SECOND DRAFT
27 September 1993
A universal telecommunications service goal, simply defined, is a public policy to spread telecommunications to most members of society, and to make available, directly or indirectly, the funds necessary. In the past this has usually been accomplished through the establishment of a monopoly system in the provision of telecommunications, with the monopolist's profits used to support some of its endusers, especially residential and rural customers. More recently, competitive inroads into most segments of telecommunications have limited the ability to generate the funds for such internal cross-subsidies. Since the demands for funds for maintaining universal service have not declined, the old system has been propped up in a Rube Goldberg style of mind-boggling complexity. It has tried to conduct social policy with the tools of industrial structure policy, and has been less and less successful in either. Similarly, upgrade plans for telecommunications infrastructure have been affected by the question whether some segments of society would fall behind. For the longer term, therefore, the question must be faced squarely: if we want to continue to assure the electronic interconnectivity of all members of society, how will we pay for it? 1 This is the subject of this paper: how to raise revenues for universal service. What to spend them on, in the present or in the future, is an equally important but quite distinct question, and is not addressed here.
Of course, increased efficiency, competition, new technology, and a narrower targeting of benefits may well reduce the magnitude of the necessary money. But these measures will not likely do away with a core of politically and socially mandated support to rural America or to the poor. We can disagree about the magnitude involved but not that it will be nonzero, at least for the foreseeable future. Therefore the question still remains: how do we pay for the necessary subsidy? This question will not go away by the invocation of competition. Food production and distribution are highly competitive and efficient, and yet we support the food prices of many in society. We should not confuse issues of production and resource efficiencies with those of distributional allocation.
We will begin a theoretical discussion of universal service. This is followed by a section outlining today's system of financing universal service. The reader in a hurry can skip these two sections and proceed directly to the third section, in which a reform proposal is developed.
The proposal operates on the premise of neutrality -- equal rights and equal burdens to all carriers in the network system. Whether the carriers are traditional or new, they would all contribute financially to the level of universal service support decided upon by society through the political and regulatory system, and they would have full rights to enter and compete.
The proposed system is not a transfer mechanism per se but primarily an accounting mechanism to assure a fairness of burden. The existing support system need not be scrapped (though it could be): existing contributions are simply taken into account and credited. Level playing field competition becomes possible. Customers, including those that are subsidized, are able to choose among carriers. All carriers have therefore access to the subsidy mechanism if customers pick them. Competition, innovation, and universal service can coexist.
Universal service goals exist in every developed country. This suggests that similar benefits for a widespread interconnectivity are perceived around the world, usually independently of the political party in power. 3
What is the mechanism leading to such similarity? Perhaps the best way to look at a network is as a cost sharing arrangement among several users. In telecommunications, fixed costs are high, marginal costs low, and a new participant C helps the incumbents A and B to lower their cost.
Subscribers will find it attractive to join a well-sized network, because the high fixed costs of the network can be shared by many, making average costs low. At the same time, the number of subscribers n adds to positive utility, because the more people can be reached, the more useful is the network. This can be seen in Figure 1, where the utility of joining a network rises at first. (The horizontal axis shows the number of network subscribers; the vertical axis depicts average cost (i.e., price) and utility, in dollars. Conversely, where the network is small, average cost is high and externalities small. In that range, below a "critical mass" point n 1 , a network will not be feasible, unless subsidized by external sources. To reach n 1 requires a subsidy of sorts, either by government or by the network operator's willingness to accept losses in the early growth phases of operations. 4
But beyond that point, the network will grow on its own. Through this phase of network growth, which can be called the "cost-sharing" phase, the network users can lower their cost by adding members. However, at some point average costs increase, and utility plateaus. The optimum point is n 2 . Left to themselves, the existing subscribers of the network would not accept members beyond that private optimum.
From a societal point of view, however, the optimal network size in an equal price system may diverge from the private optimum. Social welfare still increases at n 2 , because the positive utility to additional network users is not considered by the existing network participants when they stop expanding at n 2 . The insiders do not take the outsiders into account. If the benefits are added, the social optimum n 3 lies between n 2 and n 4 . n 4 is the point beyond which the net benefits of the network will be negative. Beyond that point the network would need again outside support to exist.
What is the implication? Left to itself and with costs equally shared the network association will cease to grow beyond n 2 . The socially optimal size n 3 will therefore not be reached by itself, but by some external governmental direction through required expansion, and/or by a differentiated pricing scheme, or through some internal politics of expansion.
This analysis serves to clarify the often-asked question: for which services will universal service be extended? The answer is to those services which
(a) have reached, through self-sustained growth, a private optimum, beyond which further growth is not internally generated because marginal average net benefits are zero, but where
(b) average net benefits are positive (and therefore encourage demand for entry), and
(c) the number of those excluded is sufficiently large to lead to an opening by political means.
2. Political price setting, redistribution and expansion.
We have so far assumed that universal service is something imposed externally by government. But it can be shown that the internal dynamics of network members will take the network towards universal service -- and also towards its own disintegration.
As discussed, a network will cease to grow on its own after private optimum n 2 . This conclusion was based on a pricing scheme of equal cost shares. Yet there is no reason why such equality of cost shares would persist if prices are allocated through a decision mechanism that permits the majority of network users to impose higher cost shares on the minority. If prices are set in such a fashion, a political majority will lower the prices to itself by raising it for others.
