by the AT&T breakup, threatened to dis-

rupt the decades of progress made for ubiquitous telephony access. Without government

mandates, AT&T had achieved the goals of universal service by voluntarily signing coop

erative service agreements with small rural competitors, and leveraging its network assets to

facilitate new investment. Through a practice of cross-subsidization, AT&T raised rates

for businesses and urban consumers, so as to afford to artificially lower the rates in poorer,

less developed regions. However, with the elimination of AT&Ts vise-like grip on the

telephone market, the private agreements and internal rate controls used to reach universa

service goals also disappeared.


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So that rural and low income consumers did not lose their low-cost telephone service, theFCC stepped in to create the Universal Service Fund (USF), a national subsidy system to

support independent telephone companies and RBOCs that were once privy to private

agreements with AT&T to stabilize rates. To finance the USF, the FCC initially levied

fees on AT&T and other long distance calling companies, thereby enabling industry regu-

lators to underwrite the operations of service providers in low-income consumer markets

and high-cost rural areas. However, the narrow scope of this government effort would soon

balloon into a massive bureaucracy through major industry regulatory redrafting from those

eager to capitalize on the breakthrough of new technologies and shifting market trends.

6 | Digital Welfare


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The Telecommunications Act of 1996

In the sixty years that followed the Communications Act of 1934, the telecommunicationsmarket underwent a series of radical changes including the industrys transformation from

monopoly to competition; the emergence of cellular telephony; the Internet; and the rise o

cable television. Congress attempted to address these developments and other major policy

concerns with the passage of the landmark Telecommunications Act of 1996.3 The Act set

the stage for an unprecedented increase in public spending and government growth in the

universal service system. These legislative changes were:

Expanding the universal service funding base.

Creating additional program priorities.

Increasing the role of government in broadband deployment and telecom connectivity.

Before the 96 Act, only long distance telephone companies paid into the Universal Ser

vice Fund, limiting the amount of money available for bureaucratic spending. In the Act

Congress required that all providers of telecommunications services make contributions

to the universal service system.4 The FCC later interpreted this mandate as requiring al

carriers that provide interstate and international calling service to pay a percentage of their

corporate revenue into USF.5 In one swift stroke, the FCC levied a revenue fee on nearly

all landline and wireless telephone companies, payphone providers, paging service compa

nies, and (until recently) DSL providers.6 At the behest of rural congressional legislators

and education advocates, the Telco Act also pledged universal service support to an array

of schools, public libraries, and rural health care providers.7 Additionally, the Telco Act

authorized the creation of a Joint Federal-State regulators board to make recommenda-tions for future universal service procedures. Congress directed this new government body

as well as the FCC, to craft new policy suggestions based on seven new principles: quality

service at reasonable, affordable rates; equal access to advanced communication technolo-

gies; equal service access for rural and high-cost regions; nondiscriminatory contributions

from telecom service providers; clear and predictable government systems to preserve and

advance universal service; equal service access for schools, health care providers, and librar-

ies; and all other principles deemed necessary and appropriate for the protection of the

public interest. 8

Although initially seeking to foster industry competition and technological ubiquity in

America, the Telco Act instead delivered disastrous results for businesses and consumersBy changing the legal definition of universal service to an evolving level of telecommuni-

cations services deemed essential by bureaucratic regulators, the Telco Act opened the

doors for unlimited programming and public spending.


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The State of Universal Service Today

With input from Congress and the Federal-State Joint Board, the FCC created four mainfunding mechanisms within the Universal Service Fund Low Income, High-Cost, Schools

and Libraries, and Rural Health Care.9 The Low Income division aims to ensure affordable

telephone service for qualifying low-income consumers through three sub-programs: Life-

line, Link Up, and Toll Limitation Service. Lifeline reimburses telephone companies for

providing telephone service to low income individuals for $10 less than regular rates. Link

Up also reimburses service providers for discounting 50% of the initial telephone service

hook-up or connection fee to low-income consumers. Toll Limitation Service underwrites

telephone companies for providing free toll limitation service, allowing qualifying recipi-

ents to limit long distance calls in advance.

The second mechanism, the High Cost program, is a collection of corporate subsidies fortelephone service providers who operate in mostly remote, rural areas. Also known as E-

Rate, the third mechanism, Schools and Libraries, provides discounted telephone service

internal connection and broadband access for qualifying schools and libraries. Subsidies

for E-Rate range from 20-90% of the service costs, depending on the level of surrounding

poverty, and the urban/rural status of the community served. Finally, under Rural Health

Care, small-town medical providers such as hospitals and clinics receive low-cost Internet

access and telephone service, in an effort to equalize telecom service rates between rura

and urban areas.

As mentioned, the FCC has ordered all long distance calling revenue to be subject to the

Universal Service Fund. The rate of corporate payment is determined through a mechanismknown as the Contribution Factor, which is reassessed each quarter by the FCC, based on

changing program demand. In practice however, it is an unbridled telecom tax, raking in

billions of dollars for public subsidies at the will of appointed bureaucrats and non-profit

administrators, a proposition that has proven precarious in recent years.

Aside from the distortions that universal service taxes created, one of the biggest problems

with the system is the management of the fund itself. To handle corporate billing and dis-

tribution of all USF funds, the FCC appointed in 1998 a private non-profit corporation, the

Universal Service Administration Company (USAC), to serve pursuant to its guidelines

and orders. By carrying out the day-to-day operations of USF programs, USAC is entrusted

with significant public sector responsibilities that have left some in Congress uneasy. Ac-knowledging concerns with a non-government entity disbursing billions in public funds

and possibly setting future policy, the FCC directed early on that the USAC may not

make policy, interpret unclear provisions of the statute or rules, or interpret the intent of

Congress.10 However, as recently as August of 2004, the FCC asked USAC to identify any

USAC administrative procedures that should be codified in our rules to facilitate program

oversight,11 a deferential order that raised doubts of how involved the FCC is with univer-

sal service management.


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1986

$0

$1

$2

$3

$4

$5

$6

$7

1988 1990 1992 1994 1994 1998 2000 2002 2004

AmountsinB

illions

Figure 1: U F Budget

Year

10 | Digital Welfare

Originally, the FCC intended to review USACs management performance one year afterit was given reins over the universal service system. 12 That review never took place, an

inexcusable failure that has only complicated matters today. USAC is now controlled by a

nineteen member Board of Directors, which is composed of individuals representing groups

eager for a piece of the USF pie education advocates, telecom industry executives, and

state regulators.13 As directors approve the budgets for programs their interest group may be

beneficiary to, the result has been a sort of free-for-all with universal service funds, a gross

FCC oversight that has led to a number of troubling program trends.

