Study: Stop the Vicious Circle of USF Subsidies and RUS Loans

In a blog post on September 14 titled New USF Tax Hike Adds Urgency to Reform Effort, I called attention to the USF fourth quarter contribution rate increase to 15.3%. The contribution factor translates into the line-item surcharge added to the interstate long-distance portion of consumers' monthly phone bills. That USF surcharge (a tax, in effect) pays for subsidies to telephone companies in rural or high-cost areas, as well as schools, libraries, some health care facilities. In the last ten years, the USF subsidy system has also grown exponentially, with subsidies for service in high-cost areas climbing from $2.6 billion in 2001 to $4.3 billion in 2010. As explained in that post, reforms are urgently needed to reverse this costly upward trend in USF subsidies.

A recent study now points to problematical aspects of government loans to carriers receiving USF subsidies. "The Rural Utilities Service Should Reassess Its Reliance on Universal Service High-Cost Support to Leverage Broadband Loans," a study released earlier this month by Jeffrey Eisenach of Navigant Economics and commissioned by NCTA, asserts that "current RUS rules create a self-reinforcing multiplier effect, in which USF subsidies not only support inefficient investments, but provide the financial basis for RUS loans to support still more inefficient investments (which, in turn beget more USF subsidies, and so forth)."

RUS operates three major programs to subsidize construction of telecommunications infrastructure through below-market rate loans: the Broadband Initiatives Program (BIP), the Rural Broadband Loan Program (BLP), and the Telecommunications Infrastructure Loan Program (TIP). Between 2008 and 2010 the programs approved some $2.23 billion in loans to carriers to build telecommunications infrastructure, particularly for broadband services.

The study provides an interesting overview of how RUS rules for its loan programs and how they relate to USF subsidies. In short, RUS has historically assumed that USF subsidies constitute a stable revenue source during the terms of long-term loans, thereby providing security for such loans. Moreover, "RUS effectively assumes that the increased USF subsidies that will result from the investment indicate the project is deserving of public support." As the study explains:

[R]ather than signaling the social value of a particular infrastructure project, [high-cost fund] subsidies under the current system may instead indicate nothing more than an individual firm's success in making investments – however unjustified or inappropriate – solely to increase its USF support. By tying RUS loans directly to USF support, RUS effectively creates a vicious circle: The more a firm invests in inefficient infrastructure, the more it gets in USF support; the more it gets in USF support, the more it can qualify for in RUS loans; the more it can qualify for in RUS loans, the more it can invest; and, the more it invests, the more it gets in USF support.

The study includes an estimate that increased USF subsidies procured by RUS-financed investments "leav[e] borrowers themselves responsible for less than 25 percent of the payments, even though they earn 100 percent of the resulting profits." This means that taxpayers, by funding the RUS loan programs, are "in the fundamentally unsound fiscal position of being the primary source of repayment on their own outstanding loans."

Along the way, the study challenges RUS claims that USF reforms would result in financial calamity for loan-receiving carriers that are dependent on future high-cost subsidies. USF reform has been a long time in the making, and for that reason it is not an unexpected event that should blindside recipients of high-cost subsidies. Moreover, the FCC has made clear in its NPRM for comprehensive USF and ICC reform that it will avoid "flash cuts" and implement its reforms incrementally.

In the end, the study calls for RUS to:

implement an immediate moratorium on further loans to USF-supported entities, or require such entities to qualify for any further loans without relying on USF subsidies. After the FCC concludes its proceeding and new rules are in place, Congress and RUS can reassess whether a loan program continues to be needed and if so, how that program can be better coordinated with the USF program to eliminate the problems inherent in the current RUS regime.

That is a sensible policy recommendation worthy of consideration, as is the study.

FCC Should Let the Sun Set on Its Set-Top Box Regulations

On September 7, the FCC's Media Bureau released an order granting TiVo a waiver from its set-top box rules requiring "digital cable ready" devices be capable of accessing analog cable channels and receiving over-the-air broadcast service. The Commission concluded that waiving its rules should reduce "by $80 to $100" the cost of TiVo's Premier Elite all-digital, CableCARD-enabled DVR.

