Texas Considers Rural Phone Universal Service Subsidy Reform

Published April 1, 2008

Local government has been struggling with different approaches to mandated “universal service” programs since they were first instituted at the breakup of AT&T in 1984. The Public Utilities Commission in Texas has been a leader in making considered reforms of the program.

New technologies, deregulation, and expanded competition pose substantial challenges for federal and state “universal service” programs that subsidize telephone service in rural areas.

At both levels of government, decision makers have scrambled to determine whether newly competitive markets require universal service subsidies, whether new competitive services should contribute or receive subsidies, whether historic subsidy levels are still appropriate, and whether current funding mechanisms for universal service programs are sustainable.

Texas Reforms

One state that has grappled extensively with universal service reform and is continuing to do so is Texas.

Ten years ago, the Texas Public Utility Commission (PUC) reduced subsidies for rural phone service that were hidden in long-distance charges, substituting explicit subsidies funded by a surcharge on Texas telephone bills. In 2005, the Texas legislature enacted sweeping telecommunications legislation that effectively deregulated the prices of many telecommunications services, further reduced hidden subsidies from long-distance to local service, and directed the PUC to consider further universal service reforms.

The price of basic local residential service remains regulated until the PUC determines how to reform the universal service programs.

Subsidies Analyzed

In December 2006 the PUC issued a report reviewing and evaluating the Texas Universal Service Fund (TUSF). This report revealed subsidies for rural phone service account for 92 percent of the fund’s $580 million disbursements in 2005. The bulk of the money went to the state’s largest four carriers, which serve the largest number of rural lines.

In September 2007, the PUC started a proceeding to reexamine universal service subsidies for rural phone service provided by the four largest companies.

To help inform the universal service debate in Texas, Joseph Rotondi and I undertook an analysis of alternative reforms the PUC might consider. We don’t espouse a particular plan, but we examined how different proposals might affect rural phone rates, the size of the universal service fund, and the overall cost to society of raising the required revenues.

Consumers Lost Value

The Texas PUC did the right thing in 1999, reasoning that subsidizing rural phone service by overcharging consumers for long-distance service was not sustainable. They nailed that one.

Given actual trends in long-distance prices and usage and consumer price sensitivity, it would be mathematically impossible to impose a surcharge on long-distance service high enough to raise the $500 million to $600 million collected annually by the Texas universal service fund.

The hidden cost to society of raising the revenues could be reduced substantially, however. Current universal service charges act like a percentage tax on telecommunications services and thus discourage use of services such as long-distance and wireless, where numerous economic studies have demonstrated that consumer usage is sensitive to price.

The value lost by consumers, operating profit lost by companies, and tax revenue lost by governments due to reduced use of these services is an additional cost to society of raising the revenues through a percentage tax. We estimate this cost totaled $176 million in Texas in 2005, over and above the $618 million in revenues raised.

This social waste could be cut in half with a different funding mechanism such as a per-number charge, which does not affect the amount of service consumers choose to use once they have decided to get a phone.

Subsidies Haven’t Worked

The subsidies have caused relatively few additional phone subscriptions. They have made phone service cheaper for many rural residents, but because local wireline phone service is not very price-sensitive, most subsidy recipients would have subscribed anyway. We estimate the rural subsidy programs increased Texas telephone subscribership by between four-tenths and nine-tenths of 1 percent–between 50,000 and 125,000 subscribers.

In addition, the subsidies may have made phone rates unreasonably low. Rural phone rates in Texas have not changed since 1999 or earlier. Because of rate regulation, most Texas rural rates are actually below urban rates, even though costs are higher in rural areas.

Reducing subsidies and allowing rural rates to match the highest urban rate–$19 per month for residences and $44 per month for businesses–would save $183 million annually. Allowing rural rates to rise to a competitive benchmark, such as the $29.99 price of a basic cell phone calling plan, would cut the cost of the rural subsidy programs in half.

Using the price of satellite phone service as a rate benchmark in high-cost rural areas would cut the subsidy programs to one-fifth of their current size.

Market-Friendly Reforms Needed

Some might object to increasing rates for all rural customers, on the grounds that not all rural households could afford to pay the higher rates. However, continuing the current subsidy levels and low rates for low-income households who participate in the joint federal-state Lifeline program would do the job and cost little, because Lifeline households make up less than 5 percent of all Texas telephone subscribers.

The current funding mechanism, while more sustainable and less costly than the implicit subsidies it replaced in 1999, generates substantial social costs in addition to the revenue raised. This is an argument both for reducing the size of the subsidies and for finding a more efficient way of raising the required revenues.

Substantial reforms could be accomplished with little or no reduction in the outcomes the subsidy programs are supposed to produce. The PUC’s 2006 report did not state subsidized rates are unreasonably low, but it did hint higher rates on these lines might be reasonable.

New technologies have made telephone infrastructure available in some rural areas previously served only by wireline incumbents, so a reduction in subsidies would not necessarily deprive consumers of access to phone service.

Finally, consumer demand for basic local telephone service is not very sensitive to price. As a result, the rural subsidies have increased telephone subscription by less than 1 percent, at a cost of $4,000 to $10,000 per additional subscriber. These results suggest modest rate increases on subsidized lines would cause few households to leave the phone network.

Jerry Ellig ([email protected]) is a senior research fellow at the Mercatus Center at George Mason University. This article summarizes research in Jerry Ellig and Joseph P. Rotondi, “Outcomes and Alternatives for Universal Telecommunications Service: A Case Study of Texas,” Texas Review of Law & Politics 12:1 (Fall 2007), pp. 4-91, available at http://www.mercatus.org/Publications/pubID.4245,cfilter.0/pub_detail.asp. Used with permission.