But with internal redistribution, several things happen. First, the minority will seek a way to exit and join in another network, provided only it is large enough to reach economies of scale that leave them better off than in the previous network where they provided the subsidies. But such "exit" would deprive the network majority of the source of its subsidy, and is therefore undesirable to it. The main way for the majority to prevent this is to try to prevent the establishment of another network.
Secondly, the network will expand beyond n 2 . For the majority, there is added utility from added network members, especially if most of its cost is borne by the minority. They will therefore seek expansion. As this process of expansion takes place, the minority is growing, too. The likelihood rises that its size increases beyond the point of critical mass n 1 . Eventually, the benefits of exit become strong enough, the first network "tips", and an additional network is created.
The process of unravelling of the existing network commences even earlier if a new network has the right to interconnect into the previous one, because in that case it would enjoy the externality benefits of a larger reach of interconnected subscribers, while not being subject to redistributory burden. This is the reason why interconnection has always been the main battleground between new entrants and incumbents.
3. Social welfare and multiple networks
But what about social welfare in such a system? The traditional fear is that the loss of some cost-sharing and externalities brought by a second network would reduce social welfare. This is not necessarily true. First, the cost curves are likely to shift downward with competition, because of greater stress on efficiency, even if economies of scale exist. More fundamentally, the welfare implications of the formation of collective consumption and production arrangements may be positive. This is something analyzed in the economics field by so-called theorists of clubs. 5 Buchanan, James M., "An Economic Theory of Clubs," Economics , 32: no. 125: 1-14, 1965.
4. Conclusion
The analysis of the model shows that a network, left to itself under an equal-price system, will be smaller than socially optimal, require a directed growth to included more participants. One the other hand, under majority-rule system of price setting, the network would expand beyond the size that would hold under rules of equal treatment of each subscriber. Such an arrangement can be stable only as long as arbitrage is prevented, as long as the minority cannot exercise political power in other ways, and, most importantly, as long as it has no choice but to stay within the restrictive network arrangement. Thus, a redistributory universal service policy leads to the need for a market structure policy.
The more successful communications policy is in terms of achieving universal service and "affordable rates," the greater its cost, its associated redistribution, and the pressures for fracture of the network. This is where we are today.
The elements of financing universal service include a multi-varied collection of contributory elements. They will be described below. It should be noted that the different segments of the communications environment -- various carriers, large users, consumer advocates, and regulators, rarely agree on financial flows, including their size, direction, or beneficiaries. Even among non-parties there is great uncertainty.
1. Inter-carrier transfers
2. From non-carrier service providers:
This category is not easy to distinguish from the previous category, insofar as, e.g., enhanced service providers are customers of network services. But one can view ESPs as a wholesale level of users, and distinguish them from retail customers, both business and residential, that are discussed here. The existing subsidy mechanism includes the following:
In some instances, carriers charge below-cost prices voluntarily as part of marketing or competitive strategy or for public relations reasons. These might be absorbed either by other customers or by shareholders or competitive . Examples:
We showed in Section I that social benefits are derived from expanding telecommunications; that such expansion, however, accelerates tendencies to the formation of new networks; and that a funding mechanism across networks is more efficient than an internal one. In Section II we reviewed the elements of the present system of financing universal service. We will now discuss alternatives to the existing system.
1. Principles for a Reformed Universal Service: Seven Neutralities and Five Friendlinesses.
Any new type of revenue raising measure should meet the following criteria as much as possible. First, a set of seven "neutralities" that should be met or approximated.
Any plan requires also acceptability by state and local governments, which play a significant role in particular in local communications and in the maintenance of universal service schemes such as lifeline programs. The state public utility commissions have concerns over their jurisdiction, and they oppose a national uniformity that would preempt them from a traditional area of involvement. For any new system to be acceptable to the states it must leave them the flexibility to fashion their own variations, and to be able to continue maintain their state programs such as lifeline.
Local regulators are also part of the picture. They oversee cable television, where their role, minor after 1984, has been strengthened by the 1992 Cable Act. Among their concerns is to protect their source of income from the tax on cable television revenues (normally 5%). To the extent that cable operations may expand into new fields such as voice or mobile telephony, they seek the local tax to be extended to these new services, yet without their being earmarked for universal service.
2. Options for Reform
In structuring a system of contributions towards universal service, these are, broadly speaking, the alternatives.
We will begin by discussing the concept of value added tax. We will analyze its advantage, but also its disadvantages when applied to telecommunications. This will lead to the next step, the development of a telecommunication-specific revenue-raising system that draws on VAT principles.
A value added tax (VAT) is a form of a general sales tax. In contrast to a sales tax, however, it is neutral with respect to the nature of internal integration. With a sales tax, a company pays taxes on inputs, and these inputs in turn may include tax payments on their inputs. It is therefore advantageous to integrate as many operations as possible within the same entity. A VAT, in contrast, gives credit for tax payments made earlier in the chain of production and distribution. It is therefore proportional to the "value added" by each producer of goods and services, with a constant tax rate imposed at each stage on the sales revenues net of purchases.
The VAT can be imposed on either buyers or sellers. There is no economic difference, since the actual burden -- the economic incidence -- of any type of sales tax is not based on the nominal payor but on the relative demand and supply elasticities of consumers, producers, workers, and suppliers of capital. 15
Invariably, a VAT is seen as a broad-based, general tax. In Europe, it covers virtually all forms of consumption. In the United States, it has been proposed as a form of federal sales tax, with the potential to be a huge revenue generator. Just to get the order of magnitudes, a VAT at the average European rate of 17.5% would be about a 17.5% tax on the GNP, or about $1.1 trillion dollars of revenues!
