Here We Go Again: Don’t Eliminate the “Incentive” from the Incentive Auction

By Gregory J. Vogt, Visiting Fellow

This past June the FCC published the Incentive Auction Order, in conjunction with the Mobile Spectrum Holdings Order. Together, their intent is for broadcasters to volunteer spectrum in the “reverse” auction, to be then repurposed for mobile broadband use in the “forward” auction. The aim of the two-sided incentive auction is to achieve a significant win-win-win for consumers, government, and industry. But the forward auction design adopted in June, in my estimation, entails novel, risky, and complex elements that gives preferences to all bidders other than AT&T and Verizon, including to multi-billion dollar industry participants.

Sprint and T-Mobile filed petitions for reconsideration on August 11. T-Mobile, unsatisfied with the advantages it already achieved, filed a petition seeking changes to certain aspects of the forward auction design. Adopting bidding preferences such as those contained in the two June Orders creates a serious risk of producing lowered revenues, as I reported from an analysis in the FSF blog based on past auction experience. Lowering revenues will risk decreasing the amount of volunteered spectrum – the “incentive” in an incentive auction – in the same way as T-Mobile’s now-discredited Dynamic Market Rule, and thus should not be entertained. T-Mobile’s proposed changes would exacerbate these already serious downsides to the two Orders. Sprint now seeks more changes to the spectrum screen to further advantage itself.

In these two Orders, the FCC developed an extremely complicated structure which I describe only at a high level here. The structure reserved a portion of the 600 MHz spectrum for nationwide-provider bidders that do not possess at least 45 MHz of spectrum below 1 GHz spectrum in each geographic market. The maximum size of the “reserve” varies with the amount of broadcast spectrum available in a particular geographic market at the initial stage, 30 MHz for 100 MHz markets declining to 10 MHz for 40 MHz markets. The auction design establishes a two-component “trigger” which must be met before the reserve spectrum becomes available: a price/proceeds component and an expense component (legislatively mandated administrative expenses such as compensating broadcasters and FirstNet funding). Until both components of the “trigger” are met, any bidder may bid on all spectrum in a market. 

In its petition, T-Mobile argues that the amount of “market based reserve spectrum” is set too low and requests that the reserve be at least half of available spectrum. It also contested the formulation of the price/proceeds benchmark component of reserve spectrum trigger as unnecessary and subject to gaming.

The most important aim of the incentive auction legislation is to maximize the amount of broadcast spectrum repurposed for mobile broadband use. Although the FCC originally agreed with this conclusion, that goal is all but absent in the final rule, apparently side-tracked in the FCC’s effort to “fairly” allocate spectrum, with the reserve tipped heavily in favor of everyone but the top two market players. Although a last minute compromise preserved the ability of all the providers to obtain some spectrum in the forward auction, it is unknown whether the FCC struck the right “balance.” We won’t know until we see how much spectrum broadcasters actually volunteer. The good news is that, at least at this point, there are no vocal defections from the auction process from either broadcasters or potential bidders.

But the forward auction design is a far cry from a free-market model characteristic of most spectrum auctions, which are routinely designed to maximize auction receipts. The forward auction picks winners and losers unrelated to a sound economically-based competition model like that normally attendant to an accepted competition analysis. Here, unless “smaller” carriers are capacity-constrained, which no one has alleged or proved, there simply is no significant anti-competitive situation that needs to be corrected. The necessity of adopting a first-ever minimum six-year holding period for awarded reserve spectrum only reinforces the conclusion that the forward auction design lacks market-driven incentives. Why would the government preclude T-Mobile from selling reserve spectrum unless it has doubts either that T-Mobile was unable to obtain needed spectrum in the first place or the mechanism will lead to lower-than-market prices? T-Mobile’s reconsideration plea for additional reserve spectrum merely seeks to exacerbate this government-made market.

The request should be rejected for four additional reasons. 

First, T-Mobile’s proposal risks further depressing auction receipts. Achieving receipts maximization is critical to producing the incentive for broadcasters to volunteer spectrum. The incentive is already at risk: the original estimate of up to 120 MHz of volunteered spectrum has declined to what government now admits will likely only achieve 85 MHz. The incentive should not be diminished further.