Due to the efforts of USAC, advocates, and lobbyists, the Universal Service Fund has suc-

cessfully evaded the fiscal scrutiny accorded to most public funds. Since it was created, USF

has operated outside the United States Treasury, and is not subject to annual congressionalappropriation. Funds are placed in a private account and are privately invested. As the

FCC has neglected to place USF under the purview of normal fiscal accounting procedures,

USAC has retained an immense power only dreamed of by bureaucrats the ability to com-

mit more money than that on hand, with little public oversight. Unlike regular public agen-

cies, USAC does not have to work within a rigid budget, and can instead make free-wheel-

ing decisions on what funding requests to approve, forcing the FCC to raise the telecom

tax to finance the subsidy agreements. Current data suggests that the implications of the

USAC/FCC fiscal arrangement for USF have been disastrous. Regulators wield their power

like a teenager with a credit card, recklessly spending public funds without consequence.

Since the FCC largely pegs the Contribution Factor by how much money the USAC com-

mits to recipients, and with the FCC adding E-Rate and Rural Health Care to the USFpayroll, the telecom tax has soared.14 As USAC has nearly doubled the size of program

disbursements since 1998, the FCC has followed suit by tripling the telecom tax rate, which

has culminated in more than $48 billion in USF disbursements.15

Source: Federal Communications Commission, Universal Service Administrative Co.


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The State of Universal Service Today | 11

Though some proponents of universal service have argued that the rapid growth in fund-ing demands are largely a result of shrinking profits in the long distance calling market

government analysts have concluded that they are in fact caused more by voracious USAC

spending practices.16

With open-ended Congressional expansion of universal service, and out-of-control spend-

ing by unaccountable bureaucrats, the beneficiaries and profiteers of USF programs have

become a national embarrassment, a reoccurring source of splashy news headlines of gov-ernment fraud, abuse, and waste.17 A closer look at recent program developments revea

the depth of government failure in providing for the public interest, as the carte blanche

attitudes of universal service regulators are matched only by their ineptitude at managing

the actual programs.

USF Low Income Issues

One of the major dubious government policies that beset the Low Income program is a self-

certification system that allowed many consumers to receive financial support by simply

telling their telephone service carrier they participate in a qualifying means-tested public

assistance program, or meet a qualifying income level.18 This has been problematic, as therehas been no system in place to comprehensively verify if applicants are indeed eligible for

public discounts. Unsurprisingly, the Low Income division under USF has seen an incred-

ible amount of recipient growth. Since 1990, administrative officials have added nearly 6

million more Americans to the Link Up and Lifeline programs.19 These results are peculiar

considering that most of the recipient growth occurred during the so-called Clinton era of

economic expansion that created more than 22 million new jobs, and saw the unemploy-

ment rate reach 30-year lows.20 The failure of government to acknowledge this contradic

tion and demand transparency for the murky universal service program is troubling.

12%

10%

8%

6%

4%

2%

0%

1998

-

1999 2000 2001 2002 2003 2004 2005 2006

Figure 2: USF Telecom Tax

Source: Federal Communications Commission


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USF High Cost Issues

Problems have also compounded USF High Cost operations. In 1986, about $55 million

was disbursed for High Cost support through USF. Now, more than 60% of the total USF

budget - $4 billion- is earmarked for the High Cost funding mechanism, a staggering figure

thats more than doubled since 1999.

This figure is discouraging, particularly since evidence suggests that High-Cost funds are

more in the category of corporate welfare than consumer welfare. As one economic study of

the High-Cost program estimated, USF funds are subsidizing rural carriers at twice the level

of what is necessary for efficient operation, with more than half a billion dollars being spent

0

2

4

6

8

10

1987

-

1990 1993 1996 1999 2002

InMillions

Year

Figure 3: USF Low Income Recipients

Source: Federal Communications Commission

High Cost64.1%

Health Care0.3%

Low Income14.0%

E-Rate21.6%

Figure 4: USF Budget, 2005 (Estimated)

Source: Universal Service Administrative Co.


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in waste each year.21

The High Cost funding mechanism also deters prudent corporate con-solidation and cost-cutting, as it awards the smallest rural telephone companies quadruple

the subsidy rate received by larger carriers.22 Underscoring this figure, the state of Califor-

nia, which is home to nearly twice as many telephone landlines than any other state (22

million) actually received less High Cost funding in 2005 than the island of Puerto Rico,

which has one million lines.23

As High Cost funding insulates rural carriers from market forces, and does little to require ef-

fective business practices, some of the recipient companies have become masters at exploit-

ing the vulnerable system. Illustrating this point is Big Bend Telephone, a company which

serves 6,000 in the town of Alpine, Texas. It reported that more than 95% of its revenue

- $13 million came from universal service subsidies, leaving consumer sales to shore up themeager rest.24 XIT Rural Telephone Collective, a tiny utility serving 1,500 residents in the

Texas Panhandle, did so well under government largesse, it paid out an average of $375 in

dividend payments to its shareholding customers, an amount more than the average $202

they paid for actual telephone service that year. This was a particularly absurd example of

corporate welfare and abuse, as it occurred during a time when most major telecom compa-

nies were pressed to merge and consolidate resources, struggling to stay financially afloat.

USF E-Rate Issues

The E-Rate program has also been riddled with a basket case of issues. The rules govern-

ing E-Rate disbursements do nothing to prohibit gold-plating, the over-procurement ofgoods and services beyond the needs of recipients. This regulatory loophole, along with the

ineptitude of federal officials to crack down on abuse, has led to rampant waste.

In late 2004, FCC Inspector General H. Walker Feaster issued a damaging report that re-

vealed the results of over a hundred audits of USF-recipient schools and libraries. Feaster

stated that he had numerous concerns about E-Rate, and believed that the program was

subject to a high risk of fraud, waste, and abuse through noncompliance and program weak-

ness. Shockingly, the report uncovered numerous program scams including bid rigging, false

reporting, misappropriation, and other forms of kickbacks. In all, auditors found more than

a 1/3 of reviewed recipients were non-compliant with government guidelines. The report

further revealed the USAC has mismanaged at least $17 million through E-Rate.26

Though some E-Rate proponents point to 2002 figures that show 99 percent of public

schools had Internet access as an indication of the programs success, there is no verifiable

measure to determine if these results can be attributed solely to E-Rate, or to an amalgam

of local, state, and private sources of funding.27 As federal analysts reported in spring 2005

[the] FCC has not developed meaningful performance goals and measures for assessing and

managing the [E-Rate] program. As a result, there is no way to tell whether the program has

resulted in the cost-effective deployment and use of advanced telecommunications services

for schools and libraries.28


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Other revelations have also dogged USAC officials, demonstrating an incompetence, and

inability to rein in system abuse. FCC audits found that Virginia schools were able to use

E-Rate subsidies to purchase 85 cell phones and 195 pagers, despite the fact that cell phones

and pagers arent approved for subsidies.29 In 2003, five people were charged with diverting

more than $1 million in E-Rate funds from schools in Illinois and Wisconsin, instead using

the funds to buy several automobiles, a home, and wire more than $600,000 to Pakistan. 30

NEC Business Network Solutions, an internal network service provider for E-Rate schools,

agreed to plead guilty to bid rigging and wire fraud in May 2004.31 Their efforts to conspire

with schools to defraud the E-Rate program in five different states highlighted the problems

of the program. A congressional inquiry determined that USAC had disbursed over $100

million over three years to connect Puerto Ricos 1,540 schools with broadband access, but

found few computers connected, and more than $23 million of telecom equipment sittingin unopened boxes in a warehouse.32 The same investigative body also found that USAC

approved a plainly fraudulent application for more than $48 million in E-Rate subsidies

for the San Francisco Unified School District in 2000. This followed on the heels of an

alleged scheme by the Gambino mafia crime family to use a Missouri-based E-Rate service

provider to defraud nearly $22 million out of the program.33

With over 8.5 million individual recipients, and a growing $7.1 billion dollar budget, uni-

versal service now rivals the basic cash assistance program of the federal welfare program.34

Universal service has devolved into a digital welfare system, repeating institutional mistakes

that have plagued the nations general welfare system for decades.