As a general tax, a proposed VAT is embroiled in at least two major debates. First is the question of new taxation, which has tormented recent Administrations. Second is the comparison to other forms of general taxes, in particular the income tax or the expenditure tax. 16 Whereas these can be set at progressive marginal rates, permitting a higher proportional taxation of high income individuals, a VAT is basically proportional to consumption. 17 Since consumption declines as a proportion as income goes up, a consumption based tax will tend to be regressive. This has therefore led to a one-two punch against the idea of a value added tax: conservatives don't like taxes, and liberals don't like regressivity. Yet it is essential to differentiate. That is part of policy analysis. Let us therefore explain why a VAT on telecommunications is different from a general VAT.
Given the advantages of the value added charge concept in terms of the seven neutralities, we should try to maintain as much of it as possible within a telecommunications specific framework. 20 We will therefore use the VAT concept as a starting point, and fashion a telecommunications-specific application. We will proceed to describe the proposed new system, entitled the "Net Transmission Account System" or NetTrans Accounts.
At their most basic, NetTrans Accounts are not primarily a new form of transferring money. They are rather a way of keeping score that all carriers pay a proportionately similar share to the maintenance of that type of universal service which the political process has decided upon. Only insofar as some carriers may be contributing less than others would the NetTrans accounting result in transfers to and from the accounts. This system also means, importantly, that one need not (though one could) eliminate or change existing contribution programs. They are simply taken into account and credited in the process.
The system would be initiated at the same time that local competition would be fully permitted, with full interconnection and collocation rights. It would also be tied in with a cost-reduction mechanism of competition, so that inefficient carriers could not shift their costs to more efficient ones.
The system in a nutshell:
In an independently administered universal service account, carriers are debited a flat percentage of their transmission path revenues, net of transmission charges paid to other carriers, and given credit for universal service contributions made and for subsidized users choosing its service.
The elements of this plan are now developed stepwise.
1. "Carriers"
a. Who and what is included in the system? Entities that provide "transmission path" services to third parties for compensation. Included are all facilities-based two-way transmission carriers with an FCC carrier identification code (CIC) that are subject to the FCC's Title II regulation (or its state equivalents), including LECs, IXCs, cellular carriers, CAPs, and satellite carriers.
Excluded are enhanced service providers (ESPs), Information Providers (IPs), resellers, intraorganizational private networks, equipment manufacturers, and cable and broadcast operators (except for their two-way telecommunications transmission services). This will be explained below.
b. Telecommunications hardware? In the old days of AT&T it would have been easy to include telecommunications equipment. Today, however, such hardware is widely user-owned, and has been merging with computer and video equipment, and with consumer electronic devices. To levy a charge on telecommunications equipment therefore would either require continuous line drawing problems, or it would reach far into the computer and video industries. This would likely to be politically unpalatable, and would go far beyond the goal or reorganizing the existing subsidy system within the telecommunications sector. For those reasons, equipment should not be included in NetTrans accounts system. (At the same time, the cost of buying hardware is not deductible for purposes of calculating the net transmission path revenue. This will be discussed below.)
c. Upper level, enhanced, and information services? To include these types of services would create major problems. It could be considered a levy on information and speech (voice, text, image, and video) and as such constitutionally suspect ( Minneapolis Star and Tribune vs Minnesota Commissioner of Revenue. 460 USS75 (1983)). It would greatly increase the number of entities subject to the account system and thus increase its complexity. And it would lead to complicated questions of what is counted as enhanced services revenues. For example, if a travel agency provides an on-line reservation ticket purchasing service, without a charge, i.e. paid for through the ticketing commission, what is the ESP revenue it would be liable for? Or, how would an AIDS hotline that is funded by a government grant be treated? Should there be exemptions for non-profit and charitable organizations? Would a teenager's computer bulletin board system be subject to periodic filing? These questions can be resolved, but should one bother? One can reach all of these activities much easier indirectly. They all use underlying telecommunications transmission, and thus a charge on such transmission would be passed on to them under normal circumstances. This assumes a relative inelasticity of demand for transmission services, which is a reasonable assumption given that the charge would be on all forms of transmission and could thus not be avoided by switching transmission modes. What would be free of the charges would be the ESP's own value added. To omit it creates a bit of a distortion, but it also reduces an opposite distortion to equipment, which can provide many of the functions of ESP services, and which would be exempt, as has been argued above.
d. Private networks? Intraorganizational networks are an important part of American telecommunications environment. They come in two basic types: 1) using their own physical transmission facilities, i.e. privately-owned and used transmission facilities, or 2) using the transmission facilities of outside carriers, either a) dedicated leased lines or b) with "virtual" use of the carriers' network. In each case, it would be difficult to impute a revenue measure to the private network, since it serves the firm, (and sometimes its suppliers and customers) internally, rather than an explicit market price. Even where such a charge is made for internal accounting purposes, it could be significantly manipulated in order to reduce the NetTrans charge. In addition, there are the same problems that were mentioned for ESPs: large number of entities, administrative problems, definitional problem, and the need for fundamental legislation if system is widened.
