FCC's Privacy Order Will Result in Higher Broadband Prices

On October 27, 2016, the FCC adopted a Report and Order purporting to “protect the privacy of customers of broadband and other telecommunications services.” The rules require consumers to affirmatively opt-in before Internet service providers (ISPs) can collect “customer proprietary information,” which applies to information that the ISP “acquires in connection with its provision of telecommunications service.”

For example, if a consumer who subscribes to Comcast chooses not to opt-in, it appears Comcast cannot collect information regarding that consumer’s Amazon purchases because the data would be acquired through the Comcast-provided Internet connection. However, Comcast will be able to purchase that consumer’s Amazon information either directly from Amazon or perhaps from the consumer’s operating system and/or web browser. In other words, ISPs are allowed to purchase consumer information from edge providers, which are not subject to the FCC regulations, even though the edge providers have greater access to consumer information than ISPs.

FCC Commissioner Michael O’Rielly discussed this important issue during his dissent:

[A]ll that the FCC has really done is raise the transaction costs. The FCC, in its typical nanny state fashion, seems to assume that consumers prefer an opt-in regime. But when consumers find out the end result is that they may have to pay more for heightened privacy rules that they never asked for, I doubt they will be grateful that the FCC intervened on their behalf. Indeed, this is a grandiose attempt to enact legacy talking points into rules so that Commission leadership can pat itself on the back while consumers receive no actual, practical protections.

Because the FCC’s regulations with the opt-in default are not imposed on edge providers, such as Google, these platforms will continue to collect massive amounts of consumer information. As FSF scholars stated in their comments, due to encryption technologies, edge providers have a greater access to consumer information than ISPs. In order to provide targeted benefits, such as zero-rated services, to consumers who choose not to opt-in, ISPs will have to purchase information from edge providers or other Internet companies. (See my Perspectives from FSF Scholars entitled “FCC Privacy Rules Would Harm Consumers by Creating Barriers for ISP Advertising.”)

As Commissioner O’Rielly discussed, because ISPs need consumer information in order to offer targeted benefits, these regulations simply raise the costs for ISPs to engage in online advertising, zero-rated programming, or other targeted consumer offerings. Consumers who choose not to opt-in will be confused because edge providers will continue to collect their information and sell it to ISPs. And it’s likely ISPs will increase the price of broadband service in order to cover the costs of purchasing consumer data from edge providers.

The FCC order also envisions case-by-case investigations of “pay-for-privacy” practices. ISPs will be less likely to charge different prices to consumers with different privacy preferences. For example, consumers who choose not to opt-in but who still want to receive targeted offerings should end up paying more than those who choose to opt-in because ISPs need to purchase consumer information on their behalf. However, the FCC’s investigation likely will chill any efforts by ISPs to offer differentiated pricing based on consumer privacy preferences. Therefore, if ISPs want to offset the increase in regulatory costs, the FCC’s investigation is more likely than not to force providers to raise broadband prices for all consumers, not a subset.

With its new regulations, the FCC claims to “protect consumer choice” and “toughen pay-for-privacy safeguards.” But by expanding the definition of “customer proprietary information” to include non-sensitive information, the effect of the FCC order will be to impose higher prices for all broadband consumers without actually creating more choices. (See my October 2016 blog.) Instead of a fraction of consumers paying for privacy, all consumers are harmed by the likely result that the FCC's new regulations will lead to higher broadband prices.

Thinking Things Through X - Paying the Price for Privacy Regulation

There are many grounds upon which to criticize the FCC’s newly-adopted privacy regulations. Among these: (1) it is doubtful the Commission possesses the legal authority to adopt the far-reaching regulations it has adopted; (2) given that the Internet service providers subject to the new regulations do not uniquely possess subscriber information, the imposition of more stringent regulations on them vis-à-vis edge providers is arbitrary and capricious; and (3) the new regulations almost certainly will confuse subscribers and, in the process, result in less information available to them than they otherwise might demand.

Putting those grounds aside, I want to focus briefly here on an aspect of the decision – the so-called “pay for privacy” provisions – highlighted by Commissioner Michael O’Rielly in his dissent. Here is what Commissioner O’Rielly said:

In addition, I was appalled to see a case-by-case approach imported to review mislabeled “pay for privacy” offers.  These are consumer incentives offered every day in the real world and now ISPs will need to obtain a blessing from an agency that has no privacy experience. The result is that broadband providers will be reluctant to extend, and may even forgo, valuable offers and discounts that consumers would want for fear that they will fall into another zero-rating style abyss.  From that experience, we know that the game is perpetually on hold awaiting heavenly intervention, and some players have just stopped playing.  Trying that again here in the privacy context does not make any sense, unless the real intention is to effectively ban pay for privacy offers without actually saying so in an attempt to avoid a legal challenge.