Second, T-Mobile’s requested modifications are anti-competitive. By increasing the amount of the reserve, and eliminating the price/proceeds component of the trigger, smaller bidders could be able to obtain spectrum without fully competing even with each other (let alone AT&T and Verizon) because there would be far more in the reserve than the 20 MHz block most competitors say they need. Thus, bid prices for reserve spectrum could be less than for unreserved spectrum, a result I note here actually occurred in Canada, because smaller carriers can make strategic bids based on the knowledge that high bidders may be excluded from competing for the reserve and there would be more than enough reserve spectrum to go around.  Reduced costs for spectrum in turn could create a competitive imbalance in the mobile broadband market due to unbalanced cost structures.

Third, T-Mobile’s claim that AT&T and Verizon might game the trigger is speculative at best because the combination of blind-bidding and delayed creation of the reserve until the final stage rule is achieved, completely undermine any incentive to manipulate the trigger. A low bid by one large provider to avoid invocation of the trigger could simply be a white flag that ends up handing spectrum over to the other major player.

Fourth, although I agree with T-Mobile that setting a complicated price/proceeds trigger is relatively arbitrary and creates other risks to the bidding process, eliminating that component of the trigger would exacerbate disincentives to participate, not improve them.

As to the modified spectrum screen, the FCC added mobile broadband spectrum to achieve a more complete product market definition in transaction analyses. Sprint, which holds significant spectrum added to the screen for the first time, seeks to blunt this reform by asking the FCC to weight differently low-, mid-, and high-band spectrum, effectively straight-jacketing the FCC when using the screen. Although unrelated in a direct sense to the spectrum auction, the request does represent another attempt by competitors to skew competitive analysis in their favor. The FCC has already announced it will take into account the potential competitive impact of certain types of spectrum, such as that below 1 GHz. Since that decision alone unjustifiably favors Sprint, it should just declare victory without seeking further undeserved advantages.

Although I do not support the Rube Goldberg contraption that the forward auction design entails, or the complications to the new spectrum screen already adopted, the FCC should reject further manipulations the parties now request. The FCC must preserve the incentive to volunteer a maximum amount of broadcaster spectrum if there is to be a chance of achieving the win-win-win situation the incentive auction was intended to produce. And it should reject strict formula-based reviews of transactions, relying instead on a fact-based competitive analysis.

The Ninth Annual Homeland Security Institute

Only rarely do I use the FSF Blog to recommend programs sponsored by other entities, but this is one of those rare cases that I want to call to your attention. For anyone with more than a passing interest in issues relating to homeland security, immigration, cybersecurity, and the like, the ABA Administrative Law Section event described below is a premier, must-attend conference.

The outgoing Chair of the Ad Law Section, Joe Whitley, is the chair of the Institute, and he and his Institute colleagues have once again put together an outstanding program with well-known leaders in their respective fields. Please take a look at the Program Brochure and consider attending.

ABA Section of Administrative Law & Regulatory Practice
9th Annual Homeland Security Law Institute

LAST CHANCE TO REGISTER! JOIN US NEXT THURSDAY & FRIDAY!

August 21-22, 2014

at the Walter E. Washington Convention Center, Washington, DC

Featuring:

• 20 panels addressing hot topics in immigration, transportation safety, privacy and cybersecurity, featuring 80 current and former Counsel, Administrators and Advisors at DHS, ICE, CBP, USCIS, NPPD, ODNI, FEMA, as well as The White House, The U.S. House of Representatives, and The Air Force Academy; academics at leading universities, and private practitioners well known in the field of homeland security

• 12 Hours of Continuing Legal Education (60 minute states) and 14.4 Hours (50 minute states), as well as the opportunity to engage the experts in lively discussion

• Recordings will be available after the program -- reserve your full set now!

Register Online: shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=212789

View Updated Program Brochure: shop.americanbar.org/PersonifyImages/ProductFiles/212789/hsli_2014_brochure.pdf

Reserve your Program Recording & Materials: Choose the option for purchase of the audio recordings and materials on the registration form in the brochure.  The Recording does NOT include CLE credit.


Any difficulties, please contact Angela Petro at angela.petro@americanbar.org or 202-662-1582.

The Real Headline: Europe Lags US in Broadband

All too often in the past, those advocating for public utility-type regulation in the United States have suggested that the U.S. lags Europe in various measures of broadband progress. The suggestion is that the U.S. ought to adopt the common carrier-like model, with its mandatory access, non-discrimination, and rate regulation requirements, that has been favored in many European countries.