Prospects for Reform

Despite the deep-seated issues facing USF, a recent display of federal leadership suggests that

universal service reform may be on its way. In late 2004, the FCC ruled that the USF was

subject to the Anti-Deficiency Act, a federal accounting law that prohibits public agencies

from incurring financial obligations in excess or in advance of available funds.35 This deci-

sion by federal regulators, if implemented, would decisively take USAC to task for regularly

committing more money than they have on hand, and would be a great step towards cleaning

house. The FCC followed up its order by opening a broad investigation in the summer of 2005

into USAC management, asking for public comments on improving the public administra-

tion of USF institutions, programs and disbursements.36

Other reform initiatives have begunat the program level. Responding to criticisms of Low-Income self-certification, the FCC

modified its rules to improve the effectiveness of program enrollment, and has asked that all

states establish procedures to verify the continued eligibility of their local recipients.37 And,

as a result of the Inspector Generals damning E-Rate audit report, USAC Administrator Lisa

Zaina planned to conduct 700 audits of universal service recipients in 2005 to target fraud and

abusive practices, including 250 audits of schools and libraries.38 In addition, USAC hired a

firm to conduct 1,000 site visits to inspect E-Rate recipient locations.

Although these efforts are admirable, they may prove to be too little, too late. A reported

released by the Congressional Budget Office (CBO) in early 2005 gave a bleak outlook



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for the future of universal service. Due to bureaucratic spending habits and new markettrends, free-wheeling USF policies are predicted to quickly burden consumer pocketbooks

A decline in long distance calling revenues, combined with increased USAC funding com

mitments have placed significant strain on telecom companies to contribute more, and may

prompt hikes in fees placed on phone bills up to 18% by 2007.39

Furthermore, internal audits and reviews may prove lackluster in achieving meaningful re-

form, given recent history. As the Government Accountability Office (GAO) noted in an

April 2005 report, [The] FCC has been slowto use audit findings to make programmatic

changes. For example, several important audit findings from the 1998 program year were

only recently resolved by an FCC rulemaking in August 2004.40 Expecting public officials

to effectively reorganize, restrain spending habits and cede authority ignores the enormoustrength of the government culture to protect and expand jurisdiction at all costs. And

with the previously mentioned initiatives taken by federal regulators to change the system

institutional resistance has already begun exposing its ugly head.

Forces in Favor of the USF Status Quo

There remains significant pressure from some in Congress to maintain the status quo on

universal service, despite all of its problems. Rural state politicians are some of the biggest

proponents of this course, as many of their constituents are heavily dependent on USF

funds, particularly in states that lack healthy economies and strong consumer demand for

advanced telecom services. The Congressional Rural Caucus, which lobbies on USF issuescounts more than 140 U.S. Representatives as members, nearly 1/3 the size of the entire

House. Efforts by both rural House and Senate members to lobby for more USF money

have proven fruitful: nearly half of all universal service funds in 2004 were earmarked for

rural telephone carriers and medical centers.41 Rural legislators also scored a major victory

by passing into law a one-year USF exemption from the Anti-Deficiency Act, undercutting

meaningful attempts to rein in unruly spending habits.42

In the policy debates currently underway, there has been a growing voice from some stake-

holders for an expansionist approach to reform flexible standards, more bureaucracy, and

new technologies to be placed under the thumb of universal service. Among the players

championing this approach is the Organization for the Promotion and Advancement ofSmall Telecommunications Companies (OPASTCO), an influential rural telephone trade

association that represents companies on the USF dole. OPASTCO has set forth a number

of eyebrow-raising recommendations for reforming the broken system. Among other sug-

gestions, they have called for 1) the enlistment of all telecommunications services, includ

ing all facilities-based broadband providers, to be required to make USF contributions, and

2) the granting of permanent immunity of USF management from the Anti-Deficiency

Act, a federal law that prohibits insolvent public funding practices.43 This proposal would

prevent effective change, as it exempts agency officials from being held accountable for

committing money they dont have on hand, and fattens the wallet of USAC in the name

of funding source equality. Rather than actually addressing the problems plaguing universa



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service, OPASTCO merely feeds the beast, perpetuating disastrous conditions for busi-nesses, consumers, and underserved communities.

OPASTCOs agenda is shared by the National Telephone Cooperative Association

(NTCA), the self-proclaimed voice of small, rural telecommunications carriers that gives

tens of thousands of dollars each year to congressional campaigns. Other interest groups

have begun grassroots efforts to expand the USF funding base, most notably a broad coali-

tion of heavy-hitting advocacy organizations that includes the American Association of

People with Disabilities (AAPD), the League of United Latin American Citizens (LU-

LAC), and the National Education Association (NEA).

The overwhelming resistance to effective reform of the universal service system leads one toresolve that there exists an iron triangle of interests between legislators, advocacy groups

and bureaucrats embedded within the universal service system.

Figure 5: The Iron Triangle of USF

The argument could be made that in exchange for public support and campaign contri-

butions from rural telephone companies and education advocates, rural representatives ofCongress empower the FCC via the Telecommunications Act to send lucrative contracts

and services to the special interest groups by way of USF. The FCC and USAC rapidly in-

crease the size of USF disbursements, which Congress shows little concern with, advancing

the interests of rural carriers and education advocates. With legislators resistant to losing

key electoral support, the FCC uninterested in ceding regulatory authority, and interest

groups unwilling to part from billions in USF funds and services, the digital welfare state

becomes institutionalized, immune to reform efforts, and exacerbating problems within the

universal service system.



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High Cost B50%

TeleconnectFund3%

High Cost A3% Deaf & Disabled

8%

Universal Lifeline

34%

-

Figure 6: CA Universal Service Budget,2006-2007

The Case of California

The issues besetting universal service policies may soon be dwarfed by the roadblocks ahead.

