Why Uncle Sam must stop subsidizing inefficient companies

From time to time, I'm going to open up this space to guest writers with an interesting point of view. This week, Gregory L. Rosston is taking a turn in the spotlight. Rosston is the deputy director of the Stanford Institute for Economic Policy Research and of the Public Policy program at Stanford University. He served as the deputy chief economist of the Federal Communications Commission from 1994 to 1997.

The Federal Communications Commission is about to continue its anticompetitive policy of protecting incumbent telecommunications providers at the expense of consumers. The FCC has one focus--making consumers better off by forcing suppliers to compete. Yet, nearly every recent FCC decision seems to promote incumbents instead of consumers. Next up is the FCC's proposal to cap universal service funding for new entrants, while maintaining excessive subsidies for incumbent telephone companies.

Ever look at the details on your telephone bill? It shows some, but not nearly all of the money you pay for inefficient "high-cost" subsidies to telephone companies. It's about 10 percent of your bill. That adds up to more than $4 billion per year to subsidize telephone service in certain locations. The costs of this system could grow substantially if Congress or the FCC votes to include more advanced services. The FCC has a chance to revamp the system to inject competition, or even better to eliminate completely the inefficiencies.

Why do we give a $4 billion gift to "rural" incumbent telephone companies? Because they have high costs--even they admit higher costs than their newer competitors. A normal market rewards more efficient providers. But this is the bizarro world of regulation. In this bizarro world, the incumbents are rewarded for their inefficiency. They keep the same subsidies even as they lose customers. Instead of encouraging more efficient competitors and penalizing less efficient competitors, regulators are set to cement in place a system that does the opposite, at the expense of consumers across the country.

High cost "universal service" programs are grossly inefficient because they tax the wrong things and the wrong people, and subsidize many who could easily afford service or who would pay for it themselves. No serious economic analysis shows otherwise.

But rural interests have political power out of proportion to their numbers. That's why taxpayers subsidize rich farm corporations and why urban telephone customers subsidize rural telephone customers, rich and poor alike. Even worse, low-income urban subscribers pay fees to universal service funds that benefit upper- and middle-income residents of suburbs and rural areas. A separate program offers subsidies to low-income consumers, but this program, which at least make distributional sense and is not at issue here, is only a small fraction of size of the high-cost fund.

The FCC has a problem--new entrants are taking customers away from incumbents. Since the new entrant gets a subsidy when it steals a customer but the incumbent never loses a subsidy, competition paradoxically increases the total subsidy.

The obvious solution to this "problem" is to end this mindless pork barrel. At the very least, the FCC should cap the total subsidy and divide the subsidy according to the proportion of rural customers each firm serves. Congressman Joe Barton just introduced a bill to do at least this. Instead of following that logic, the FCC is proposing to cap payments to the successful new entrants, but to maintain fully the payments to the incumbents who are losing customers. The Barton bill actually adds another potentially beneficial step--using "reverse auctions" to drive down the subsidy dollars in each area.

Far better than even the Barton bill would be for Congress and the FCC to declare the high-cost universal service program a success and close it down. The entire program could be capped this year and then phased out over the next five years. A gradual elimination of the program would allow firms to cope with the transition, but it would mean a real transition.

In five years most rural areas are likely to still have service from well-funded rural telephone companies--the cost of continuing to serve a customer is a small fraction of the cost of installing a high-cost telephone line to that customer, and most of those lines were installed years ago. In addition, wireless providers continue to expand their coverage areas, and satellite technology is already making Internet service available anywhere in the country. But these competitive alternatives are less likely to sprout and thrive if they have to compete with an unfairly subsidized provider.