This ConsumerGram draws on conclusions from research done by academics and public policy analysts inside and outside government. It addresses the current scheme of subsidizing some telephone companies by making other companies pay fees well above costs. These fees represent hidden taxes that consumers ultimately pay. This “tax and subsidy” scheme has a long history in the telecom sector, but the consensus is that it is outdated, inefficient, not sustainable in the face of continued increased competition, and, most importantly, discourages investment in new technologies in all parts of the country, including high cost rural areas.
Reduce and Make Subsidies Explicit
Universal service has been a cornerstone of telecommunications policy focused on providing affordable nationwide services. Historical support for universal services has come from several areas, but principally from taxing long distance services, using the proceeds to price other services below cost, and hiding the results in the rates (called access charges) that telephone companies charge one another for completing consumer calls. In the decades leading up to the 1980s, this was possible, in large part, due to that fact the local telephone operated as regulated monopolies. However, with increased competition and technological advancements in broadband and wireless services, the monopolies are gone, and with them the ability to generate excess revenues used to sustain hidden subsidies.
The Telecommunications Act of 1996 recognized the need to end hidden subsidies and in fact required that hidden charges be eliminated and universal service support be made explicit. Despite the Act, consumers continue to be overcharged for some services in order to subsidize old technologies at the expense of newer technologies like wireless and Internet protocol technologies.
Academic and government research on the matter are clear and unanimous. The practice of hiding taxes and subsidies in prices creates inefficiencies, the costs of which are borne by consumers. Importantly in this context, most consumers prefer transparency in the taxes they pay and the use of the funds generated. Neither of those is present in the current access charge scheme.
Eliminate Barriers to Broadband Investment
One of the few points of agreement among different stakeholders and political perspectives is the need for a coherent national policy framework for encouraging investment that will broaden the availability of broadband, digital networks. The current access charge regime of hidden costs and selective subsidies tends to deprive rural and other consumers of access to such broadband facilities. Potential competitors wishing to provide broadband services must face the prospect of competing with uneconomically low subsidized telephone rates. The hidden subsidies hold rates below cost and thus defeat the prospect that new investors might find it profitable to construct competitive alternatives. Thus, the current scheme tends to deprive rural consumers of diversity and choices enjoyed by urban consumers. Investors in alternative platforms find it difficult to compete against services that are subsidized, which tends to discourage wireless and broadband competition.
Eliminate Hidden Taxes
The price of long distance and toll services are laden with hidden fees that represent a subsidy for many telephone companies. When a customer in Chicago makes a 1,300 mile call to another customer in Miami, the telephone company in Chicago that originates the customer’s call must pay a fee to the telephone company in Miami that terminates the call. These payments are referred to as “interstate” access charges and represent hidden fees that consumers pay when they make long distance calls. These hidden intercompany payments differ depending on whether or not a customer uses a traditional telephone service, wireless service, telephone competitor (CLEC) or Internet-telephony provider, with traditional telephone services garnering the largest subsidy. In addition, a call from an urban city to Colorado can generate terminating access charges that are several times greater than a call going in the reverse direction, even though the call uses the exact same facilities in either direction. This can mean that low-income consumers in urban America can pay more for services in order to subsidize potentially more affluent consumers living elsewhere.
The most egregious form of hidden tax comes from the imposition of shorter calls made within the same state, called “intrastate” access charges. As shown in the chart above, for a small telephone company, these hidden taxes are much higher for intrastate calls than interstate calls, in many cases averaging several times more for a 30 mile call compared to a 1,300 mile call. This is the very sort of rate distortions that were outlawed decades ago when regulators discovered that railroads were charging more for short haul traffic than for longer distances. The result there, and here, is to discourage investment and competitions, by distorting markets prices.
The disparity in intercompany access charges creates odd incentives. As consumers increasingly adopt wireless and high-speed Internet services, and disconnect their traditional telecommunications services, these subsidies undermine competition among different technologies, which discourages investments in advanced services while supporting an outdated network now in decline. Consumers feel the pain over time through fewer choices and higher rates. And, the amounts are not trivial to most households. The fees in the table are averages, but many consumers pay as much as 35 cents per minute in hidden intrastate access charges, making a fifteen minute call equivalent to the price of a small pizza just to stay in touch. If a consumer made such a call just one a week, they would generate $273 per year in hidden access fees.
Consumers have a right to know what kinds of taxes are buried in the telephone prices they pay and to what use the proceeds are put.
Eliminate Consumer Costs from Gaming the System
The mismatch between rates and costs generate artificial losses for some services and artificial profits for others. “Smart” businessmen sometimes partner with small telephone companies, directing traffic (though chat lines and related services) to areas with overpriced access fees. The practice, called traffic pumping, generates high margins for both the partners to split, but represents real costs that must be paid elsewhere. Traffic pumping costs consumers hundreds of millions in hidden fees each year and, in many instances, does so without providing any value in return. The misalignment of rates also encourages other forms of gaming and arbitrage that increase intercompany costs and do not benefit consumers in the least. Generating these costs is counter to consumer demands for more low cost services and fewer high cost ones.
Eliminate Barriers to Competition and Choice for Consumers
If the hidden taxes resulting from access charges could be reduced and made uniform, competitors would have the right incentives to invest in new technologies and consumers would have greater choice among them. That would spare urban consumers the cost of subsidizing other networks. In turn, providing the correct incentives to invest would benefit rural consumers. For consumers adversely and significantly affected by the rebalancing of rates, explicit universal service funding could be used to mitigate this impact.
In short, such a policy would reduce consumer prices, make subsidies more explicit and encourage competition between wireless, wireline and broadband providers. Heightened competition, in turn, would be an added bonus for consumers and consumer welfare.
Posted: September 12, 2008
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