Some within the USF iron triangle have indicated their desires to expand universal service

into the Internet frontier. Joined by the Congressional Rural Caucus, OPASTCO and the

NTCA have suggested that the USF funding base be broadened to include Voice over

Internet Protocol (VoIP) providers. This move is a result of a fear that new Internet-based

communications will increasingly dry up tax revenue from long-distance calling. Arguments

have also been made to expand the notion of basic service to include high-speed Internet

access, known as universal broadband, which would require an entirely new regulatory

regime for Internet service providers to pay into, and be regulated under. Surprisingly, the

battle lines for government controlled Internet access have been drawn in California, the

home of Silicon Valley and birthplace of the Internet Revolution.

Like many states, California supplements USF payments with its own universal service sys-

tem. There are currently five major state-based programs two high cost funds (California

High Cost Funds A & B); a low-income subsidy fund (Universal Service Telephone

Service Program); a fund for state schools, libraries and hospitals (California Teleconnect

Fund); and telecom equipment subsidies for the disabled (Deaf & Disabled Telecommuni-

cations Program). These programs receive funding directly through state government fees

tacked onto consumer telephone bills. In all, Californias universal service system operates

on an $860 million budget and subsidizes nearly four million state residents, the most com-

prehensive effort of its kind in the United States.45

With the additional $600 million received annually through USF, the Golden State is now

a recipient to more than $1.4 billion in universal service support each year. 46 Despite the el-

ephantine proportions of combined USF-California funding, some insatiable legislators and

industry regulators have been actively seeking ways to further fill local government coffers.

Shaking Down Advanced Technologies for Universal Service

Legislators in Sacramento posed as pioneers for universal broadband, spurring early ef-

forts to ascertain its feasibility with the states universal service system. But as state utility

Source: California Public Utilities Commission


24/41


officials found in a 2002 study, universal broadband is a costly, difficult, and unneces-sary enterprise.47 Subsidizing broadband access for low-income and rural residents would

have drastic effects on the consumer market, resulting in an additional 4% surcharge for

non-subsidized broadband subscribers, quadrupling low-cost basic telephone service, and

raising costs for the states own low-income program by $1 billion per year. While high-

speed Internet access is available to at least 73% of Californians, it was discovered that

only 13-17% subscribed for service undercutting arguments that broadband was an

essential communications service that warranted government intervention for some

segments of society.

Golden State regulators also took a prominent role in fighting for jurisdiction over

Internet telephony, or Voice over Internet Protocol (VoIP) technology. As the CaliforniaPublic Utilities Commission (CPUC) reported in 2004, the projected consumer transition

from landline telephony to VoIP could result in up to $400 million disappearing from state

funding for universal service by 2008. During proceedings at the FCC, the CPUC vigor-

ously advocated for VoIP to be subjugated to federal and state universal service regula-

tions. Federal preemption of regulatory jurisdiction has since spared VoIP from dozens of

state-based universal service regulations, but threats to bring it under the yoke of USAC

are ever present today.51

USF in California

California has historically used a USF Low Income self-certification system whereby a tele-phone company must immediately enroll a customer that verbally certifies their eligibility

without showing any documentation, leaving it up to the company to decide whether to

later verify their income or not.52 Considering that the telephone company received federal

reimbursement regardless if the customers are actually eligible or not, the program had been

rife with abuse. During related FCC proceedings, it was noted that the state of California

appeared to have more households receiving Lifeline discounts thanare eligible for the

discount. Based on a federal analysis, California had nearly 800,000 more households re-

ceiving Low Income assistance than were qualified in 2002, a figure that becomes even

more unsettling when one considers that the nationwide average for subscription rates was

only about 33% of all eligible households in each state. At this critical opportunity to re-

form their broken self-certification system, the CPUC stated that their objective was to ex-pand Low Income support to accommodate even more residents, going so far as to explicitly

include illegal aliens for eligibility under a future verification system:

LIF states that the important point about the Women, Infants and Children pro-

gram (WIC) and the Free School Lunch program is that undocumented persons

are eligible for them, which they are not for the other programs listed in the [draft

CPUC decision]. LIF asserts that WIC is a critical program to reach a large group of

persons who are ineligible for all the other adult programs designated in the [draft

decision]. We agree and will include both the Free School Lunch program and

WIC on our list of means-tested programs.53


25/41

The Case of California | 19

High Cost USF problems have migrated to California as well. Of the more than $95 millionin federal funds the state receives for high-cost subsidies, 2/3 is disbursed for seventeen rural

telephone companies that serve less than 2% of the telephone lines reaching consumers.54

California Universal Service System Issues

The states own high cost programs have also exhibited signs of waste and short-sighted

regulatory provisions. The California High Cost Fund A (CHCF-A), which subsidizes

small rural carriers whose (landline) service rates would otherwise be increased to levels

that would threaten universal service.55 However, it has facilitated an incredible increase

in public funding, which have grossly overstepped the tepid growth of served landlines

Claimed costs by recipient carriers have increased nearly 25% in four years, despite only a2% increase in new household landlines during this same time.56

Rural Telcos 2002 2006

Yearly State Support $37 million $47 million

Total Landlines 122,197 124,868

Sources: Universal Service Administrative Company, California Public Utilities Commission

In a recent request for an adjustment in CHCF-A funding, Siskiyou Telephone Company, a

rural carrier that serves only 4,700 customers, requested funds to undertake what the CPUCcalled a very aggressive plant investment program of over $10 million.57 This proved

somewhat troubling to state regulators, as Siskiyou is not experiencing growth and may be

facing declining numbers of access lines.

California High Cost Fund B (CHCF-B) has been bogged down with regulatory problems

causing market maladies in the state. CHCF-B was originally created to facilitate industry

competition in designated areas where the cost of providing service exceeded the normal

telephone rates for state customers.59 However, CHCF-B subsidies are only practically avail-

able for large-sized carriers who can be designated as carriers of last resort (COLR), an

onerous build-out requirement for companies to serve all consumers who request service

within that area.60 The combination of these two policies has effectively entrenched locacarriers, discouraging competition and new market entrants in places where theyre needed

most. Though the CPUC vowed to review the effectiveness of the CHCF-B funding mecha-

nism every three years, that assessment has never occurred, likely leaving California con-

sumers with a regulatory lemon.61

In examining the case of California, its clear that expanding the role of government is not

the answer to universal service woes. Whether on the state or federal level, policymakers

handling universal service funds retain an unhealthy political interest in expanding pro-

grams and available financial resources, regardless of the consequences for consumers, busi-

nesses, or industry innovation. For the politically appointed industry regulators, the pursuit


26/41

of stronger regulatory control, pork for lobby groups, and new potential sources of staterevenue precede the interests of the public.

Universal Service v. Market Competition

Though some would suggest that the benefits of a dysfunctional universal service system for

schools and low-income Americans outweigh the costs to the telecom industry and average

consumers, a broader perspective of whats at risk must be taken into account. Short-sighted

laws have the power to turn consumer markets into stagnant pools with major international

impact. Deleterious provisions under the Telecom Act and revenue demands under univer-

sal service have stalled the deployment of technologies like DSL and Broadband over Power

Lines, as investors chose not to waste their money on over-regulated enterprises.