In consequence, such private networks might be treated similarly to ESPs or resellers, which they frequently resemble. Where they use other carriers' facilities, they would contribute indirectly through the charges levied against the carrier facilities. Their demand elasticity is likely such that they would be subject to the charge's incidence. The main problem is where private networks use their own facilities. Including them is administratively difficult; excluding them creates a distortion in favor of facilities ownership. On the whole, it seems simpler to exclude them from the NetTrans account system than to include. Yet this does not mean that one needs to exclude them altogether from other forms of contribution to universal service, if such is desired. For example, today such networks are charged above cost for PBX trunk interconnection to the network. Such mechanisms could be maintained in the future, if desired.
e. Resellers? Pure resellers are poised between transmission carriers and enhanced service providers. On balance, its seems easiest to exclude them from the NetTrans system, and instead reach them indirectly through the charge on the underlying transmission services which they resell. This also avoids the sticky problem how to differentiate resale from enhanced services. Where resellers are not "pure" and provide basic switching functions in addition to their transmission resell, such switching service would be subject to Net Trans.
f. Cable television operators, broadcasters, direct broadcast satellites, wireless cable? Traditionally, what can be broadly called the mass media have not been part of the support system for universal service in telephony. To include them now would therefore change things negatively for them, which would translate into political problems. Furthermore, they are mostly one-way rather than two-way carriers. Also, the charge would have to be limited to the transmission function of such media, in order to be symmetric to the exclusion of ESPs and IPs discussed above, and in order to avoid establishing an unconstitutional burden on information and speech. Yet it is difficult to separate or impute transmission revenues in these media. Broadcasters or cable operators do not charge themselves transmission fees; cable operators often pay for program providers to use their facilities, rather than the other way around. In other instances, they must provide channels for free (public access; must-carry channel); in some cases they are paid (leased access), but the amount is a trivial part of overall revenues. Most revenues are derived from consumers paying for basic and premium program packages or per-view events. It is conceptually difficult, to say the least, to differentiate between revenues for transmission, programs, and advertising. This would argue for an exemption from NetTrans account.
A more fundamental point is that one cannot burden cable operators while assigning the revenues to the customers of other carriers. One cannot burden the customers of one service without also providing a benefit to some of them, too. Hence, the inclusion of cable operators in the system would mean that cable television provision itself would become subject to a universal service requirement, i.e. the policy that all Americans be accessed by cable at affordable rates, and, if necessary, be subsidized. This would be a policy that goes much further than the present approach, and its establishment would require a political mandate.
It is a different matter if these media enter telecommunications-like services. Cable operators, for example, are poised to offer voice, data, and mobile services. Time Warner's state-of-the-art trial in Orlando, Florida, will include switched long distance voice service. Other cable companies are owners of LECs, of CAPs (competitive Access Providers), or of mobile service providers. It would be difficult to explain why such services should not be included. Nor should it be too difficult to measure their revenue, since presumably customers would be charged for the services. And where a cable company bundles such services within a larger service package, it would have to unbundle, both for reasons of communications policy and in its own self-interest if it want to avoid a charge on otherwise excluded revenues.
A related question is whether a DBS satellite providing transmission services for broadcasters should be included. Here, the test would be whether the transmission service is for a two-way service subject to Title II regulation, or whether it is a mass media service subject to Title III. The distinction may be difficult to maintain for carrier transmission for a future interactive television, but let's cross that bridge when we come to it.
g. Paging companies? One-way paging services would be excluded.
h. Rights of way providers? In most cases, a transmission requires rights of way, even for micro-wave or satellite based services. To incorporate every landlord, however, would be far too complicated. The NetTrans account system would be limited to actual carriers engaged in the electronic and photonic aspects of telecommunications. These carriers could not subtract payments to rights of way owners from their gross revenues. In the setting of the price for the right-of-way the NetTrans debit charge would, presumably, lead to somewhat lower market prices for rights of way. Hence, the owners of such rights of way would indirectly also contribute to the system.
i. Software providers? Software and hardware are partly substitutes. Software is also difficult to separate from enhanced services and information services. It should be excluded.
Having now excluded a large number of participants, who is included, specifically?
Also exempt could be start-up carriers or new operations within these categories, partly as a form of "infant-industry" assistance, and partly to reduce the administrative burden by including only carriers who seem to survive. Such exemption should be limited in duration, for example to three years.
2. "Transmission path revenues" .
How would these carriers be treated under NetTrans account system? Proportional allocation of the burden of universal service could be accomplished by using various criteria, such as number of access lines, number of customers, or message units. All suffer from problems. Message units are not relevant in high capacity lines and where rates are not usage-sensitive. Access lines are relevant primarily for LECs, but not for other carriers. Nor could it be used in situations in which a customer utilizes multiple carriers, as would be the case with a "least-cost-routing." And the number of customers would be skewed in favor of carriers serving a few large accounts. One the whole, revenues are a good proxy for economic activity. The revenue numbers are also available for the traditional carriers as a byproduct of the regulatory process. Furthermore, if new carriers were to be stymied in entering the market, their revenues and thus the NetTrans obligations would be small. In consequence, for NetTrans accounting, the transmission path revenues of a carrier would be chargeable, net of payments made to other carriers who are subject to the system. Transmission path means transport plus basic switching Conceptually, it is the technical network utilized to get information from network interface A to network interface B. This would omit all types of services by service providers already excluded above such as enhanced services; information services; paging; resale; one-way services; equipment; or software. Also excluded would be miscellaneous non-transmission path services such as directory assistance; billing and collection services; special features such as caller-ID, or call-forwarding.