Commissioner O’Rielly is responding to the part of the FCC’s order that says the agency reserves the right to respond on “a case-by-case basis” to “financial incentive practices that are unjust, unreasonable, unreasonably discriminatory, or contrary to Section 222.” [Para. 303].

There is certainly a role for case-by-case adjudication in administering the Communications Act and enforcing the Commission’s regulations. Indeed, I have advocated the use of such case-by-case adjudication in the past if carried out properly and in proper circumstances. But Commissioner O’Rielly’s concern about the agency’s approach in this case deserves close attention. It is difficult to discount his fear that any such “case-by-case” reviews “will fall into another zero-rating style abyss.”

The FCC initiated some form of informal inquiry into the zero-rating (free data) practices of AT&T, T-Mobile, and Comcast in December 2015. Over the past year, there have been non-public responses to inquiry letters from the Commission and meetings between company representatives and agency officials. But, almost year later, as far as the public knows, there has been no resolution of the inquiries.

In other words, the fate of the Internet service providers’ zero-rating plans remains in regulatory La-La-Land, or what Commissioner O’Rielly refers to as the “abyss.” Call it what you will, the price for this particular form of “case-by-case” approach is regulatory uncertainty that unduly chills further innovation and investment.

I’m not suggesting that “regulatory uncertainty” can be eliminated entirely in a regulatory regime. Of course not. But a proper regulatory regime should be constructed and administered in a way that does not unnecessarily exacerbate such uncertainty. This is especially so in dynamic markets characterized by the emergence of new business models responsive to changing consumer demands.

In the case of the FCC’s concerns about so-called “pay for privacy” offers, the agency first should more clearly delineate the factors that it will consider in assessing the lawfulness of offers and plans that contain financial incentives. Then, the agency should require the filing of a formal complaint which addresses, with particularity, the factors delineated by the Commission and which addresses the claimed market failure and consumer harm allegedly caused by the practice at issue. The complainant should bear the burden of proof in an on-the-record evidentiary proceeding.

There is a role for case-by-case adjudication in a proper administrative regime. But the Commission’s apparent approach to assessing the lawfulness of zero-rating plans is not such a regime. If that informal approach is what the Commission has in mind with regard to assessing the lawfulness of financial incentive offers in the privacy area, the price paid by consumers in lost innovation and the unavailability of desired information will be far too high.

No Signs of Slowing Down in the North American Mobile Economy

A new GSMA study entitled “The Mobile Economy: North America 2016” finds that mobile technologies contributed $710 billion in economic activity (3.6% of GDP) to North America in 2015 and will grow to almost $1 trillion in economic activity (4.5 of GDP) in 2020.

Here are some of the key findings regarding mobile technologies in North America:

• In 2015, the mobile ecosystem supported 2.3 million jobs.

• In 2015, the number of unique subscribers was 284 million and the mobile economy had a penetration rate of 79%. By the end of 2020, those figures are expected to grow to 315 million and 85%, respectively.

• In 2015, smartphones represented 74% of mobile connections and 4G represented 55% of mobile connections.

• Venture-capital investments in mobile and telecommunication services totaled $16.5 billion in 2015, a 41% increase from 2014.

• The mobile economy will invest nearly $170 billion in spectrum and network deployment from 2015 to 2020.

• In 2015, the mobile economy raised $82 billion in the form of general taxation and an additional $46 billion in government revenues from spectrum auctions.

There are no signs of slowing down in the North American mobile economy. Despite the FCC’s Open Internet Order, which imposed substantial regulatory costs on mobile broadband providers, the GSMA study shows that competition and innovation in the mobile economy will create more benefits than the FCC’s regulations will create costs. That being said, the regulatory costs are very burdensome and the mobile economy likely would grow even faster if not for the FCC’s unnecessary regulations.

Google May Be Influencing Copyright Office Leadership

On November 2, 2016, The Wall Street Journal published an article [Subscription Required] connecting Google’s lobbying efforts and turnover at the Copyright Office. Maria Pallante served more than five years as the U.S. Register of Copyrights before resigning last month. Ms. Pallante opposed several efforts that Google supported, including the FCC’s set-top box proposal and a Justice Department interpretation of copyright licensing. The article states the following:

There is some circumstantial evidence that Google’s lobbying influence was brought to bear in removing Ms. Pallante, though both Google and Ms. Pallante declined to talk to us. Google’s business model is essentially making money off other people’s content, and the company’s strategy has been to infringe on copyrighted material like books and fight it out later in court. The copyright office administers laws that protect owners.