Wireless calling companies have also found difficulty making a business case for entering

regions where government-picked winners are insulated by subsidies and bear no provoca-

tion to make business operations more efficient. For too long, lawmakers have propped up

landline telephony with billions of industry dollars through the USF system that could be

otherwise invested elsewhere. This has caused the business decisions of service providers

to be skewed, serving inexpert regulators rather than the customers. As a result of harm-

ful provisions in industry laws, the U.S. has been left in the global dust when it comes to

deployment of advanced communications many of which were developed here in our own

country. In April 2005, the International Telecommunication Union (ITU) announced

that the United States dropped from 13th to 16th place in global broadband penetration,lagging behind the telecom policy prowess of such countries as Canada, Israel, and Nor-

way.62 The Organization for Economic Cooperative Development (OECD) found similar

results, with the U.S. tumbling from 4th place in 2001 to 12th by June 2005. 63 Even more

telling, The World Economic Forums Networked Readiness Index (NRI), a global as-

sessment of national telecommunications laws, technology usage, and the maturity of the

telecom industries, found that the U.S. fell from 1st place in 2003-2004 to 5th place in

2004-2005.64 The international laurels once accorded to the United States for superior

market-driven policies and technological innovation have been revoked, and will continue

to be out of reach so long as the voices of regulators and lobbyists drown out the real needs

of consumers and the national economy.



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Whittling Away the Welfare State

As it is structured today, universal service will only continue to threaten the growth and

well-being of the communications industry, digging deeper into consumer and corporate

pockets, drying up investment dollars and creating more government bureaucracy. In the

best interests of improving consumer welfare and capital expenditures, the iron triangle of

USF should be broken as soon as possible.

By eliminating USF taxes and subsidies, lawmakers can facilitate new growth and invest-

ment in underserved communities without manipulating markets and dissuading industry

innovation. Consumers will be exempt from rising phone bill fees, and free from funding

dubious service providers fattening from the trough of public funds. Responsible compa-

nies will have more capital to finance new technologies, and could work cooperatively,

rather than compulsively, with policy regulators to achieve public goals in quality serviceand affordable calling rates.

Some have suggested that rural landline telephone companies play an irreplaceable com-

ponent in achieving universal service goals. However, in the last ten years, landline tele-

phony has been overshadowed by a host of alternative services that are connecting people

in the telecom sphere. Indeed, federal data shows that innovative communication tech-

nologies have rendered USF subsidies obsolete, as growing consumer interest in other

affordable products have dwindled landline demand.65

VoIP, which can operate over any broadband connection such as cable, satellite, or wire-

less, shows strong potential in meeting the cost-savings concerns of low-income residents,and can thrive off new demand for broadband access. According to recent estimates, over

60% of American households own a computer,66 with virtually no difference between rural

and urban ownership rates.67 Overall, nearly 20% of U.S. households subscribe to broad-

band service.68 FCC data suggests that though fewer rural consumers have high-speed In-

ternet than their urban counterparts, the gap between the two markets is closing quickly,

and may be more reflective of local demand rather than actual access, as in Californias

case.69 By utilizing cable, wireless and wire line broadband technology, VOIP subscriber-

ship is expected to reach 27 million by the end of the decade, demonstrating a diminishing

need to prop up high cost and inefficient rural landline providers.

Cellular technology also continues to be a healthy alternative to the obsolete age of wireline telephony. Using line-of-sight technology, cellular service surmounts many of the

physical challenges that perplex the deployment and maintenance of cumbersome copper

wires. Furthermore, with prepaid options, roll-over-minutes, and big bucket plans, cell

phone service has a flexibility and affordability that has been a hit with consumers. Ac-

cording to a 2005 survey by Harris Interactive, 9% of Americans have already given up

their landline service for a wireless-only home, and that number is predicted to grow even

larger.70 With more than 190 million cellular subscriptions, wireless service plans eclipsed

the number of telephone landlines in the country by December 2004.71


28/41


Some big government apologists suggest that there is a sustaining market for USF landlinesupport, but that is simply not the case. One must remember that the Universal Service

Fund was created at a time when copper cables were the only way Americans connected

with each other, and cellular phones were luxury items owned by the elite. Now, with

the advent of communication technologies such as VoIP, cellular, cable, satellite, Instant

Messaging (IM) technology and Broadband over Power Lines (BPL), subsidizing wire line

telephone service for millions has become an unnecessary and obsolete approach to achiev-

ing universal service goals. Considering that without the aid of huge corporate subsidies,

nearly 100% of U.S. households own a television set, more than 60% subscribe to cable

service, and nearly 70% own a cellular phone,72 the more money, more landline mantra

of some USF proponents falls flat on its face.

Other advocates have declared that no matter how many new technologies enter the tele-

com marketplace, low-income and elderly populations would be resistant to change and

adoption of unfamiliar products and services. However, the data suggests otherwise. 60%

of Americans aged 60-69 now report they own a cellular phone, and half of those aged

70-79 say the same.73 And, in the last four years, Americans aged 65 and older have made

the greatest increase in Internet use among all other age demographics.74 This growing

desire for new technology suggests that lawmakers must think outside the copper wire box.

It should also be noted that entrepreneurs could make telephones of all types cellular,

VoIP, and satellite look and feel like traditional landline telephones, mollifying any un-

easiness that may occur with the foreign aesthetics of new products.


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Forging an Exit Strategy

Its clear that Universal Service isnt working, but what may not be as clear is how to fix it. The

following is a seven-point road map to reform USF, improve program management, and foster

forward-thinking policies in the telecom sphere, benefiting both businesses and consumers.

Refocus the Core Objective of Universal Service. The Telecommunications Act of

1996, along with succeeding FCC orders have made universal service an amorphous

program that can be manipulated by the wants and whims of politicians, corporations

and advocacy groups. Theodore Vails original vision for universal service is unrecog-

nizable today, as it has long since been muddied by the scandals and excess which have

rocked the public system. Congress should lead a back to basics initiative by changing

the legal definition of universal service to a detailed and reasonable public goal, rather

than the open-ended entitlement scheme we have on the books today. Furthermore,with the ubiquity of Internet access in schools, and the encouraging growth of the con-

sumer communications market, lawmakers should limit the USF to only one funding

mechanism. A single program that assists indigent consumers in both urban and rural

America will be more effective in reclaiming the true goal of universal service. States

with a continued demand for subsidized telecom connectivity for traditional recipients

should refocus their state-based universal service funds to supplement these needs.

Overall, USF should stop subsidizing failure, and work towards drastically reducing the

governments role in telephone connectivity.

Prohibit the Expansion of the USF Revenue Base. Based on FCC data, $77 billion of

the $289 billion dollar in annual revenue from the telecom industry is taxed for USFcontributions. Some universal service advocates are looking to increase these funds, by

extending contributions to include a portion of local calling revenue. However, the

current telecom tax on interstate and international revenue has been poorly managed,

and has increasingly burdened telephone companies and consumers. If history serves

as a predictor, granting public administrators more fiscal authority will fail to meet the

self-declared financial needs of program recipients.

o Congressional leaders should amend universal service rules to exempt revenue from

local calling, VoIP, and Internet-based services from USF payments. Public admin-

istrators should work with the funds available and solve the problems of today,

rather than expect that a life raft of new financing power is on its way.

o Congress should also steady its hand, and force USF to be subject to the Anti-Deficiency

Act. If any meaningful change is to occur with USF, the FCC and USAC must first be

made to account for the billion-dollar mistakes of the modern universal service system.