The TiVo waiver order follows close behind the FCC Media Bureau's release of two other waiver orders on August 25. Those orders extended waivers of the FCC's set-top box integration ban for two small cable operators. The integration ban prohibits set-top boxes provided by cable operators from being self-sufficient in order to create and manage a niche market for independently manufactured set-top boxes. The ban forcibly separates conditional access (or video content navigation) from security functionalities, prohibiting both from being performed by a single device.

In one integration ban waiver order, the FCC concluded that James Cable, LLC, demonstrated financial hardship justifying a partial extension of its waiver. And in the other order the FCC concluded that a waiver extension should be granted to Choice Cable T.V. Rico since the record demonstrated that "the integration ban would make HD service prohibitively expensive for rural Puerto Rico residents and could potentially eliminate the availability of HD/DVR service for the few residents who can afford it."

The FCC has granted waivers from its set-top box rules before. And these orders are welcome as far as they go. One can appreciate the Commission's willingness to provide the requesting parties at least some relief from the agency's self-imposed device design requirements. But limited waivers from set-top box regulations aren't enough.

Given the costs of its set-top box regulations – recognized in part through its granting the waiver orders – and the dynamic growth of the video marketplace since late last century, the agency should – even if belatedly – consider a course change for this century. The FCC should exercise its powers under the sunset provision of Section 629 and waive all set-top box regulations. Permanently.

The FCC's integration ban rests on a conceptually counterintuitive and counterproductive regulatory policy. By disintegrating those set-top box functionalities, the FCC seeks to make independently manufactured set-top boxes and set-top boxes leased to subscribers by cable operators both rely on the same security solution. This is meant to make it more attractive for cable customers to purchase independently manufactured set-top boxes at electronics retail outlets.

However, the FCC's integration ban has never created the niche market that the agency first imagined back in the 1990s. In a FSF Perspectives paper from last year titled "The FCC's Continuing, Costly Video Navigation Device Regulation," I wrote that:

The costs of the integration ban — ultimately leading to more expensive devices for consumers — should have lead the Commission to jettison its ban. But the Commission instead tries to cabin its concession by insisting that the exemption can still work 'without undermining the effectiveness of the integration ban.' This despite the Commission's own admission that since the ban went into effect: 'most manufacturers have abandoned the [CableCARD] technology. Indeed, since July 1, 2007, cable operators have deployed more than 22.75 million leased devices pre-equipped with CableCARDs, compared to only 531,000 CableCARDs installed in retail devices connected to their networks.'

Those numbers suggest that consumers usually prefer to lease set-top boxes from cable operators (and trade them in for more advanced devices) over making trips to the store and fronting the cash to purchase devices that will become outdated after a few years.

Nevertheless, the FCC stubbornly persists in enforcing its set-top box regulations, including its CableCARD rules. The FCC amended those rules in part in 2010, and further tweaked them in early 2011, with the most recent set of changes not going into effect until year's end. The end game of FCC's propping up of the CableCARD regime is to eventually install an expansive set of video device navigation regulations called "AllVid."

In a blog post this spring titled "Video Competition Should Lead FCC to End Old Regulation," I pointed out how the landscape of the video marketplace has dramatically altered since the 1990s. For instance, where so-called cable bottlenecks once existed, consumers now enjoy competition from two national DBS providers, and in some places telco entrants into the video services market. Consumers are also experiencing broadband-delivered video content through a variety of devices, including PCs, video game consoles, Internet-connected HD TVs, and even wirelessly-connected tablets and smartphones.

These dynamic video market developments suggest that government regulation of set-top boxes or other video navigation devices is wrong-headed. If anything, video device regulation should be the exception rather than the rule. In other words, in today's competitive video market, aggrieved competitors or consumers should first demonstrate an abusive exercise of market power or anticompetitive conduct before regulatory restrictions on video devices should be imposed. But the system we have still takes the opposite approach: set-top box regulation is the rule unless special waivers can be obtained from the regulators. Unfortunately, that approach relies on 1990s assumptions about the marketplace.