The new Librarian of Congress Carla Hayden may be hiring new employees to revamp a Copyright Office that is in need of modernization, but Ms. Pallante was a dedicated public servant with a thoughtful perspective on copyright. Given Ms. Hayden’s former relationship with Google, the article says that she may have pushed out Ms. Pallante and her opposing views. But let’s hope this decision was made in the interest of protecting copyright and modernizing the Copyright Office to achieve an easily accessible, efficient, and reliable registration and recordation system.

IP-Intensive Industries Make Significant Contribution to European Economies

A new joint study by the European Union Intellectual Property (IP) Office and the European Patent Office entitled “Intellectual Property Rights Intensive Industries and Economic Performance in the European Union” finds that IP-intensive sectors make a significant contribution to European economies.

Here are some of the key findings regarding IP-intensive industries in Europe:

• IP-intensive industries generated 27.8% of all jobs in the EU during the period 2011-2013. On average over this period, 60 million Europeans were employed by IP-intensive industries. In addition, another 22 million jobs were generated in industries that supply goods and services to the IP-intensive industries. Taking indirect jobs into account, the total number of IP dependent jobs rises to 82.2 million (38.1%).

• Over the same period, IP-intensive industries generated more than 42% of total economic activity (GDP) in the EU, worth €5.7 trillion. IP-intensive industries account for approximately 90% of the EU’s trade with the rest of the world.

• IP-intensive industries pay significantly higher wages than other industries, with a wage premium of 46% over other industries. This is consistent with the fact that the value added per worker is higher in IP-intensive industries than elsewhere in the economy.

• IP-intensive industries have proved most resilient to the economic crisis. Comparing the results of this study with those of the 2013 study reveals that the relative contribution of these industries to the EU economy slightly increased between the two periods 2008-2010 (2013 study) and 2011-2013 (2016 study).

• The detailed analysis of the economic weight of industries engaged in the development of climate change mitigation technologies (CCMTs) shows that they account for 1.2% of employment and 2.1% of economic output in the EU. They generated a substantial trade surplus for the EU and, despite a small drop in employment, were able to increase their GDP contribution between the two periods 2008-2010 and 2011-2013.

This study supports what FSF scholars have stated for many years: strong IP rights protections encourage increased economic activity because they enable and promote creativity, innovation, and investment from artists and entrepreneurs throughout the entire economy. And, importantly, as the new European study shows, securing IP rights grows jobs and wages. 

Pirated CDs Still a Costly Copyright Problem

An October 30 article in the Wall Street Journal [subscription required] regarding the extent to which pirated CDs sold on the Internet unjustly harm artists and record labels is well worth reading. Here's the beginning:

"Even in the digital era there are plenty of music fans who still buy old-fashioned compact discs for more than $10 a pop. But the money that shoppers have been spending on CDs lately hasn’t necessarily been going to the artists and record labels who created the music.

In the latest challenge for the battered music industry, pirates are flooding Amazon.com Inc. and other online retailers with counterfeit CDs that often cost nearly as much as the official versions and increasingly are difficult to distinguish from the real goods."

More needs to be done to stop, or at least greatly reduce, such piracy.

Maryland Spending Continues to Outpace Revenue

This week, The Washington Post published an article discussing the need for fiscal reform in Maryland. Amelia Chasse, a spokeswoman for Governor Larry Hogan, stated: “Over the past year, our state has experienced solid revenue growth of 3.5 percent, but as reported today by the legislature’s own budget analysts, spending growth continues to outpace revenue growth.” With Maryland facing a budget shortfall of hundreds of millions of dollars, Warren G. Deschenaux, Executive Director of the Department of Legislative Services, said that Maryland policymakers need to “get real” and “look at what is driving our spending upwards.” Ms. Chasse also said that Governor Hogan looks forward to working with the General Assembly to address Maryland’s spending problem. In an October 2016 blog, Free State Foundation President Randolph May called for compromises between Governor Hogan and the General Assembly to lessen the burden of Maryland’s tax and fiscal policies.