Increase USF Transparency. With a weak oversight structure, recipients have taken

advantage of a system where it seems anything goes. Without headline stories of pro-

gram abuse, USAC and FCC have little inducement to clamp down on USF abuse. Its

clear that the current rules governing USF funds do little to guarantee that the billions

of dollars disbursed arent being wasted. Responsible legislators in Congress should


30/41


direct the FCC to create mechanisms that objectively measure efficiency, need, andsuccess for the corporate beneficiaries of the universal service system. With so many

dubious government bodies having a hand in the affairs of USF, fiscal transparency is

critical in the march towards real regulatory reform.

Reform Universal Service Management. Asking USAC to rein in spending and pro-

gram abuse in the universal service system is akin to asking wolves to herd sheep.

Professional public administrators must replace the current Board of Directors, which

should be divested and unassociated with any organizations or companies that may

have an interest in USF disbursements. Special interest groups can voice their opin-

ions from a voluntary advisory committee, but should not be privy to any public purse

strings. The universal service system needs to be managed by administrators who canbe held accountable for their actions and the malfeasance of their subordinates.

o In-house reform efforts at the FCC are inherently limited in their effectiveness, as

they are susceptible to the same corporate culture and internal pressures that USAC

falls under. Furthermore, infrequent congressional inquiries and federal investiga-

tions do not provide a continuing level of accountability to the system. Given uni-

versal services budget size and the history of incompetence at USAC and FCC,

Congress should provide the FCC Inspector General with sufficient resources to

conduct thorough audits and investigations.

o Responsible regulators at the FCC must call for new provisions that will restrictschools and libraries to only receiving funds that reflect actual need, and swiftly

penalize recipients for gold-plating and sloppy handling of services. Americas youth

need first-rate learning experiences in the classroom, and parents deserve to know

if their school administrators are letting valuable resources fall through the cracks.

Replace Corporate Subsidies with Consumer Vouchers. With swelling subsidies for

small, poorly-run landline carriers and the growing affordability of telephone service via

cellular and Internet technology, federal regulators should re-evaluate the best way to

facilitate investment in Americas communications network. To this end, a voucher pro-

gram for low-income and high-cost subscribers may provide a solution to the problems

wracking regulators: voracious rural telephone companies, rising budget numbers, andmarketplace distortions from technology favoritism. By directly giving funds to disadvan-

taged consumers, and empowering them to choose the telephone service they want, tra-

ditional USF carriers will be prodded to maximize efficiency and improve business opera-

tions, consolidate with competitors, or else face bankruptcy just like every other business

in America. High cost area vouchers could subsidize the difference between the cost of

service, and a consumer rate that regulators consider affordable.75 Low income voucher

eligibility could be based on national poverty standards, and potential recipients could

automatically apply for vouchers when they fill out federal tax forms, bringing cost-sav-

ings and effectiveness to program certification. And with the emerging growth of satellite

telephony and new technologies like Broadband over Power Lines, lawmakers could foster

stronger deployment of advanced communications in every corner of the country.


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Forging an Exit Strategy | 25

Introduce Carrier Auctions in Targeted High Cost Areas. Federal regulators couldauction off some traditional High Cost USF obligations to carriers through a competi-

tive bidding process, which would reveal true corporate expectations of cost and rev-

enues, reducing wasteful subsidies. A dynamic funding mechanism that awarded mul-

tiple winners in different communities would facilitate new market entrants and infuse

competition, as innovative companies would be free of market distortions to serve con-

sumers. Limited service contracts and government performance measures could keep

winning bidders effective and efficient, for the benefit of the public.

Foster Real Competition and Regulatory Reform in the Golden State. Due to a dearth

of oversight and accountability, the extent of waste and mismanagement in the Califor-

nia universal service system is unknown. State regulators would be wise to take a boldapproach to reforming its programs, beginning with studying the real costs of providing

service, and determining the true number of indigent consumers who may need public

support. With burgeoning competition in the broader communications marketplace, the

CPUC should consider empowering consumers with new service choices through a vari-

ety of policies, including high cost auctions. Technology-neutral consumer vouchers may

also be appropriate for many low-income and high-cost consumers, who have been unable

to benefit from affordable technologies like cellular and VoIP.76 Eliminating regulations

that prohibit companies to respond to market forces in costly regions, such as rate price

caps and carrier of last resort obligations, should be evaluated during this time.

Safeguard the Future of the Internet From USF. Broadband ubiquity is a criticacomponent of U.S. technological competitiveness on the global stage, but increasing

government taxes on Internet access is not the best way to accomplish it.

o Billions of dollars in corporate subsidies and new bureaucracy have failed to be the

answer for universal telephony service, and have created more problems than theyve

solved. A permanent federal ban on universal broadband taxes would help keep the

Internet free, and allow legislators to refocus their energies on innovative, market-

based broadband initiatives.

o VoIP and other Internet-based communications should be permanently exempt by

the FCC from receiving and contributing to USF subsidies, so as to cultivate thecontinued market-based growth of affordable services in the telecommunications

market. Companies that merely host applications, and pay other parties for bulk

network access and transport should not be subject to USF.

Eliminating USF abuse, increasing oversight, delineating accountability, and protecting new

technologies from legacy taxes will put the universal service system in a position that wil

allow its proper phase-out. In the future, federal regulators should monitor market trends, as

well as the success of reform efforts to determine when USF can be properly dismantled.


32/41


33/41

Conclusion

This briefing paper sought to answer three major policy questions about universal service:

Are consumer fees and corporate subsidies the best method to connect communities with basic

phone service? From the facts and figures revealed in this briefing paper, it can be confi-

dently asserted that consumer fees and corporate subsidies have failed to serve the public

interest, mostly benefiting special interest groups. The USF telecom tax has wasted bil-

lions of dollars in potential investment for underserved consumer markets and advanced

telecom products that would have helped policy goals better than the sloppy redistribu-

tion scheme we have today. Eliminating the unsound regulations of universal service bear

more potential for improving the federal system than the provision of more public graft.

Has universal service stifled technological innovation and entrepreneurship in areas wheretheyre needed the most? By taxing DSL revenues, and threatening to place Internet

access in government hands, universal service has hindered investment in broadband

deployment. Rather than facilitate new entrants into the communications industry,

the universal service system has propped up antiquated landline telephony in areas

where new ideas and solutions are needed the most.

Can the marketplace play a bigger role in achieving the core objectives of universal service? At the

current levels of public spending and taxing, the universal service system cannot sustain

its present course. Additional taxes and regulations will be nothing more than a quick-fix,

providing no long-term answers to the deep-seated problems that ail the federal program.

