Crisis Looms in Universal Service

Published June 1, 2005

President George W. Bush has laid out the case for why Congress should tackle the looming Social Security crisis, even though the real financial crunch is still several decades away. He’s right, of course.

But there’s another looming funding crisis, this one more near-term, that Congress also should address this year as it embarks on a much-needed overall review of the country’s communications laws. The archaic and wasteful “universal service” support system should be reformed.

Under the existing universal service program, subsidies are directed to rural areas, where it is often more costly to provide traditional wireline telephone service, and to low-income households presumed to need subsidies to maintain telephone service. These subsidies are funded through a surcharge on long-distance calls that, under the Telecommunications Act, are classified as “telecommunications.”

The surcharge– really a tax–appears on telephone bills as a “universal service fee.” Largely because more and more subsidies are being directed to rural telephone companies, the universal service fee has nearly doubled in the past several years, and it now exceeds 10 percent.

New communications services–such as cable telephony, Internet telephony, and electronic messaging–are rapidly eroding the market share of traditional phone companies. Because these services are not classified as “telecommunications” under the existing law, they do not contribute to the subsidy funds. So, like Social Security, the universal service system faces growing support obligations and a shrinking funding base.

The shortfalls are measurable. Long-distance revenues will shrink at a compound annual rate of 11.5 percent between now and 2009, according to InStat/MDR. By then, the phone industry as a group will be collecting $30 billion less a year from conventional service, the type that funds universal service, than it did in 2004.

Myths and Realities

To help policymakers understand that the universal service system can be fixed without undermining the commendable goal of ensuring reasonably priced telephone service for all citizens, the Progress & Freedom Foundation released in March a comprehensive study: “The Myths and Realities of Universal Service: Revisiting the Justification for the Current Subsidy Structure.”

The study shows that 6 percent of U.S. households already are cellular-only, while 51 percent have both cellular and wireline service. In rural areas, the percentages are not materially different: 5.3 percent have cellular service only and 45 percent have both wireless and wireline.

According to the study, annual household income is the key independent variable driving penetration. Households where annual income is less than $25,000 tend to fall below the 94 percent penetration level that is the average for all U.S. households. The pattern remains consistent across population segments.

Our key conclusions are:

  • Market forces are ensuring a choice of service provider and lower prices for voice service independent of the universal service subsidy regime. For example, 43 percent of U.S. households with incomes under $25,000 subscribe to wireless service, even though such service is not subsidized. Likewise, 57 percent of low-income households subscribe to cable television service; they can be expected increasingly to get telephone service from their cable company, again with no subsidies involved.
  • Low-income support programs effectively address universal service goals. While 80 percent of low-income households take voice service without benefit of any subsidies, existing “Life Line” and “Link Up” discount programs are in place to provide a safety net for the 20 percent of low-income households that may require some form of subsidy to remain on the network.
  • The time has come to modify the rural subsidy program. The rural subsidy, intended to support lower rates for local calling, has increased from $2.2 billion in 2000 to $3.5 billion in 2004. Because rural households tend to make proportionately more long-distance calls than do non-rural households, the subsidy–funded by the surcharge on long distance–is placing an increasing financial burden on rural households. There are better ways to serve targeted rural population segments without raising the prices paid by all consumers.

Congress should fix the existing subsidy system before competitive forces bring it crashing down. New competitive services–unsupported by subsidies and made possible by less-costly technologies–are now providing all consumers, including those living in rural and lower-income households, with reasonably priced choices for telephone service.

Marketplace developments mean reform can occur without jeopardizing traditional universal service goals. If any subsidies are needed to achieve universal service goals, the focus should be on providing a more narrowly targeted safety net for truly needy low-income households.

As with Social Security, it is often said that changing universal service is “too politically difficult.” Nevertheless, we remain optimistic that Congress, armed with an understanding of the new competitive realities and how those realities undermine the rationale of the existing bloated subsidy regime, will act to implement meaningful reform.

Joseph S. Kraemer ([email protected]) and Richard O. Levine ([email protected]) are adjunct fellows, and Randolph J. May ([email protected]) is a senior fellow at the Progress & Freedom Foundation.