What would be included:
To separate these revenues from the others received by LECs might not be easy under normal circumstances. But the NetTrans account system benefit from the already existing requirement on the LECs to conduct such separation. In a series of lengthy and complex proceedings ( Computer I, II, and III ) the FCC has already established such separations, and NetTrans would piggy-back on the accounting system established, which requires a separation of revenues for "basic" and for "enhanced" services.
There is a question whether to include Centrex and switching services. On the one hand, since equipment is being excluded, and with it PBXs -- a close Centrex substitute -- Centrex would be disadvantaged if its revenues were subject to a debit account. On the other hand, Centrex is close to general switching, and indeed takes place within the same central office equipment, so that its exclusion would logically require the exclusion of switching, too. Yet basic switching is an integral part of the transmission path. In the case of packet switching, it is even difficult to separate transmission from switching functions. Also, customers do not tend to pay separately for transmission and switching, but for a transmission path from point A to point B. (This could be changed in the under an unbundling of charges). LECs charge under Open Network Architecture arrangements for unbundled "Basic Serving Arrangements" or BSAs, which includes loop and switching, and such BSAs may be the appropriate definition for the loop-central office path of a transmission, i.e., switching revenues and the relevant unbundled centrex charges would be included in transmission path revenues. 23
A related question is what among the several central office functions to include, and what to exclude. Here, fortunately, the Open Network Architecture process of the FCC and by several of the states 24 New York Public Service Commission (NYPSC). Case 88-C-004, Order Instituting Procedures for the Implementation of Open Network Architecture , New York: NYPSC. September 29, 1988; and Eli Noam, From Liberalization to Open Networks: A Review of Open Network Architecture and the Evolution of Telecommunications Policy in the United States , Columbia Institute for Tele-Information Working Paper Series, 1992. has provided the groundwork for the NetTrans account system separation. In these proceedings, the RBOCs unbundled their central office functions into several Basic Servicing Arrangements (BSAs) and specialized Basic Service Elements (BSEs). This framework can be adapted for the NetTrans accounts, simply by including BSAs and excluding BSEs. (This, incidentally, would also serve as a check against RBOCs incentives to excessively expand the BSAs, which they control.)
The other carriers would be treated along the same principles as the LECs, in order to be consistent. The disadvantage here is that their internal accounting system, in contrast to the larger LECs which have been required to do so for some time, may not be geared up to the task of identifying transmission path revenues within the larger company revenues. To institute such a system might therefore be a burden for some types of carriers. Where such is the case, the introduction of the system to the particular carrier category might be delayed a bit to provide extra time for the accounting system to be set into place, and to provide through the delay also some compensation for the changeover costs. It should be kept in mind that al carriers would have an incentive to establish an accounting system that provides them with the desirable exclusions.
3. "Net of payments made to other carriers who are part of the system" .
An important feature of the NetTrans account system, gleaned from the value added tax concept, is to give credit for the cost of inputs. In this case, those are transmission path inputs purchased by a carrier from other carriers. For example, long-distance or mobile carrier reaches its customers, or its customers' called parties, through local exchange companies. It pays for such access through access charges. The carrier's own transmission path value-added are its transmission path revenues minus payments for such services to others carriers. This feature of the plan means that there is no accumulation of tax upon tax, as would be the case with a sales tax imposed at each stage. In consequence, there are no advantages to being vertically integrated across multiple stages.
The logic of subtracting input payments is to avoid multiple payments. But if that input is exempt from payment, there is no reason for a subtraction. For example, if the interconnected carrier is a foreign government monopoly carrier from which no NetTrans payment may be obtainable, then payments to such a carrier should not be subtractable. Similarly, a carrier's use of other ESPs' services, or its equipment input purchases, are not deductible, since these firms do not contribute to NetTrans.
4. "Flat Percentage."
With these steps, we can define and estimate a revenue base for the charging account mechanism. If we know how much of a universal service contribution we must generate in total, we can calculate a debit percentage. That percentage rate, applied to any carriers net transmission path revenues, would then be its debit in its NetTrans account. The percentage would have to be periodically recalculated to keep from over- or underrecovery. In calculating the amount of overall universal service burden, there needs to be a mechanism to keep costs declining. This will be elaborated below.
5. "Independently Administered."
For the account system to operate equitably and without suspicion, it could not be administered by any particular industry group, or else it may shift its costs to its rivals. The alternatives are:
6. "Credit for Universal Service Contributions Made."
At present, carriers contribute to universal service in a variety of ways. Some pay access charges that are substantially above cost. Others serve rural areas at prices that are below cost. Etc. These contributions should be credited against the universal service fund debit.
One major advantage of the NetTrans account system is that is does not force an already existing subsidy mechanism to change. Nor is it dependent on such a change. A rebalancing of rates could take place, but one need not wait for it, because NetTrans can accommodate either situation. What it does to credit all these programs within a general calculation of share of burden. If access charges, toll pools or lifeline contributions have already been made by a carrier, they are taken into account, to the point that high burdens through other contribution programs will lead to net repayment. If the present hodge-podge of contribution programs should, by some miracle, be perfectly equitable in its net financial burdens on the various carriers, no additional transfers at all would have to take place.