Opening up the telecom marketplace to increased competition will benefit indigent Amer-icans, who have been kept away from its consumer cost-savings through USF policies.

After years of legal rewrites and burgeoning pork projects, the modern universal service sys-

tem resembles less of a benevolent policy goal, and more of a public entitlement program,

stacked with special interest groups, layers of bureaucratic red tape, and billions of dollars

culled for government redistribution. With financial fraud, regulatory abuse and waste in-

fecting the system, Congress and federal regulators have undeniably spawned a new digital

welfare state in the United States.

As former President Ronald Reagan once said, government does not solve problems, it

subsidizes them. Public administrators have clearly failed to redistribute corporate funds inany meaningful way, and have created a regulatory mess with the Universal Service Fund.

To break free from the entrenched iron triangle that maintains the USF status quo, strong,

independent leadership must emerge from Congress and the FCC, providing a steady hand

for substantive reform.

In this time of major industry change and regulatory upheaval, government officials on all

levels must rediscover whats truly in the public interest, and connect the least among us

with basic communications through technology neutral, pro-growth policies. When leaders

turn their attention away from their own political agenda, and focus on the bigger picture,

consumers and innovators win.


34/41


35/41

1 For further information, see Thierer, Adam. Unnatural Monopoly: Critical Moments in the Development of the Bell

System Monopoly. The Cato Journal 14 (Fall 1994).2 47 U.S.C. 151.3 For a more detailed history of the 96 Act, see Deonne L. Bruning, The Telecommunications Act of 1996: The Challenge of

Competition, 30 Creighton L. Rev. 1255 (1997).4 47 U.S.C. 254 (b)(4).5 Federal Communications Commission. Report and Order. FCC 97-157. Washington: GPO, May 8, 1997, p. 388.6 Due to an August 2005 FCC ruling, the rules that required revenue from DSL service to be subject to USF payments

have been reversed. However, as of the publishing of this study, DSL providers are still making contributions, under atransitionary 270-day order from the FCC.

7 47 U.S.C. 254 (h).8 47 U.S.C. 254 (b).9 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.10 United States Government Accountability Office. Concerns Regarding the Structure and FCCs Management of the

E-Rate Program. Testimony. Washington: GPO, March 2005.11 United States Government Accountability Office. Application of the Anti-Deficiency Act and Other Fiscal Controls to

FCCs E-Rate Program. Testimony. Washington: GPO, April 2005.12 FCC Adopts Plan to Restructure Administration of Universal Service Mechanisms (CC Docket Nos. 97-21 and

96-45). November 19, 1998. Federal Communications Commission. December 8, 2005. < http://www.fcc.gov/Bureaus/Common_Carrier/News_Releases/1998/nrcc8084.html>.

13 Board of Directors Members Universal Service Administrative Company (USAC). 2005. Universal Service Adminis

trative Company. October 20, 2005. .14 According to the FCC, the Contribution Factor is calculated from the projected needs of USF, and the anticipated

revenues from interstate and international calling.15 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.16 Congress of the United States. Congressional Budget Office. Financing Universal Telephone Service. Washington:

GPO, March 2005.17 Johnson, Johna. Universal Service Fraud: Bailouts for Billionaires.Network World March 7, 2005, p. 28. Lee, Chris-

topher. A Disconnect on School Internet Funds; Congressional Report Finds Waste in 9-Year-Old E-Rate Program.

Washington Post October 28, 2005, A21. Feller, Ben. Auditors Find Lax Oversight of Internet Program for Schools,

Libraries. San Diego Union-Tribune March 16, 2005. Smith, Greg. MOB DIALS FOR DOUGH: Say Millions Swindled

Using Tiny Midwest Firm.New York Daily News September 19, 2004, p. 33.18 Federal Communications Commission. Report and Order and Further Notice of Proposed Rulemaking. WC Docket

No. 03-109. Washington: GPO, April 29, 2004.19 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.20 The Clinton Presidency: Historic Economic Growth. 2005. The White House. November 16, 2005. .21 Economics and Technology, Inc. Lost in Translation: How Rate of Return Regulation Transformed the Universal Ser-

vice Fund for Consumers into Corporate Welfare for the RLECs. Boston, Mass.: February 2004, p. iv.22 Ibid., p. v.23 Its worthwhile to note that in late 2005, the Puerto Rico Telephone Company convinced the FCC to tentatively adopt

a new non-rural insular support mechanism to supplement High Cost funding to the Commonwealth of Puerto Rico,

adding to the headaches of growth and bureaucracy in the Universal Service Fund.24 Davidson, Paul. Fees paid by all phone customers help rural phone firms prosper. USA Today November 16, 2004, p.1B25 Federal Communications Commission. Office of Inspector General Semiannual Report to Congress: April 1, 2004

September 30, 2004. Fall 2004.26

Ibid., p. 12.27 Microsoft Corporation has committed more than $1 billion in cash, software, and technology assistance to developtechnology skills and literacy for at-risk youth, and Cisco Systems has committed $40 million to connect Mississippi and

Louisiana schools with advanced education technology.28 United States Government Accountability Office. Application of the Anti-Deficiency Act and Other Fiscal Controls to

FCCs E-Rate Program. Testimony. Washington: GPO, April 2005.29 Davidson, Paul, Greg Troppo and Jayne ODonnell. Fraud, waste mar plan to wire schools to Net. USA Today June 8, 2004.30 Ibid.31 Federal Communications Commission. Office of Inspector General Semiannual Report to Congress: April 1, 2004

September 30, 2004. Fall 2004.32 U.S. House of Representatives. Committee on Energy & Commerce. Waste, Fraud and Abuse Concerns With the E-

Rate Program. Washington: GPO, October 18, 2005.33 Birsendine, Steve. Two plead guilty to conspiracy in $9 million phone scam. San Diego Union-Tribune February 24, 2005.34 Source: U.S. Department of Health & Human Services.

Endnotes


36/41

35 United States Government Accountability Office. Application of the Anti-Deficiency Act and Other Fiscal Controls to

FCCs E-Rate Program. Testimony. Washington: GPO, April 2005.36 Federal Communications Commission. Report and Order and Further Notice of Proposed Rulemaking. WC Docket

Nos. 05-195, 02-60, 03-109, CC Docket Nos. 96-45, 02-6, 97-21. Washington: GPO, June 14, 2005.37 Federal Communications Commission. Report and Order and Further Notice of Proposed Rulemaking. WC Docket

No. 03-109. Washington: GPO, April 29, 2004.38 States Think Time is Ripe to Fix Intercarrier Compensation. Communications Daily February 15, 2005.39 Congress of the United States. Congressional Budget Office. Financing Universal Telephone Service. Washington:

GPO, March 2005.40 United States Government Accountability Office. Application of the Anti-Deficiency Act and Other Fiscal Controls to

FCCs E-Rate Program. Testimony. Washington: GPO, April 2005.41 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.42 DeHaven, Ted. A Universal Waste of Money.National Review Online January 7, 2005.43 Action Issues: Universal Service. 2005. Organization for the Promotion and Advancement of Small Telecommunica-

tions Companies. December 8, 2005. .44 Top Contributors to Federal Candidates and Parties: Telephone Utilities. October 2005. Center for Responsive Poli-

tics. December 8, 2005. .45 California Public Utilities Commission. Universal Service. Power Point Presentation. San Francisco: March 2005.

