1. Killing With Kindness: Fatal Flaws in the Universal Service Funding Mission and What Should be Done to Narrow the Digital Divide A Presentation at the 33 nd Annual Telecommunications Policy Research Conference Hosted by The National Center for Technology & Law, George Mason University School of Law Arlington, Virginia September 23-25, 2005 Rob Frieden, Professor of Telecommunications Penn State University rmf5@psu.edu web: http://www.personal.psu.edu/faculty/r/m/rmf5/ http://www.personal.psu.edu/faculty/r/m/rmf5/

2. Universal Service Funding: A Flawed $5.7 Billion Annual Mission USF in the U.S. subsidizes specified services of local exchange carriers operating in high cost areas, and the rates paid by residents in rural areas and Indian reservations, the poor, schools, libraries, rural hospitals and clinics. The USF mission has included such ulterior motives as preserving the Bell System monopoly, transferring funds from urban to rural carriers and from long distance callers to local service subscribers, subsidizing service even for consumers quite able to afford the full price, and making it possible for regulators to showcase extraordinarily cheap local calling rates. USF avoidance technologies and strategies, e.g., VoIP and calling cards, coupled with consumer discontent with a 10.2% “tax” threaten the sustainability of the current regime. The Brand-X decision creates an ever expanding information processing “safe harbor” exempt from USF liability.

3. USF Failures The mission as structured will never achieve its core goals, or the expanded mission established by the Telecommunications Act of 1996. The USF mechanism benefits politicians and carriers first and consumers last. Subsidy mechanisms distort market forces and the USF mechanism provides unnecessary benefits to some people while imposing excessive burdens on others. Should monthly “lifeline” POTS cost less than a case of beer, or 2 packs of cigarettes? USF emphasizes carrier-specified costs and recurring service charges with little regard for new technological options, the need to promote computer/digital literacy and the importance of advanced broadband access in lieu of POTS. The USF mechanism creates an unwieldy bureaucracy and process prone to abuse and gaming.

4. Macro-Level Problems With the Current System Marketplace Distortion —USF creates artificial pricing signals by under- and over-pricing service; telcos operating in high cost areas benefit without regard to whether their subscribers need subsidies; compassion fatigue leads to USF avoidance strategies. Marketplace Distortion —USF creates artificial pricing signals by under- and over-pricing service; telcos operating in high cost areas benefit without regard to whether their subscribers need subsidies; compassion fatigue leads to USF avoidance strategies. Poor Calibration of Benefits and Burdens--The current 10.2% surcharge paid by all dial up long distance telephone users places a comparatively higher burden on heavy users which might include individuals with incomes just above the local service subsidy qualifying level. Poor Calibration of Benefits and Burdens--The current 10.2% surcharge paid by all dial up long distance telephone users places a comparatively higher burden on heavy users which might include individuals with incomes just above the local service subsidy qualifying level. Inflexibility—USF applies to specified (primarily narrowband POTS) carrier services with no option for targeting qualifying non- subscribers with alternatives. Inflexibility—USF applies to specified (primarily narrowband POTS) carrier services with no option for targeting qualifying non- subscribers with alternatives.

5. Micro-Level Problems With the Current System Status Quo Serves the Interests of Several Powerful Constituencies-- Elected officials perceive a benefit in helping to maintain below cost telephone service for some constituents. The Universal Service Administrative Company (“USAC”) has every incentive to make itself indispensable even though its principle duty lies in the seemingly straightforward task of collecting and dispensing USF funds. A cottage industry of USF consultants help schools maneuver an inscrutable maze. Status Quo Serves the Interests of Several Powerful Constituencies-- Elected officials perceive a benefit in helping to maintain below cost telephone service for some constituents. The Universal Service Administrative Company (“USAC”) has every incentive to make itself indispensable even though its principle duty lies in the seemingly straightforward task of collecting and dispensing USF funds. A cottage industry of USF consultants help schools maneuver an inscrutable maze. Accepts Costs With Few Auditing Safeguards—the FCC has conducted few audits and only recently discovered massive fraud and abuse. Accepts Costs With Few Auditing Safeguards—the FCC has conducted few audits and only recently discovered massive fraud and abuse. Emphasis on Service Subscriptions—USF primarily subsidizes recurring carrier costs and services rather than partially underwrite equipment purchases having little recurring costs. Emphasis on Service Subscriptions—USF primarily subsidizes recurring carrier costs and services rather than partially underwrite equipment purchases having little recurring costs. Potential for Substantial Future Deficits in USF Funding— migrating telecom to information service increases the burden on “late adopter,” dial up customers. Potential for Substantial Future Deficits in USF Funding— migrating telecom to information service increases the burden on “late adopter,” dial up customers.