To extend credit will require quantification. One somple way to establish the credit is to let the various carriers declare their valuation of their own contribution. One might think that this will lead to an overestimate. But if the estimate would be the minimum debit for the next period, adjusted for growth, the incentive to exaggerate would be reduced. Another method would be to evaluate the contribution. The incremental difficulty of this task should not be overestimated, in that the LECs, for a very long time, have gone through state rate cases and federal proceedings in which they have argued the extent of their various contribution to universal service. Similarly, other parties had the time to develop significant expertise in dissecting some of these numbers. Regulators, in turn, had ample opportunity to reach some conclusions, determine cost allocations, etc. Thus, this experience and numbers would be used for purposes of credit. In the future, this might be a task where the experience of state regulatory commissions would be useful, operating under broad FCC principles, and with some averaging to even out jurisdictional quirks.
One should not try to make the crediting system perfect, or else it will be overly complex. Its elements should include:
But in the short term, market power still exists, and an LEC left to its own devices would not reduce below a monopolistic price. In consequence any payments a price-regulated carrier obtains from the NetTrans account would have to be flowed through to price reductions of profit-making contributory price-regulated services. In such a way a carrier would not be over-credited. Where the flow-through is partial only, the NetTrans credit would be reduced correspondingly.
One question is how to handle the problem of "stranded investment, " i.e. of LEC investments that become economically or technically obsolete due to the competitive entity. Here, one needs to differentiate between "new" stranded investment and "old" one. If new investments become worthless, investors bear the burden, as in any industry. Earlier investments, however, were undertaken within a context of assured but lower returns for a specified period, and were approved by regulators. LECs have a choice: they can either write down the value of the investment and thereby lower their cost. Their competitive position improves, but shareholders bear the loss of investment value. Or the LECs can keep cost at the original level but thereby provide an added incentive for competitors to enter. The average cost per remaining subscriber could well rise (before productivity gains), but this cost would be partly borne by other carriers through the NetTrans system insofar as the subsidy amount is based on the average cost-price gap.
7. "Credit ... For Subsidized Users Choosing Its Service"
The administrating body verifies a carrier's calculation of its net account debit. It then collects the amount due, or reimburses a carrier which has a net positive balance. At the end of a an accounting period, a true-up takes place. The accounting system is used in accordance with the relevant universal service laws and regulations, and carriers and/or users receive credits to support telephone or other services, whether traditional or new. It is not the task of this paper to analyze what types of services might be supported, for how long, what kinds of users might benefit, and whether support ought to be broadbased and expansionary or narrow and means-tested. The mechanism could be used for upgrading of the communications infrastructure, if such is decided upon, for each purpose, even to support a NetTrans mechanism that is a content-neutral that can support any plan. One way to proceed, after defining the benefitted class of users and services, is to provide these users with "virtual vouchers". They would choose carriers freely; and the chosen carrier would then be credited in its NetTrans account for the value of the voucher. The customers' telephone could reflect the credit, which would be fully passed on to them. Such a system would be much simpler to administer than actual vouchers that would have to be sent out and collected. 25
8. A Sales Tax?
Could this system be accomplished similarly through a special sales tax on telecommunications? As has been argued above, a sales tax at each stage of telecommunications inputs would accumulate across stages, and thus be distortive, without being much simpler. Another alternative would be to institute a single-stage sales tax, collected only at the enduser level. But here are its problems:
It is natural to seek simplicity. But simple systems entail distortions and unfairness, and they soon become modified and increasingly complex. This will inevitably happen to a sales tax.
9. Jurisdictional Issues.
a. State Jurisdiction
It therefore seems that the FCC would be within its delegated powers to introduce such a system. However, it would also make sense for the broad outline of the system to receive express Congressional and Executive approvals. But it would be a mistake to make approvals in a form that is as detailed as tax legislation, and with special provisions for various favored causes. The devil is in the detail, and a specialist agency such as the FCC, with its independent status, would be best in a position to deal with the details.
Let us look at a simple numerical example of NetTrans, using arbitrary numbers.
Assume:
Customer A is being subsidized at a price that is 20 below cost. The revenue comes from two sources: (a) customer B, who pays 10 above cost; and (b) long distance customer C, whose call generates an access contribution of price minus actual cost of 15 - 5 = 10.
such a system:
(a) the CAP will have an over-incentive to serve customer B. It will to be prevented from offering that service to B, or else the contribution by B to A would be lost. B thus has no choice among local carriers.
(b) CAP will try not to serve customer A, who thus has no choice among local carriers.
(c) IXC has an incentive to link up with CAP rather than LEC. It will be prevented from doing so to maintain the subsidy from C to A. (If it is permitted to bypass LEC, to maintain the subsidy to A, the rates on B would have to be increase from 40 to 50, thereby increasing the pressures on B to try to switch to CAP.)
(d) Customers C and B call less than otherwise, because their rates are above cost.
(e) Customer A calls more than otherwise since their calls are below cost.
(f) LEC has no incentive to reduce cost of operations.
Under NetTrans:
Local competition is instituted. Assume that the price for subsidized customer A remains at 10, plus the NetTrans charge. 27 The "benefitted service" of A would still be subject to a NetTrans debit, but it would not be paid by A, even on the portion he is paying. LEC would both be debited for the NetTrans and credited for it, so it would be a wash. One could therefore leave it out entirely from the NetTrans system. But in so doing, one creates unnecessary accounting and administrative problems, since the LEC (and ALT) would have to segment their revenues between different customer classes.