Through its waiver orders and its recent amendments carving out new exceptions from its CableCARD rules, the FCC's recognizes at least some of the costs imposed by its set top box regulations. But a broader view of the history of its set-top box regulations shows that the promised benefits of the FCC's integration ban and CableCARD regulatory regime have never materialized.

It's undesirable and an overreach to have government controlling video device designs in a competitive market. And developments in the video market that have led to new services and platforms for video delivery suggest a market that is effectively competitive, making existing or any future set-top box or video navigation device regulation unnecessary and outdated.

Fortuitously, Congress gave the FCC a unique "sunset" power under Section 629 to eliminate such regulation when it determines the market is effectively competitive.

The FCC should let the sun set on its set-top box regulation.

Constitution Day at the FCC - Daily Caller

The Daily Caller has my piece, "Constitution Day at the FCC", which ends by urging that "everyday should be Constitution Day at the Federal Communications Commission."

Would that it were so.

Before it is, "the agency needs to understand the First Amendment was included in the Constitution to prevent government interference with private speech, not to authorize the government to interfere with private speech on the premise that it is enabling more important, balanced, or fairer speech."

Mr. Copps and the First Amendment

I have no hesitancy in congratulating FCC Commissioner Michael Copps on receiving the Four Freedoms Award from the Roosevelt Institute the other day. I have never questioned Commissioner Copps' good faith. I just have profound a difference of opinion regarding his regulatory philosophy and his understanding of the Constitution.

For example, in accepting the award, Mr. Copps used the occasion to expound on the most persistent theme of his long tenure as a commissioner -- that the agency has failed in ensuring that the public receives through the media the type of content that Mr. Copps believes it should receive. I know Mr. Copps doesn't put the point so boldly.

But what else can he really mean when, in an era of media abundance heretofore unimaginable, he continually rails against the lack of what he calls "quality news" and "dumbed-down civic dialogue."

It's become clear over time that Commissioner Copps just wishes the news and dialogue was more to his liking. He insists the FCC should ensure that "the people's airwaves serve the people's interest."

In an era with so much media, and so much competition, presumably they already do.

It's a pretty scary proposition when an FCC commissioner really wants to define what constitutes "quality news".

Again, I am happy to offer my congratulations on Mr. Copps' award. But, I wish, in return, he'd read, and take to heart, my piece in today's Daily Caller, "Constitution Day at the FCC." I have a profoundly different view of the First Amendment's free speech guarantee than Commissioner Copps.

New USF Tax Hike Adds Urgency to Reform Effort

On September 13 the FCC issued a public notice announcing that for the fourth quarter of 2011 the universal service contribution factor will be climbing back up to 15.3%. The contribution factor translates into the line-item surcharge amount that is added to the interstate long-distance portion of consumer’s monthly phone bills. So, in essence, for the last few months of this year consumers will get hit with a 15.3% surcharge (a tax, in effect) on the long-distance part of their bills.

The USF system subsidizes telephone companies in rural or high-cost areas, as well as schools, libraries, and some health care facilities. And, in some instances, it subsidizes providers serving qualified low-income consumers. The USF subsidy system has also grown exponentially over the last decade, with the program subsidies for telecommunications service in high-cost areas growing from $2.6 billion in 2001 to $4.3 billion in 2010.

Below is a chart that shows the decade-long trend of steady increases in the USF contribution factor that is resulting in surging surcharges hitting consumers to fund the system:

This dramatic growth of the USF system, as reflected above in the dramatic growth in the USF contribution factor, highlights the urgency of USF reform.

Earlier this year, FSF submitted comments and reply comments to the FCC in its comprehensive USF and intercarrier compensation reform proceeding. In those comments we emphasized the need to impose a cap on the overall size of the USF high-cost fund. We also urged the FCC to set a goal of eventually eliminating subsidies for telecommunications providers altogether by establishing a ten-year sunset on USF high-cost subsidies.

In comments submitted by FSF in the Lifeline and Link Up Reform and Modernization proceeding, we recommended the FCC implement reforms to control waste, fraud, and abuse. Just as important, we urged the FCC to treat Lifeline and Link Up as the exclusive, or at least the near-exclusive, mechanism for distributing USF support once the high-cost fund is sunset. Lifeline and Link Up are targeted to low-income individuals who can choose a communications service that best fits their needs. Such targeted subsidies are more efficient and can be more reliably monitored for accountability than subsidies targeted more broadly to service providers.