PUC Continues Commitment to Telecommunications Programs. September 2005. California Public Util ities Commis-sion. January 20, 2006. .

46 Federal-State Joint Board on Universal Service. Monitoring Report on Universal Service. Washington: GPO, December

2005.47 California Public Utilities Commission; SB 1712 Study of High-Speed Internet Subsidies. San Francisco: Summer 2002.48 Ibid., p. 1.49 Does the Commission Regulate VoIP? 2005. California Public Utilities Commission. October 20, 2005. .50 Comments of the People of the State of California and the California Public Utilities Commission in Opposition to

Vonage Petition. WC Docket No. 03-211. Washington: GPO, October 27, 2003.51 Federal-State Joint Board on Universal Service Seeks Comment on Proposals to Modify the Commissions Rules Relat-

ing to High-Cost Universal Service Report. CC Docket No. 96-45. Washington: GPO, August 17, 2005.52 Federal Communications Commission. Report and Order and Further Notice of Proposed Rulemaking. WC Docket

No. 03-109. Washington: GPO, April 29, 2004.53 California Public Utilities Commission. Decision Adopting New Universal Lifeline Telephone Service Certification

and Verification Processes. San Francisco: April 7, 2005.54 Federal-State Joint Board on Universal Service. Monitoring Report on Universal Service. Washington: GPO, December

2005.55 California Public Utilities Commission. Resolution T-16963. Sacramento: December 1, 2005, p.1.56 California Public Utilities Commission. California High Cost Fund A Administrative Committee Orientation.

Sacramento: March 2003, p.4. California Public Utilities Commission. Resolution T-16956. Sacramento: September 22, 2005, p.3.

First Quarter Appendices 2002 FCC Filings Governance About USAC. 2002. Universal Service Administra-tive Company. January 26, 2006. .

First Quarter Appendices 2006 FCC Filings Governance About USAC. 2006. Universal Service Administra-

tive Company. January 26, 2006. .

57

California Public Utilities Commission. Resolution T-16968. December 15, 2005, p.7.58 Ibid.59 Ibid., p.14.60 Ibid., p.8.61 Office of Ratepayer Advocates. The Office of Ratepayer Advocates Review of The California High Cost Fund B: A $500 Mil-

lion Subsidy Program For Telephone Companies. San Francisco: March 2004, p.17.62 CI Host. CI Host Calls for Broadband-Friendly Legislation in Telecom Act; Changes Essential As United States Slips in

Global Broadband Ranking. Press Release. Fort Worth, Texas: May 4, 2005.63 Clark, Drew. U.S. Drops Again in Global Internet Race.National Journals Technology Daily April 25, 2005.64 Global Information Technology Report 2004-2005. World Economic Forum. Geneva, Switzerland: March 2005.65 United States. Cong. Senate. Committee on Commerce, Science and Transportation. Competition in the Telecommu-

nications Industry. The Testimony of Honorable Michael K. Powell, Chairman, Federal Communications Commission,p. 4. Hearing, 14 Jan. 2003. 108th Cong.. 1st Sess., Washington: GPO, January 2003.

66 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.67 United States Census Bureau: Statistical Abstract of the United States: 2004-2005. Washington: GPO, 2005.

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68 Federal Communications Commission; Trends in Telephone Service. Washington: GPO, June 2005.69 Ibid.70 Pilcher, James. Landline losing popularity to cell phone. Honolulu Advertiser September 6, 2005.71 Source: CTIA.72 Source: Federal Communications Commission.73 Online News Audience Larger, More Diverse. The Pew Research Center. June 2004, p. 22.74 Ibid., p. 17.75 The FCC had previously considered a voucher-like policy of high cost credits, to be dolled out to the carrier of a

consumers choice, supporting some corporate costs under certain regulatory conditions.76 Its worthwhile to note that the California Public Utilities Commission had previously proposed establishing a virtual

voucher system, whereby qualified carriers could receive credits to offset the cost of providing service in high cost

areas. In areas that carriers were not interested in serving, auctions would be held to determine what additional amountof subsidy is necessary to provide

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Vince Vasquez is a public policy fellow in technology studies at the Pacific ResearchInstitute (PRI). He works on a wide variety of current high-tech policy issues, including

universal service, telecommunications, municipal broadband, the digital divide, biotech-

nology, e-government, and privacy.

Mr. Vasquezs opinion pieces have been published in the Wall Street Journal, San Jose Mer-

cury News, San Francisco Examiner, San Francisco Business Times, the Houston Chronicle and

Red Herring. He is the co-author of other PRI publications, including Upgrading Americas

Ballot Box: the Rise of E-Voting, as well as Crossed Lines: Regulatory Missteps in California

Telecom Policy. Mr. Vasquez is also the author ofFinancing Freedom, a fundraising manual

for grassroots politics which he wrote before joining PRI.

Also prior to coming to PRI, Mr. Vasquez worked at the Leadership Institute, a non-profit

educational foundation in Arlington, Virginia. Mr. Vasquez earned a B.A. in political sci-

ence at the University of California - San Diego, where he was also editor-in-chief of the

California Review, a conservative journal.

About the Author


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The Pacific Research Institute champions freedom, opportunity, and personal responsibil-

ity by advancing free-market policy solutions. It provides practical solutions for the policy

issues that impact the daily lives of all Americans. And it demonstrates why the free market

is more effective than the government at providing the important results we all seek good

schools, quality health care, a clean environment, and economic growth.

Founded in 1979 and based in San Francisco, PRI is a non-profit, non-partisan organization

supported by private contributions. Its activities include publications, public events, media

commentary, community leadership, legislative testimony, and academic outreach.

Education Studies

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choice in education, high academic standards, teacher quality, charter school, and school

finance reform.

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PRI shows how the entrepreneurial spirit the engine of economic growth and opportunity

is stifled by onerous taxes and regulations. It advances policy reforms that promote a ro-

bust economy, consumer choice, and innovation.

Health Care Studies

PRI demonstrates why a single-payer, Canadian model would be detrimental to the healthcare of all Americans. It proposes market-based reforms that would improve affordability,

access, quality, and consumer choice.

Technology Studies

PRI advances policies to defend individual liberty, foster high-tech growth and innovation,

and limit regulation.

Environmental Studies

PRI reveals the dramatic and long-term trend towards a cleaner, healthier environment. It

also examines and promotes the essential ingredients for abundant resources and environ-

mental quality property rights, markets, local actions, and private initiative.

About the Pacifc Research Institute

pacific research institute digital welfare the failure of the universal service system february 2009

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