Indeed, now-former FCC commissioner Michael Copps has always been one of the most vocal leaders of what, back in 2007, I called the "Talking Broadband Down Crowd".  I explained then, and many times since, why the claims of Mr. Copps and his allies were not factually grounded -- but, in the service of advocating broadband regulation, the "talking broadband down crowd" persisted in downplaying U.S. broadband progress. Here is an March 2013 FSF blog entitled, "Europe Lags Behind U.S. in Broadband Speeds and Connectivity," with facts and figures refuting the "U.S. Lags Europe" storyline.

In the face of accumulating new data, I have the sense that former Commissioner Copps already may have begun to abandon the "talking broadband down" argument in favor of other (equally unpersuasive) arguments.

In any event, he should. Because now comes a newly-published study by Roslyn Layton, PhD Fellow for the Center for Communication, Media and Information Studies at Aalborg University, and Michael Horney, a Research Associate at the Free State Foundation. Their study, entitled, "Innovation, Investment, and Competition in Broadband and Impact on America's Digital Economy," is a must-read for anyone interested in broadband policy. This most certainly includes, of course, those interested in the FCC's net neutrality proceeding.

I commend the entire Mercatus study for your close attention. But in the meantime, here is a brief summary of their conclusions:

"How true are fears that the United States is falling behind the rest of the world when it comes to broadband? Are Americans paying more for lower-quality broadband than Europeans and South Koreans, and are US companies falling behind their global counterparts?

In a new study for the Mercatus Center at George Mason University, Roslyn Layton and Michael Horney survey broadband in America and compare broadband costs around the world. They find that the United States is a global leader in broadband, as measured by the level of broadband-enabled economic activity, the number of Internet-based companies, the level of digital exports, and the level of Internet-enabled employment.

.  . .

America’s broadband networks have allowed the United States to become a leading digital econ­omy. Building on a sound broadband foundation and leveraging the advantages of America’s inno­vation ecosystem have allowed American firms to export their digital goods and services to other countries, making the digital sector America’s third-largest category of exports after industrial supplies and capital goods. Policymakers should take the following steps to ensure that the United States continues to be the leader in global competitiveness:

• In order to maximize investment, avoid utility-style regulation. Instead, focus on market-based, technology-neutral approaches that encourage dynamic competition with different networks and technologies.
• Avoid subsidies for any particular technology: a variety of broadband technologies keep the market competitive. Government involvement in the broadband market may cause private firms to exit, stifling growth in the industry.
• Permit competition-enhancing consolidation of broadband companies because mergers lower overhead costs and make operations more efficient.
• Remove barriers to mobile infrastructure at the local level. Municipalities often hinder the deployment of infrastructure, which limits broadband competitors, particularly in rural areas.
• Focus on increasing Internet adoption rather than the deployment of network. More than 80 percent of Americans use the Internet, and those who do not cite lack of usability and relevance as their primary reasons rather than cost or lack of access."

Presently, there is far too much loose talk about imposing public utility regulation on U.S. broadband providers under Title II of the Communications Act -- the same form of regulation imposed on the railroads in the late nineteenth century and Ma Bell throughout much of the twentieth century. I understand that Mr. Copps and his acolytes are serious about wanting the FCC to adopt this draconian approach. But my sense, perhaps wrongly, is that many of those suggesting that the FCC should adopt public utility regulation of broadband really don't believe the FCC would take such a fateful step or they don't really appreciate the consequences.

In either event, those urging such a course should read and carefully consider the new study by Aalborg University's Roslyn Layton and the Free State Foundation's Michael Horney.

IP Rights Are Not Expendable!

This is the lead from today's WSJ's story [subscription required] on the pre-release piracy and posting of the "Expendables 3" movie:

"At least 2.2 million people have already watched "The Expendables 3." The problem for the movie's distributor, Lions Gate Entertainment Corp., is that its big-budget action movie doesn't open until Friday.

Just over two weeks ago, a complete and nearly pristine copy of "The Expendables 3," which features more than a dozen stars including Sylvester Stallone, Mel Gibson and Harrison Ford, leaked online. It is Hollywood's highest profile piracy leak since 2009, when an incomplete version of "X-Men Origins: Wolverine" found its way online before the superhero movie came out."

You don't need to have an economics degree from Harvard to appreciate that intellectual property piracy of this magnitude necessarily will impact the decision-making surrounding incentives to invest in future films and other creative endeavors. There are various dimensions to the problem of piracy as it relates to movies, sound recordings, and other intellectual property. But one important dimension that cannot be overlooked, or excused, is the public's all-too-often failure to understand that securing and protecting IP rights is a foundational constitutional principle.