And in FSF's comments in response to the FCC's Further Inquiry regarding comprehensive USF and ICC reform, FSF President Randolph May commended the FCC for its urgency in finally undertaking such reforms. And he called the ABC plan offered by six price cap companies "a major step forward." But he also offered points for the FCC to consider for improving on the ABC plan. Reiterating the position FSF staked out in earlier comments, the FCC should "explicitly and immediately impose a hard cap on the high-cost fund at $4.5 billion per year, without any loopholes for overall subsidy increases above that cap." The FCC should also establish a sunset date for rate-of-return ("ROR") regulation.

As Mr. May further explained:

"Rate of return regulation provides all the wrong economic incentives – incentives that inevitably lead to an inefficient, wasteful allocation of societal resources. In most areas of the country, incumbent wireline telcos are subject increasingly to intense competition from wireless, cable, and satellite operators. Under these circumstances, it is difficult to understand why these providers are subject to ongoing rate regulation at all, much less ROR regulation. In any event, however, at this stage in the development of marketplace competition, it makes sense for the Commission to establish a firm – and not unduly long – transition for ending all ROR regulation. If any rate regulation is deemed necessary,it should be in the form of price cap (incentive-based) regulation."

Many of these USF and ICC reform issues were discussed and debated at FSF's July 13 seminar "Universal Service and Intercarrier Compensation Reform: Will the FCC Finally Bite the Reform Bullet?" And Professor Gerald Brock, a member of FSF's Board of Academic Advisors, recently wrote a Perspectives paper urging the FCC to "Abolish Access Charges Now."

By imposing a cap on the USF high-cost fund and eventually eliminating subsidies to carriers resulting from high-cost service, ROR, and outdated access charges, the FCC can reduce waste and inefficiencies, limit subsidies and target them to those who actually need them. And, of course, it would give consumers much-deserved relief from a USF surcharge now exceeding 15%.

And in so doing, the FCC can transform the outdated system we are still stuck with into a more disciplined system that fits the intermodal competition and broadband-centric world that exists today.

Rep. Blackburn's Privacy Roundtable - Tomorrow

Tomorrow I am participating in an Online Privacy Roundtable discussion from 8:00 - 9:30 AM in the Capital Visitors Center Meeting Room North. The roundtable is hosted by Rep. Marsha Blackburn, a member of the House Energy and Commerce Subcommittee on Telecommunications and vice chair of the Subcommittee on Commerce, Manufacturing, and Trade.

Rep. Blackburn is one of the leading free market thinkers -- and doers -- in Congress, and she is especially knowledgable on communications, Internet, and high-tech issues. So, the roundtable, with a number of other free market think tankers participating, is sure to be informative and interesting.

Details, including a listing of the other participants, is here. All are welcome to attend!

9.11.11

9.11.01.

9.11.11.

Ten years later, above all, we should reaffirm that we will never forget those innocent Americans who died in a wanton Islamic terrorist attack – the worst attack by a foreign adversary on American soil in our nation's history.

We must never forget to remain vigilant against future attacks, while at the same time remaining faithful to our Constitution and the liberties it guarantees.

I have no hesitancy in proclaiming today, or any other, that America is an "exceptional" country. I do so proudly.

At the Free State Foundation, we strive, through our research and educational activities, to promote free market, limited government, and rule of law principles. In our view, adherence to these foundational principles is central to restoring and maintaining America's economic prosperity, including marketplace dynamism in the communications, Internet, and high tech sectors in which we principally toil. And adherence to these principles is central not only to promoting the general welfare here at home, but also to providing the basis for ensuring we possess the strength to remain secure in a dangerous world.

While we will never be shy about trying to influence the direction of law and policy in a free market, limited government, and rule of law direction based on our understanding of the proper application of these principles, we recognize others have different views and understandings. And we respect their right to hold and advocate them. Indeed, a considerable body of our work promotes the defense of First Amendment free speech rights against government interference.

