Wednesday, October 26, 2011

ICC Reform: Another Subsidy System that Needs a Sunset

Anticipation is building for the FCC's upcoming public meeting on Thursday, October 26. The Commission is expected to finally vote on an order to comprehensively reform the universal service fund (USF) and intercarrier compensation (ICC) system. In a blog post from earlier this week, FSF President Randolph May restated the case for including a sunset date for all USF high-cost subsidies in the FCC's reforms. The outdated ICC system, for its part, deserves a sunset as well.

When FCC Chairman Julius Genachowski announced some of the basic components of the Commission's forthcoming reforms on October 6, he specifically mentioned three main elements for ICC reforms. One element is to phase down access charges over a multi-year period, "starting by bringing intrastate access rates to parity with interstate rates." This is a commendable reform proposal that, among other things, will help reduce direct transaction costs and reduce incentives for ICC-induced arbitrage. Establishing a low, uniform access charge rate would also establish a path to eventually sunset the ICC access charge regime.

In short, ICC is a system of payments between carriers to compensate each other for the origination, transport and termination of voice traffic. Professor Gerald W. Brock, a member of the Free State Foundation's Board of Academic Advisors, summarized the origins of the ICC/access charge regime in his September 6 FSF Perspectives paper "Abolish Access Charges Now":

Access charges were first implemented in 1984, and they were designed to maintain a portion of the pre-divestiture subsidy from long distance to local service for a temporary period while the industry adjusted to early competition. Access charges were created through a rigid cost allocation system for companies subject to rate of return regulation with an expected industry structure of competitive long distance companies and monopoly local exchange companies. Price discrimination was a fundamental feature of access charges from the beginning and the system has generated a long series of disputes and innovative ways to arbitrage between higher and lower rates for essentially the same service.

This system is supplemented by a system of differing and often high intrastate access charges over which state regulators have oversight. Another component of the ICC system is the subscriber line charge (SLC) that is assessed against consumers in their monthly phone bills.

But the nearly 30 year-old ICC system makes little sense in relation to today's advanced telecommunications market. American consumers no longer exclusively on the public switched telephone network (PSTN) to obtain plain old telephone service (POTS). Instead, consumers are increasingly subscribing to bundled services offering voice, text messaging, instant messaging, video, broadband Internet, and other data services—many of which are now delivered over IP-based networks.

One of those services is VoIP, typically offered by cable providers and over-the-top providers like Skype and Vonage. VoIP and other IP-enabled services are eroding the distinctions between local- and long-distance services and between intrastate and interstate telecommunications. The latter distinction historically relied on the ability to identify the two end points of every call. Yet as the FCC recognized in its Vonage Order (2004): "the inherent capability of IP-based services to enable subscribers to utilize multiple service features that access different websites or IP addresses during the same communication session and to perform different types of communications simultaneously, none of which the provider has a means to separately track or record."

Wireless services are flourishing when compared to wireline and have broken down the local/long-distance distinction, similarly making it more difficult to tell where a call starts and ends. And as Professor Brock pointed out, the FCC's rulings in the 1990s establishing wireless-wireline connection based on reciprocal compensation and prohibiting wireless carriers from filing access tariffs "made it feasible for cellular carriers to eliminate the earlier sharp distinction between rates charged for local and for long distance calls and to begin the now standard practice of distance insensitive rates for calls that begin on a wireless telephone."

Imposing interstate and intrastate access charges varying by technology or provider makes little sense in an increasingly data-centric, IP-based and wireless world. Calculating compensation payments according to the ICC system's per-minute rate structure – and based on whether the call is interstate or intrastate as well as on the type of technology used – create significant compliance costs.

Not surprisingly, the access charge regime is becoming an increasingly strained and poorly suited coping mechanism when it comes to dealing with the technological changes of the past 30 years. The growth of wireless and IP-enabled services such as VoIP has led to the steady decline in minutes of use (MOUs) for which local exchange carriers are to be compensated. This decline in MOUs has serious consequences because rate-of-return carriers' interstate access rates are designed to give such carriers opportunity to earn an 11.25% rate-of-return. Declining MOUs mean increasing access rates to offset demand reductions and help ensure their guaranteed rate-of-return.

Data cited in the Universal Service Monitoring Report (2010) show the steady but significant drop in MOUs over the last several years, with ILECs seeing the overall number of interstate access minutes declining every year since 2000. Those declines are roughly on the order of ten percent annually. Interstate access minutes for ILECs dropped from near 576 billion in 2000 down to approximately 401 billion in 2005, and down further to about 277 billion in 2009.

As the FCC's NPRM for comprehensive USF/ICC reform points out, "rate-of-return carriers' interstate switched access rates increased 9.4 percent in 2010, which follows similar increases during the last few years." High access rates have also inadvertently created incentives for arbitrage schemes such as phantom traffic and traffic pumping. The FCC is finally proposing to specifically address those abuses in its forthcoming reform order. A low, uniform access charge rate would also reduce arbitrage incentives.

Adoption of a low, uniform access charge rate amounts to a much more modest reform than the immediate abolition of all access charges that Professor Brock admirably urges. But streamlining and simplifying the ICC system could help reduce the misalignment between that system and today's technological realities. Meanwhile, the Chairman's reform proposal includes implementing a recovery mechanism to better ease carriers' transition away from ICC subsidies. And to the extent states find that local conditions require any further subsidies, they should address those concerns by enacting or reforming state USFs.

Reducing and bringing intrastate access charge rates into parity with interstate access charges could also help put us in a position to consider the next step: eventual sunset of the ICC regime. The ultimate end game should be an unregulated, free market in IP-based traffic exchange, similar to what prevails today with the Internet. The closer we can get to such a system and sooner we can get there the better.