6. Applicants post requests for services to SLD web site www.sl.universalservice.org using Form 470. www.sl.universalservice.org Applicants wait 28 days while service providers submit bids to applicants. Applicants sign contracts on or after Allowable Contract Date (29 th calendar day after 470 is posted). Applicants submit 471 to request discounts to SLD during 471 window. SLD’s PIA Team reviews every application and calls applicants for verifications. SLD mails applicant and service provider a BEAR approval letter. Applicants submit 486 to SLD for each funding request to “turn-on funding” and certify CIPA compliance, normally by Oct. 28 Copy also is mailed to service providers listed on 471. SLD mails applicants and service providers funding commitment letters (FCDL) that indicate approval/denial of requests. If applicant disagrees with a funding decision, they appeal to the SLD or FCC within 60 days of date on FCDL. Reimbursement Method Applicants pay bills in full and submit Form 472 BEAR quarterly, semi-annually, or annually to SLD. Discounted Bills Applicants begin receiving discounted bills. SLD mails applicants 470 Receipt Notification Letter. SLD mails applicants Receipt Acknowledgement Letter for each 471 received. Applicants submit Form 500 to release any unused funds. SLD mails applicant and service provider a 486 approval letter. E-rate Flowchart Source: Michigan Dept of Educaton, http://www.michigan.g ov/mde/0,1607,7-140- 6530_21417---,00.html

8. Best Practices in USF true technology neutrality coupled with a willingness to fund well articulated and community-supported projects rather than limit support to a fixed list of existing carrier services; true technology neutrality coupled with a willingness to fund well articulated and community-supported projects rather than limit support to a fixed list of existing carrier services; capping government project funding to a percentage of total cost thereby requiring project advocates to seek financial support from other grantors, or from bank loans; capping government project funding to a percentage of total cost thereby requiring project advocates to seek financial support from other grantors, or from bank loans; creating incentives for demand aggregation among government and private users, particularly for broadband and data services; creating incentives for demand aggregation among government and private users, particularly for broadband and data services; emphasizing one time project funding rather than recurring discounts; emphasizing one time project funding rather than recurring discounts; promoting innovation and creativity in projects, including technologies that provider greater efficiency and lower recurring costs; promoting innovation and creativity in projects, including technologies that provider greater efficiency and lower recurring costs; encouraging competition among universal service providers by auctioning off subsidy access; and encouraging competition among universal service providers by auctioning off subsidy access; and blending government stewardship and vision with incentives for private stakeholders to pursue infrastructure investments. blending government stewardship and vision with incentives for private stakeholders to pursue infrastructure investments.

9. Best Practices in ICT Development— Government Roles Successful ICT development requires a government role as incubator, steward, partial underwriter and anchor tenant without being central manager; the USG pursued this route for Internet development. Successful ICT development requires a government role as incubator, steward, partial underwriter and anchor tenant without being central manager; the USG pursued this route for Internet development. Government develops a vision and executes a multi-faceted strategy to achieve articulated goals. Government develops a vision and executes a multi-faceted strategy to achieve articulated goals. Government partially funds specific projects, but emphasizes private enterprise and facilities-based competition. Government partially funds specific projects, but emphasizes private enterprise and facilities-based competition. Funding reaches a variety of different grant seekers and supports digital literacy and not simply installation of equipment. Funding reaches a variety of different grant seekers and supports digital literacy and not simply installation of equipment. Creates incentives for investment and disincentives for litigation and other delay tactics. Creates incentives for investment and disincentives for litigation and other delay tactics. Initial government services offered via ICT include healthcare, education, access to information and licensing. Initial government services offered via ICT include healthcare, education, access to information and licensing. Government revises and reforms safeguards to promote trust, security, privacy and consumer protection in ICT services, especially e-commerce. Government revises and reforms safeguards to promote trust, security, privacy and consumer protection in ICT services, especially e-commerce.

10. Best Practices in ICT Development— Non-Government Roles Entrepreneurial and development hot beds such as Silicon Valley show that the U.S. ventures can successfully incubate ICT. Entrepreneurial and development hot beds such as Silicon Valley show that the U.S. ventures can successfully incubate ICT. Academia and commercial ventures can collaborate and exploit favorable and transparent rules of the game, i.e., a meritocracy that rewards talent and ability coupled with laws and regulations that support access to capital, research and development, risk taking and even failure. Academia and commercial ventures can collaborate and exploit favorable and transparent rules of the game, i.e., a meritocracy that rewards talent and ability coupled with laws and regulations that support access to capital, research and development, risk taking and even failure. A critical mass occurs when a talented work force and entrepreneurial risk takers gravitate to the same region that openly welcomes innovation. A critical mass occurs when a talented work force and entrepreneurial risk takers gravitate to the same region that openly welcomes innovation. ICT development requires a specialized business infrastructure serviced by consultants, lawyers, venture capitalists and executive recruiters. ICT development requires a specialized business infrastructure serviced by consultants, lawyers, venture capitalists and executive recruiters. Despite traffic congestion, high costs and a relentless pace hot beds provide a high quality of life. Despite traffic congestion, high costs and a relentless pace hot beds provide a high quality of life.