There continues to be a real need to educate the public concerning the importance of respecting this constitutional principle no less than others. That's why at the Free State Foundation we're engaged in an ongoing effort to educate the public, especially including those who otherwise think of themselves as constitutionalists, concerning intellectual property rights.

Here are the first five papers in our ongoing series and there is another posted on our website:

Randolph J. May and Seth L. Cooper, "The Constitutional Foundations of Intellectual Property," Perspectives from FSF Scholars, Vol. 8, No. 13 (2013).

Randolph J. May and Seth L. Cooper, "Reasserting the Property Rights Source of IP," Perspectives from FSF Scholars, Vol. 8, No. 17 (2013).

Randolph J. May and Seth L. Cooper, "Literary Property: Copyright's Constitutional History and Its Meaning for Today," Perspectives from FSF Scholars, Vol. 8, No. 19 (2013).

Randolph J. May and Seth L. Cooper, "The Constitution's Approach to Copyright: Anti-Monopoly, Pro-Intellectual Property Rights," Perspectives from FSF Scholars, Vol. 8, No. 20 (2013).

Randolph J. May and Seth L. Cooper, "The 'Reason and Nature' of Intellectual Property: Copyright and Patent in The Federalist Papers," Perspectives from FSF Scholars, Vol. 9, No. 4 (2014).

Internet Freedom Forever Act Should Garner Attention Over Recess

While Congress is on recess for the next five weeks, there will be plenty of issues constituents will be talking about with their Representatives and Senators at town hall meetings and community centers.  One topic that will hopefully garner attention during the recess is the Senate’s vote on the Internet Tax Freedom Forever Act. As urged in previous FSF blogs (see here and here), the Senate should pass the Internet Tax Freedom Forever Act, permanently banning state and local taxes on Internet access, well before the current tax moratorium expires on November 1^st.

Within the Internet world, the term “digital divide” describes the separation between individuals online and offline, either because they cannot afford Internet access or have chosen not to connect. The Internet Freedom Forever Act is something both parties should support because taxes on any good or service raise the price and result in a decrease in the quantity demanded from consumers. As for the Internet, a price increase for access could push more people offline, or prevent them from going online in the future. Those most likely to be affected are low-income users, expanding the digital divide.

Without having to recite all the positive benefits of the Internet, it should be understood that any barrier that forces individuals to consume less of a positive good or service leads to lower economic growth, because individuals cannot prosper the way they would like.  While supporters of an Internet access tax might conjecture that this tax will be absorbed by large Internet Service Providers (ISPs), such as Comcast and AT&T, this is simply not true.  While ISPs may have to pay a small portion of the tax, most of the burden will be levied onto consumers.  

Many Internet users know how many videos to stream, songs to download, pictures to upload, or webpages to visit in a given day or week to keep themselves happy. So an increase in price from an Internet tax might only result in one or two less weekly Facebook selfies for the median individual. But more importantly, individuals on the margin of Internet connection place a lower value on Internet access. Therefore, those who have not yet connected or just recently connected – often low-income individuals – will surely be impacted the most by imposition of an Internet access tax.  The increase in price could push them onto the wrong side of the digital divide or even further away from connection if they were already offline.

This is why it is important that the Senate pass the Internet Freedom Forever Act.

Uber Back in Business - For Now - in VA

I was glad to see that Virginia authorities have granted Uber temporary authority to operate its ridesharing service in Virgina. Presumably, the temporary authority will remain in effect until next year when the state legislature considers whether Uber should be allowed to operate, and under what conditions.

It is important that state lawmakers and regulators not apply old laws in a way that impedes the development of new business models such as Uber and Airbnb. These companies use Internet applications in innovative ways to give consumers more choices and convenience.

Please see the Free State Foundation's recently released Perspectives paper, "The Sharing Economy: A Positive Shared Vision for the Future."  The paper discusses the value that both Airbnb and Uber -- and other similar innovative firms -- are bringing to the nation. I'm confident you will find it informative.

Alabama Needs a LifeLine to Common Sense

I just became aware through a story in today's Communications Daily that Alabama collects a fee of $1.75 per month for 911 service from LifeLine subscribers. According to the story, Alabama estimates there are 200,000 consumers in the state who are LifeLine customers who must pay the $1.75 per month fee on the $9.25 per month subsidy they receive.