The universal service shortfall for serving A is 30 - 10 = 20. To cover this amount, a charge against net revenues is levied.
net transmission revenues are:
IXC: C = 20 - 15(access charge) = 5
LEC: A = 10
B = 40
access charge: = 15
subtotal: = 65
ALT: D = 30
______
Total net revenues = 100
To yield the required 20 to support A's universal service out of the aggregate net revenues of the entire telecommunications system (a hefty subsidy) of 100 requires these revenues to be charged at a NetTrans debit rate of 25%. (The reason the rate is not 20% is that we assume here that customer A's rates remain at 10, plus NetTrans on that amount, i.e. that he does not pay the NetTrans debit charge on the subsidized part of the cost. The formula for the debit percentage can be calculated as % = S/(R-S), where S is the desired pre-NetTrans subsidy, and R is the total of net revenues. In our example S = 20, and R = 100, for a debit percentage of % = .25. If we maintain A's price at 10, i.e. without NetTrans charge, the equation becomes %=S/R-C. In this case, it would be 28.57146%.
This would mean debits on the various carriers net revenues:
IXC: -.25 x 5 = -1.25
LEC: -.25 x 65 = -16.25
CAP: -.25 x 30 = -7.5
1. Scrapping the Old System
Let us also assume for the moment that the previous subsidy schedules are abolished, and competition is free. What happens?
(a) Customer A gets a voucher enabling him to get service at the previous rate of 10.with the contribution in the access charge to LEC abolished, access charges would be at 5, plus NetTrans charge. Also, because of competition in the long-distance market, and since all other IXCs would have the same reduced access charge costs, the IXC cost to serve customer C would drop to 12.5 (comprised of IXC's operating cost of 5, plus its access charge payment (now at 5), plus the universal service contribution of 1.25 on its net revenue).
(c) LEC lowers its contributory price to customer B, since it now faces competition for that customer from CAP. The price would drop to 30, plus NetTrans of 7.5, i.e. to 37.5.
(d) LEC can charge A the market price, i.e. 37.5, against which A can use their voucher of 25.
(e) CAP now contests customers A and B. Its price would be 30 plus NetTrans of 7 for 37.5. Let us assume for computational simplicity sake that the two customers remain with LEC. This will result in the following revenue streams and contributions.
In each case, revenues would match costs:
IXC: 12.5(price to C) - 5(operating cost) - 6.25(access) - 1.25(NetTrans debit) = 0
6.25(Access charge received) - 5(cost) + 1.25(NetTrans on 5 passed on) = 6
CAP: 37.5(price to D) - 30(cost) - 7.5(NetTrans debit) = 0
NetTrans: 1.25(IXC) + 16.25(LEC) + 7.5(ALT) - 25(Voucher A) = 0
This is summarized in Table 1.
What are the implications?
It is likely that not all previous contribution elements would be abolished. The NetTrans accounting would accommodate elements of the old system. If access charges, for example, would not be reduced, NetTrans could simply adjust for it. If IXC would still have to pay LEC an access charge of 15, including a contribution of 10 plus NetTrans charge of 2.75, the contribution would be credited to IXC's account against its debit of 1.25. IXC would then be owed a net of 11.5. LEC, on the other hand, would have to add 12.75 to its debit of 16.25, for a total of 29.
Similarly, if LEC does not reduces the price for customers B from 40 to 30 before the charge, its NetTrans account would look different. For example, if price to B would remain at 40, perhaps because CAP's competition has not yet arrived, then LEC's NetTrans account would be debited by its allowed internal contribution of 10, and it would not receive it doubly through NetTrans.
The best concept will flounder if the impact on a powerful industry segment is unfavorable in the absolute in comparison to its rivals. Thus, it is important to estimate a rough impact of the NetTrans account system.
What is the cost of universal service? These are difficult questions to answer. In one study, prepared for the U.S. Telephone Association, Monson and Rohlfs conclude that the contribution of switched access provided to IXCs, and intraLATA toll service was between $18.3 and $21.1 billion, about $12 per month per access line in the U.S., and twice the total earnings of the entire telephone industry. 28 (Figure 4) In another analysis, Bellcore finds a $17.4 billion contributions to residential service. 29 These figures, originating as they are in one segment of the carrier industry, may be the upper bound. But they suggest a substantial transfer.
Raising prices to cost would decrease telephone penetration. With price elasticities of demand estimated in various studies to be between -0.2 and -0.05 as the extremes. 30 An increase of 40% in rural rates 31 in price would lower rural penetration by between 2% - 8%.
The estimate for total transmission path revenues in the US is, back of the envelope, about $150 bill. If the total universal service subsidy of $18 billion (accepting the LEC industry's numbers) means a charge rate of about 17% against transmission path revenues.
Let us assume the same support level to continue. More back of the envelope calculations show the following distribution among the main industry segments in Table 2.
The order of magnitudes of these numbers is important. The reader may recall that among the criteria for a new system of financing was "transitional neutrality," i.e., that no customer class or carrier type should reap a windfall or be subjected to a shock. If the numbers indicate that this would happen, one may have to redesign the system.
Why fix the old system? The answer is that the old system is a patchwork that barely holds together, and that it is a stumbling block to a transition to a truly competitive telecommunications environment. We have neither real competition, since we are reluctant to dismantle the welfare arrangement everybody has gotten used to, while at the same time we are undermining the universal service support system by present inaction. It is the worst of both worlds. We can pretend that present policy is not at cross-purposes. And we can pretend that competition and technology will solve all problems, ignoring that the policy question is not one of efficiency but one of allocation. But sooner or later we will have to face the problem. The underlying forces will not go away; they bring us many benefits, but they also force us to pursue policy goals such as universal service in new ways.