Right after the 9.11.01 attacks, the French newspaper of record, Le Monde, ran a front-page headline reading "Nous sommes tous Américains," or "We are all Americans."

This expression of solidarity from a foreign quarter was especially comforting at the time. But on 9.11.11, regardless of our political or philosophical persuasions, it is we Americans who should remember, "We are all Americans."

And, above all, on 9.11.11, we should remember that we should never forget.

Labor Day 2011

I am an optimist by nature, but it is difficult to be optimistic about the nation's economy this Labor Day. Indeed, as he prepares to address the nation next week on the dire jobs situation, President Obama acknowledged on August 31 that the nation faces "unprecedented economic challenges."

President Obama has a certain special way of exaggerating – does he recall the Great Depression? – but there is no doubt the economy is in serious straits.

It is sad to take note, on this Labor Day, that the most recent report shows the nationwide unemployment rate at 9.1%. Yesterday the Obama Administration announced that it expects the rate to remain around 9% well into 2012. When President Obama took office in January 2009, the unemployment rate was 7.6%. The latest report indicates there are13.9 million unemployed persons in the U.S., with 6.2 million of those classified as long-term unemployed.

President Obama's policies are not solely responsible for the current poor economy and jobs situation. But they must bear significant blame for the sorry state of economic affairs.

And surely President Obama's regulatory policies are a substantial contributor to the economic malaise. Despite recent rhetoric to the contrary, however welcome, the Administration has been on a regulatory binge, apparently oblivious to the costs imposed by unnecessary regulations. These costs raise prices to consumers, and they dampen incentives to invest in new plant and equipment – and, importantly, in new job hires.

There are many research reports tracking the Obama Administration's increased regulatory activity and the costs imposed. Here is a relevant excerpt from a recent Heritage Foundation research report:

The cost of new regulations, however, can be tracked, and it is growing substantially. Following record increases in fiscal year (FY) 2010, regulatory burdens have continued to increase in 2011. Overall, from the beginning of the Obama Administration to mid-FY 2011, regulators have imposed $38 billion in new costs on the American people, more than any comparable period on record.

In total, according to the Government Accountability Office, 1,827 rulemaking proceedings were completed during the first six months of FY 2011 (between October 1, 2010, and March 31, 2011). Of these, 37 were classified as “significant/substantive” or “major,” meaning they each had an expected economic impact of at least $100 million per year.

Fifteen of those rulemakings increased regulatory burdens (defined as imposing new limits or mandates on private-sector activity). No major rulemaking actions decreased regulatory burdens during the first half of fiscal 2011.

The annual costs of the 15 new major regulations total more than $5.8 billion, according to estimates by the regulatory agencies. In addition, the regulations impose nearly $6.5 billion in one-time implementation costs.

The Free State Foundation focuses primarily on communications and Internet law and policy, and related high-tech issues. Here the Obama Administration's FCC record mirrors that in other areas – adopting and proposing new regulations that are not necessary to protect consumers or the public, and the failure to repeal costly, outdated regulations that are no longer needed.

The FCC's adoption of new "net neutrality" regulations to control the business practices of Internet providers, which the agency pursued doggedly for a year-and-a-half in the face of the expenditure of significant public and private resources, is a prime example. The FCC never presented any persuasive evidence of existing market failure or consumer abuse. Yet it adopted the Internet regulations before it even attempted to quantify their costs and weigh the costs against the claimed benefits.

Even now, more than eight months after the FCC majority voted to adopt them, the new Internet mandates (thankfully) have yet to become effective as the Administration's Office of Management and Budget conducts an after-the-fact proceeding to try to quantify just the information collection costs associated with the new regulations. CTIA, the association representing wireless operators, has told OMB that the transparency prong of the new Internet regulations specifies over 30 different topics an Internet provider may be required to disclose in order to offer service.

As for proposed regulations, the FCC's so-called "bill shock" regulation, which would require wireless operators to provide a range of new usage notifications and additional information disclosures, is another case of regulatory overkill. A review of the Commission's rulemaking notice indicates this proposal is driven primarily by anecdotal evidence of a small number of claimed abusive incidents without regard to the substantial overall costs that would be imposed.