I think someone needs to throw Alabama a Lifeline to the Common Sense safe harbor.

Apparently, Alabama is among the few states that require low-income residents who receive subsidized telephone service to pay a 911 fee. It may be the only one. It is true that LifeLine customers may need to call 911, just like non-LifeLine. But that's not the point. Indeed, there is a reason it is called LifeLine service.

To my mind, it just doesn't make sense to grant certified low-income consumers a $9.25 subsidy on the one hand, and then make those same customers pay a $1.75 fee on the other.

TracFone has filed a lawsuit challenging the authority of Alabama under state law to impose the 911 fee on LifeLine subscribers. If common sense doesn't prevail first, perhaps TracFone's lawsuit will bring about a change.

One way or the other, Alabama's practice of imposing the 911 fee on LifeLine customers should be jettisoned.

FSF’s Deborah Tate on Equipping Children with Knowledge for the Digital Age

Deborah Taylor Tate, a Distinguished Adjunct Senior Fellow at the Free State Foundation and former FCC Commissioner, acknowledges in a blog the vast educational opportunities for children available through the Internet, but cautions against the inherent risks.

“One of the most effective ways of keeping young people—or users of any age—safe online is to equip them with the knowledge and skill to recognize, identify and respond appropriately to risks they may encounter. These skills include media literacy, digital literacy and social-emotional literacy,” she writes. The Aspen Institute, in cooperation with the MacArthur Foundation, recently launched a “National Report on Learning and the Internet” following a year of in-depth research and public input. Ms. Tate is a member of the Task Force, which included educators, policymakers, researchers, nonprofits, and experts in technology, security, privacy and sociology. The Task Force’s goal was to understand the ways in which young people learn today and to optimize learning and innovation within a trusted environment.

Ms. Tate, the ITU Special Envoy and Laureate for Child Online Protection, is a leader in efforts to protect children online, while enhancing their educational experience.

 

Maryland’s Lack of Business Friendliness Could Hurt the State

A recent survey of small businesses conducted by Thumbtack.com and the Kaufman Foundation graded states on the basis of business friendliness and Maryland received a C- overall. Previous Free State Foundation blogs have discussed Maryland’s tax climate and the subsequent impact on interstate migration as well as the difficulty Maryland has remaining competitive in relation to other states due to its heavy business tax burden. But Maryland not only received a D+ for its heavy tax burden, it also received a D+ for its lack of business friendliness in the separate categories of regulations, licensing, environmental requirements, and zoning requirements.

It is very important that Maryland improve in these categories to attract more businesses and maintain a healthy tax base in order to continue to provide essential government services in the most efficient manner.

Neighboring states, Delaware and West Virginia, were not ranked because they did not have enough survey respondents to score, but Pennsylvania, Virginia, and the District of Columbia received grades of D, A+, and A-, respectively. The Tax Foundation’s latest report on state business tax climate suggests that Maryland is 41^st, which is fairly consistent with the survey. As you can see below, Maryland’s neighboring states all rank higher.

While Maryland may be collecting a significant amount of taxes, it could do so in a way that does not discourage (as much) business and entrepreneurial activities.

When attempting to maximize tax revenue, economists would say the approach should be to keep the tax rate low and the tax base broad. Broadening the tax base can occur without even making changes to the tax code if other changes are implemented which reduce the costs of doing business in Maryland. Lessening the burden of regulations, and the costs of licenses and entry fees, will broaden the base by attracting more businesses, either from other states or new start-ups. Lower regulatory barriers in conjunction with lower tax rates will likely generate more revenue for the state than simply increasing the rates, because there will be more economic activity that the state can tax. Not to mention, we have seen how the status quo of Maryland’s business climate has negatively affected the migration patterns of individuals and businesses.

It is not just businesses possibly migrating into Virginia or other neighboring states that should be of concern. Businesses that remain in Maryland could be operating more efficiently if regulatory costs were lower.

Unnecessary regulatory costs increase the prices of goods and services, pushing some consumers out of the market and lowering the taxable profits of Maryland businesses. The cost of complying with regulatory burdens means businesses will have less money to put towards innovation, investment, or possibly new jobs - all of which could lead to more tax revenue for the state. In other words, broadening the tax base does not just mean lowering tax rates to incentivize businesses to move to or originate in Maryland. It means reducing all the regulatory burdens that current Maryland businesses must incur.