11. The Disconnects in Promoting Universal Service and ICT Instead of promoting pure and applied research and development in solving access issues, universal service funding flows to only a small set of stakeholders who received “tied aid,” i.e., funds tied to purchasing a narrow set of existing services primarily from incumbents. Instead of promoting pure and applied research and development in solving access issues, universal service funding flows to only a small set of stakeholders who received “tied aid,” i.e., funds tied to purchasing a narrow set of existing services primarily from incumbents. Instead of promoting ease of access to venture capital, e.g., through tax credits, the USF comes from compulsory subsidies that sure look and feel like a tax. Instead of promoting ease of access to venture capital, e.g., through tax credits, the USF comes from compulsory subsidies that sure look and feel like a tax. Instead of promoting a fair and transparent business environment, the USF rewards skill in working the e-rate system and the existing incumbent carrier voice network. Instead of promoting a fair and transparent business environment, the USF rewards skill in working the e-rate system and the existing incumbent carrier voice network. Instead of funding digital literacy the USF underwrites the purchase of equipment and services. Instead of funding digital literacy the USF underwrites the purchase of equipment and services. Broadband emphasized for e-rate beneficiaries only. Broadband emphasized for e-rate beneficiaries only.

12. Learning from Other Nations Promoting near term availability of nearly ubiquitous broadband infrastructure does not require “heavy handed” “command and control” centralized management by the federal government. Promoting near term availability of nearly ubiquitous broadband infrastructure does not require “heavy handed” “command and control” centralized management by the federal government. It requires a cohesive “top-down” vision coupled with “bottom-up” community champion projects that aggregate supply of services and demand for them. It requires a cohesive “top-down” vision coupled with “bottom-up” community champion projects that aggregate supply of services and demand for them. It denies laggards exclusive universal service territories and allows “eligible” replacements to offer new and better technological options, e.g., wireless. It denies laggards exclusive universal service territories and allows “eligible” replacements to offer new and better technological options, e.g., wireless. It does not allow incumbents to leverage possible future investment in broadband with even more regulatory forbearance. It does not allow incumbents to leverage possible future investment in broadband with even more regulatory forbearance. It coordinates many possible funding strategies including direct underwriting, loans, favorable tax treatment, financial support for research, development and technology demonstration projects (as was done with NSFnet). It coordinates many possible funding strategies including direct underwriting, loans, favorable tax treatment, financial support for research, development and technology demonstration projects (as was done with NSFnet). It trains people to become suppliers and consumers of ICT-mediated services. It trains people to become suppliers and consumers of ICT-mediated services.

13. A Limited and Strategic Role for Government Government should not usurp private enterprise and initiative, nor should it respond to every demand for incentives, subsidies and rights of first refusal. Rather than limit USF and ICT development funding to a closed and specific group of constituencies, government should offer several types of financial support, e.g., loan guarantees, grants and tax credits, to any applicant that proposes effective, efficient and innovative ways to stimulate ICT literacy and the provision of desirable services. Bottom-up, user initiatives better serve USF missions than top-down government, or carrier strategies. Bottom-up, user initiatives better serve USF missions than top-down government, or carrier strategies.

14. Reshaping the Mission Infrastructure--the scope and nature of networks that provide users with access to basic and advanced telecommunications and information services; Infrastructure--the scope and nature of networks that provide users with access to basic and advanced telecommunications and information services; Services--a revised determination of what constitutes basic “life-line” services and what other services, including broadband, that the FCC should include in an expanded universal service goal; Services--a revised determination of what constitutes basic “life-line” services and what other services, including broadband, that the FCC should include in an expanded universal service goal; Cost--who should support universal service objectives and who could qualify for universal service subsidization of basic and advanced services; and Cost--who should support universal service objectives and who could qualify for universal service subsidization of basic and advanced services; and Maintenance and Upgrades--what incentives must regulators create to ensure that universal service providers maintain and upgrade their networks, but do not object to innovations, including user operated telecommunications networks, that achieve scale, efficiency and cost savings. Maintenance and Upgrades--what incentives must regulators create to ensure that universal service providers maintain and upgrade their networks, but do not object to innovations, including user operated telecommunications networks, that achieve scale, efficiency and cost savings.

15. Conclusions and Recommendations Regardless of the telecom/information services regulatory dichotomy apply USF responsibility to any service provider accessing the PSTN and assigning subscribers a telephone number; charge on the basis of connections or lines, not minutes of use. Regardless of the telecom/information services regulatory dichotomy apply USF responsibility to any service provider accessing the PSTN and assigning subscribers a telephone number; charge on the basis of connections or lines, not minutes of use. Auction off USF subsidy access, rather than increase the burden when a competing “eligible telecommunications carrier” seeks funding; this would determine whether wireless carriers actually can offer cheaper and ubiquitous service, rather than cherry-pick. Auction off USF subsidy access, rather than increase the burden when a competing “eligible telecommunications carrier” seeks funding; this would determine whether wireless carriers actually can offer cheaper and ubiquitous service, rather than cherry-pick. Increase audits, create smaller cost areas, simplify the funding process and rethink the need for the USAC bureaucracy. Increase audits, create smaller cost areas, simplify the funding process and rethink the need for the USAC bureaucracy. Eventually replace the predominate POTS orientation with emphasis on broadband and applications like VoIP. Eventually replace the predominate POTS orientation with emphasis on broadband and applications like VoIP.