Maryland and Other States Must Reduce Wireless Tax Rates

On October 11, 2016, the Tax Foundation published a report entitled “Wireless Tax Burdens Rise for the Second Straight Year in 2016.” According to report authors Scott Mackey and Joseph Henchman, wireless tax rates have increased to a record high 18.6% for the average U.S. consumer. Wireless consumers are paying an estimated $17.2 billion in taxes, fees, and government surcharges. And while average wireless bills have been dropping since 2008, consumers have been unable to enjoy the benefits because “taxes are growing at a rate twice as fast as average wireless prices have been falling.”

Wireless services have raised living standards for low-income Americans, offering them flexible low-cost connections to the rest of the world. Wireless communications provide low-income Americans cost-effective means for accessing health, transportation, and education services. However, burdensome state and local tax rates on wireless connections increase costs for low-income Americans who access these valuable services.

At the end of 2015, more than 64% of all low-income adults subscribed only to wireless voice services, whereas more than 48% of adults overall were wireless only. Wireless taxes and fees disproportionately harm low-income consumers because the taxes they pay represent a higher percentage of their income compared to middle and high-income consumers. With a federal Universal Service Fund rate of approximately 6.64%, state and local governments account for the remaining 11.93% of tax burden for the average American wireless consumer. These heavy taxes make it more likely that low-income consumers will drop wireless services. State and local governments must alleviate these disproportionate harms affecting low-income wireless consumers. For low-income adults who currently have no connection, a reduction in state and local wireless tax rates likely would encourage them to connect wirelessly.

Of course, all wireless consumers are harmed by record-high wireless tax rates. Artificial price increases from taxes reduce consumer demand and thereby reduce network investment. As Mr. Mackey and Mr. Henchman explain: “The reduced demand impacts network investment because subscriber revenues ultimately determine how much carriers can afford to invest in network modernization.” The authors add, “Higher taxes on wireless service, coupled with increased taxes on wireless investments, may lead to slower deployment of wireless network infrastructure, including fourth generation (4G) and fifth generation (5G) wireless broadband technologies.”

In Maryland, the wireless tax burden is severely harmful to consumers. Maryland and its localities charge up to five different taxes on a consumer’s monthly wireless bill. All combined, average wireless consumer tax burdens in Maryland far exceed the state’s general sales tax rate of 6%. Including Washington, DC and Puerto Rico, Maryland has the 15th highest combined wireless tax rate at 19.47%. But among Maryland’s neighboring states, Delaware ranks only 48th with a 12.98% combined rate. Meanwhile, Virginia is 47th highest with a 13.36% combined rate, and West Virginia is 46th highest with a 13.36% combined rate.

In particular, Baltimore has notoriously high wireless taxes. Baltimore charges a $4 tax per line per month. Therefore, the taxes on a basic $100 per month family plan of 4 lines would add almost $30 extra a month. (See chart below.) With the second highest combined wireless tax rate in the country – only Chicago ranks higher – Baltimore should reduce its wireless tax rates immediately in order to improve opportunities for its residents to cost-effectively access wireless services. More generally, Maryland should lower wireless tax rates to enhance opportunities for wireless providers to invest in statewide networks.

Table 6: Wireless Taxes and Fees on Multi-Line Plan in Selected Cities, July 2016
Federal, State, and Local
City	Tax on 4 line plan @ $100 per month	Tax Rate
Chicago, IL	$36.24	36.24%
Baltimore, MD	$29.84	29.84%
New York, NY	$27.11	27.11%
Philadelphia, PA	$26.24	26.24%
Omaha, NE	$26.06	26.06%
Seattle, WA	$25.94	25.94%
Providence, RI	$23.68	23.68%
Tallahassee, FL	$22.58	22.58%
Kansas City, MO	$21.49	21.49%
Los Angeles, CA	$21.19	21.19%

(Source: Scott Mackey and Joseph Henchman, “Wireless Tax Burdens Rise for Second Straight Year in 2016”)

In an October 17 blog post, Free State Foundation President Randolph May discussed ways that Maryland Governor Larry Hogan can improve his fiscal record. Governor Hogan’s two-year record of reducing taxes and fees and proposing to eliminate unnecessary regulations provides a strong start. The time is now right for the Governor to work with the Maryland General Assembly to reduce the tax burdens that wireless consumers experience on a monthly basis.

All state and local governments that burden their wireless consumers with heavy taxes should think twice about the harms being visited disproportionately on low-income consumers. State and local governments – including Maryland’s – should also recognize the negative impact that excessive and discriminatory taxation has on consumer demand and on network investment. High taxing states and localities should significantly decrease wireless tax rates to encourage more wireless connections for consumers of all income levels and more investment from wireless providers.