There are other examples, of course. The FCC's current so-called "AllVid" proposal to mandate, despite the fierce competition among providers in the video marketplace, uniform technical standards for the delivery of video through set-top video boxes, comes readily to mind as another example of a costly, unnecessary regulation. And like other FCC regulations affecting media companies, this one raises serious First Amendment concerns, as my colleague Seth Cooper explains here. The same is true for the FCC's outdated media ownership regulations, which were adopted over three decades ago when most Americans got the news from a daily newspaper and three television networks.

Most importantly for present purposes, aside from the impact of unnecessary regulation in other market sectors, the adverse economic impact caused by such unnecessary regulation in the communications, Internet, and high-tech market sector is likely to be especially acute – and unfortunate. This is because the communications/Internet/high-tech sector is one of the few bright spots in the nation's economy, one of the few sectors that has experienced increased investment and job growth.

Again, there is much evidence for this. But an August 16 report in USA Today, entitled "IT Jobs Thrive Despite Lackluster Economy," captures the point well:

"Even in a tough labor market, IT is where the jobs are. The unemployment rate for technology jobs was 3.3% in June, compared with a 9.2% unemployment rate overall that month, according to the Bureau of Labor Statistics. In the most recent edition of its Occupational Outlook Handbook, the BLS said it expects IT employment to grow 'much faster than the average' of all occupations through 2018."

According to Dice's Spring 2011 report, "The Rising Demand for Tech Talent," "the unemployment rate for technology professionals has been generally half the rate of the overall labor market in the U.S."

The long and short of it is that, confronted with an increasingly competitive and dynamic communications and Internet marketplace, the FCC should be aggressively seeking to reduce unnecessary regulations, not seeking to impose new ones. Following the lead of President Obama's recent rhetoric and Executive Order on Regulation for Independent Agencies, FCC Chairman Julius Genachowski has now begun to talk the talk. On August 22, as the FCC announced in a news release that the agency was eliminating outdated rules, Mr. Genachowski stated: “Our extensive efforts to eliminate outdated regulations are rooted in our commitment to ensure that FCC rules and policies promote a healthy climate for private investment and job creation." Good.

It's one thing, however, to talk the talk. As they say on the streets, Mr. Genachowski now needs to walk the walk. For while he touted the elimination of the Fairness Doctrine rule, which hasn't been enforced for a quarter century, and the Broadcast Flag rule, which hasn't been enforced for many years, taking these and other outdated non-enforced rules off the books has no practical impact, except perhaps to make the Code of Federal Regulations volumes a slight bit slimmer. Mr. Genachowski's FCC has yet to seriously engage in a review of the multitude of outdated regulations that do remain on the books and that do have a practical – and costly -- impact.

President Obama's Executive Order No. 13563 ["Improving Regulation and Regulatory Review"], issued on January 18, 2011, directs agencies to review existing regulations to determine whether they are "outmoded, ineffective, insufficient, or excessively burdensome." This order was issued to carry out President Obama's injunction, as he put it in his January 2011 "Towards a 21st Century Regulatory System," Wall Street Journal commentary, to initiate a government-wide review to "remove outdated regulations that stifle job creation and make our economy less competitive."

As I write this, we have just learned that the Department of Justice will go to court to block the proposed AT&T/T-Mobile merger. Without delving into the merits of that decision here from a strict antitrust perspective, I have little doubt that in the high-tech, communications, and Internet venues in which executives are making day-to-day decisions, the Administration's action will be viewed more negatively that positively with regard to future hiring and investing. After all, the wireless sector is one of the economy's most dynamic – with a consistent record of declining prices and increasingly innovative product offerings.

It is way past time for the Obama Administration generally, and the FCC specifically, to forget the rhetoric. It is time to get serious about the elimination of unnecessary regulations.

On this Labor Day, the country desperately needs more job creation and more investment that elimination of unnecessary regulations would bring. Period.

As I said at the outset, I am an optimist by nature. It is in that spirit that I wish you all a happy and safe Labor Day.