If it'll break for sure, fix it now.
| 1 | Europeans, too, have begun to confront that question, and are addressing it in a Green Paper by the European Commission, anticipated by the end of 1993. |
| 2 | Noam, Eli, "A Theory for the Instability of Public Telecommunications Systems," in Cristiano Antonelli, ed., The Economics of Information Networks , Elsevier, 1992, pp. 107-128. |
| 3 | Exceptions were some of the communist countries of old, which wanted their societies both technologically modern and politically controlled, and failed in both. |
| 4 | The strategic problem is to identify in advance a situation in which such a break-even point n 1 will be reached within the range n < N, where N = total population. Possibly, such a point does not exist, and subsidies would have to be permanent in order to keep the network from imploding. |
| 5 |
Schelling, Thomas C.,
Models of Segregation
, Santa Monica: Rand, 1969.
|
| 6 | The set of possible utility distributions among separate groups dominates (weakly) the set of such distributions among integrated groups (McGuire, JPE, p. 124). [FULL CITE] |
| 7 |
Federal Communications Commission,
Reference Book: Rates, Price Indexes, and Household Expenditures for Telephone Service
, by Lande, James L., Washington, DC, May 1993.
|
| 8 | This is one area where ignorance is bliss |
| 9 |
Federal Communications Commission,
Reference Book: Rates, Price Indexes, and Household Expenditures for Telephone Service
, by Lande, James L., Washington, DC: Federal Communications Commission, May 1993.
|
| 10 | Weinhaus, Carol, Sandra Makeeff and Peter Copeland et al, "Telecommunications Industries Analysis Project: What is the Price of Universal Service? Impact of Deaveraging Nationwide Urban/Rural Rates," Cambridge, MA: Telecommunications Industries Analysis Project, 1993 July 25. |
| 11 |
The Rural Electrification Division of the Department of Agriculture provides three types of loans.
|
| 12 |
An example how non-neutrality affects industry structure may be AT&T's recent acquisition of McCaw Cellular. According to Wall Street analysts, this deal significantly affected by AT&T's desire to reduce the access charges it is paying to LECs by establishing an alternate access route to users.
|
| 13 | There is, at present, a 3% federal excise tax on telephone bills; the excise revenue goes into the generaal budget and is not earmarked. |
| 14 | Einhorn, Michael A., Recovering Network Subsidies Without Distortion , Antitrust Division U.S. Department of Justice. |
| 15 | See Ernest S.Christian Jr., "If, When You Say "Value-added Tax," You Mean...", in Weidenbaum, Murray L., Raboy, David G. and Christian, Ernest S., editors. The Value Added Tax: Orthodoxy and New Thinking. Mass: Kluwer Academic Publishers, 1989. |
| 16 | Not to be confused with a sales tax. An expenditure tax is basically a tax on income minus investments, and can be progressive. |
| 17 | Progressivity in the actual incidence of the tax could exist if demand and supply elasticities shift the tax to suppliers of capital and sellers of goods and services, and assuming that those are higher income. |
| 18 | Tait, Alan A., Value Added Tax: International Practice and Problems , Washington, DC: IMF, 1988 |
| 19 | Tait, Alan A. Value Added Tax: International Practice and Problems, Wash. DC: IMF, 1988, p. 68. |
| 20 | A major advantage of most forms of taxes on the telecommunications sector is that demand is fairly inelastic. In consequence, any charge against it would not distort consumption decisions much. This conforms to one of the major desirable attributes of an ideal tax. |
| 21 | Only for transmission services, i.e. electronic or photonic transport etc, but not for the rights of way. |
| 22 | See discussion of international service below. |
| 23 | At the same time, enhanced Centrex functionalities would be excluded, as they are ESP type services. |
| 24 |
See Federal Communications Commission, In the Matter of Filing and Review of Open Network Architecture Plans,
Memorandum Opinion and Order
, FCC 88-381, CC Docket No. 88-2 (
Phase I
)(Adopted November 17, 1988; release December 22, 1988);
|
| 25 | See also Gail Garfield Schwartz, "Universal Service Assurance Via Equal Access to the Subsidies." Thinking points by the Teleport Communications Group. September 21, 1993. |
| 26 | We assume in this example, for numerical simplicity, that no CAP access charges exists. There is no problem in dropping that assumption. Similarly, the assumption that cost to serve customers A, B, and D, is in each case 30 is made for computational simplicity and transparency. There is no problem in assuming that costs are different from each other. |
| 27 |
We assume here that the NetTrans assessment on A's payment would be passed on to A. However, there is no problem in absorbing this charge and supporting it also. It makes the calculation a bit more complicated.
|
| 28 |
Monson, Calvin S, and Jeffrey H. Rohlfs, "The $20 Billion Impact of Local Competition in Telecommunications", Bethesda, MD: Strategic Policy Research, 16 July 1993.
|
| 29 | NYNEX, filing to the Federal Communications Commission, CC Docket 91-213 in the matter of Local Transport Rate Structure, July 14, 1993, Chart 1. |
| 30 |
Taylor, Lester D,
Telecommunications Demand: A Survey and Critique
, Cambridge, MA: Ballinger Publishing Company, 1980, p. 80, Table 3-1.
|
| 31 |
Weinhaus, Carol, Sandra Makeeff and Peter Copeland et al, "Telecommunications Industries Analysis Project: What is the Price of Universal Service? Impact of Deaveraging Nationwide Urban/Rural Rates," Cambridge, MA: Telecommunications Industries Analysis Project, 1993 July 25.
|