Thinking Things Through IX - The FCC As An Independent Agency

On October 11, the Court of Appeals for the D.C. Circuit held that the Consumer Financial Protection Board (CFPB), as currently structured and as operated in practice, is unconstitutional. Deservedly, the decision, received considerable attention, for as Judge Brett Kavanaugh declared in the opinion’s opening sentence: “This is a case about executive power and individual liberty.”

Judge Kavanaugh’s opinion warrants close attention not only by those interested in the fate of the CFPB, but by FCC-watchers as well. This is because of what the opinion says about the way the FCC, as one of the so-called independent agencies, is intended to operate in order to be constitutional.

In short, the D.C. Circuit held that the CFPB is unconstitutionally structured because its single Director, Richard Cordray, is not accountable to the President because he cannot be terminated at the pleasure of the President. Judge Kavanaugh proclaimed that Director Cordray, operating as a one-person “independent” regulator, enjoys “more unilateral authority than any other officer in any of the three branches of the U.S. Government, other than the President.” As the court emphasized, Article II of the Constitution “lodged full responsibility for the executive power in the President of the United States, who is elected and accountable to the people.” To save the entire CFPB from being thrown out lock-stock-and-barrel as unconstitutional, the court held that Mr. Cordray must be made accountable to the President by submitting to the President’s supervision and, like other officers in the executive branch, by serving at the President’s pleasure.

I’ve long held the view that the FCC and other independent agencies, with their blend of quasi-legislative, quasi-executive, and quasi-judicial powers, and with their commissioners subject to removal by the President only for cause rather than at will, occupy a shaky position in our tripartite constitutional regime. And, like Judge Kavanaugh, I have observed many times that “the independent agencies collectively constitute, in effect, a headless fourth branch of the U.S. Government.”

But, for present purposes, I don’t want to argue about the constitutionality of the independent agencies like the FCC. That question, at least for now, has been settled by the Supreme Court’s landmark decision in Humphrey’s Executor v. United States (1935), when the Court upheld the constitutionality of the Federal Trade Commission.

Instead, I want to highlight what Judge Kavanaugh, in the D.C. Circuit opinion, said about the independent agencies by way of distinguishing them from the unconstitutional structure and operation of the Consumer Financial Protection Board. First, he pointed out that, to mitigate the risk to individual liberty from unchecked power, “the independent agencies, although not checked by the President, have historically been headed by multiple commissioners, directors, or board members who act as checks on one another.”

To put a fine point on it, Judge Kavanaugh declared: “In other words, to help preserve individual liberty under Article II, the heads of executive agencies are accountable to and checked by the President, and the heads of independent agencies, although not accountable to or checked by the President, are at least accountable to and checked by their fellow commissioners or board members.” (Last emphasis supplied.)

Second, Judge Kavanaugh observed, quoting Humphrey’s Executor, that each independent agency traditionally has been established as a “body of experts appointed by law and informed by experience.”

Third, Judge Kavanaugh emphasized that the Humphrey’s Executor Court found it significant that the FTC was intended to be “non-partisan” and to “act with entire impartiality.”

So, here’s the important point for purposes of thinking things through: All of the characteristics recited above, considered separately and collectively – that is, a non-partisan multi-member body of experts informed by experience, acting with entire impartiality, and serving as a check upon each other – presumably were crucial to the Supreme Court’s finding that independent agencies like the FCC and FTC are constitutional.

It might surprise you to learn that I don’t intend here to lay out a case suggesting that, over the last couple of years, at times the FCC has departed in significant ways from adherence to the criteria that led the Humphrey’s Executor Court to sustain the constitutionality of agencies like the FCC – even though I do think such a case can be made. You can engage in that exercise as a mind game yourself if you wish.

Instead, the point I want to emphasize now, in thinking things through, is that the more the FCC deviates from the Humphrey’s Executor criteria, the less constitutional support it enjoys for its actions. In other words, the more the FCC deviates from the Humphrey’s Executor criteria, the more the agency’s constitutional veneer, as part of the “headless fourth branch” of government, wears thin.

FSF To Celebrate Its Tenth Anniversary!

This past June the Free State Foundation celebrated the Tenth Anniversary of its founding. In ten short years FSF has become one of the nation's leading, most respected think tanks promoting free market-oriented, property rights-protective, and rule of law policies, especially in the communications law and policy and intellectual property areas.

Please join FSF celebrate the Tenth Anniversary of its founding at a gala celebratory lunch on Wednesday, December 7, 2016, from 11:45 a.m. to 2:15 p.m. at the National Press Club in Washington, DC. A complimentary lunch will be served, but you must register to attend.