[12/02/15 – Note: this article was published on August 18th, 2004. The original HTML page no longer appears in a Chrome browser, so it has been reposted here]

[Editor’s Note: Many thanks to Mr. David Irwin, Managing Partner, Irwin, Campbell & Tannenwald, PC and Director of the Institute for Communications Law Studies at the Catholic University Law School, for his insight and assistance with this article. His comments regarding the telco industry are always very valuable. Come to the IP @ Telecom 04 conference to hear him provide an overview of what is required from a regulatory standpoint for telcos to add video services.]

With passage of the Telecommunications Act of 1996, the Universal Service Fund was set up by the Federal Government to ensure access to telephone service to all Americans, regardless of income or geographic location. The USF is funded by surcharges in wireline or wireless phone bills. These monies are distributed to telephone companies serving “high-cost” areas to ensure that people living and working in these areas can, afford local telephone service. I will leave the argument for or against the USF for another day, but the reality is that USF in some form is not going away, as indicated by the proclamations of both President Bush and Senator Kerry that broadband should be available to all Americans, which would imply an expansion of today’s program.

The two big challenges with USF are; 1) maintaining revenue flow into the fund and 2) distribution of the funds to qualified parties in an equitable manner. This article will only address an alternative way of funding USF. Currently, USAC (Universal Service Administrative Company) a quasi-Federal Government-private organization administers this approximately 5.5 billion dollar fund (page 2 of 2003 annual report). In 2003, 3.27 billion of the fund went to “high cost” areas, while the remainder funded low income telephone customers, rural health care and schools and libraries.

The Telecommunications Act of 1996 defined two types of services; “Telecommunications Services” (e.g. Plain Old Telephone Service, POTS) and “Information Services” (e.g. the Internet). A special fee to fund universal service is mandated for Telecommunications Services, while Information Services are exempt from this requirement as well as most federal regulation. The USF fee appears as a line item on the monthly telephone bill and is currently set at 8.9% of a telecommunication’s interstate revenues.

The challenge in maintaining USF funding is that, as POTS lines decrease because of substitute products that are deemed “information services”, the amount of money flowing to USF decreases. The concern is what OPASTCO calls a “death spiral”, which will occur when the USF fee has to increase to cover the same costs with fewer and fewer POTS lines. This argument further suggests that raising the USF fee will accelerate erosion in POTS lines until such a point is reached that USF cannot effectively be funded. Right now there is a significant opportunity for arbitrage between information services that are very similar in nature to Telecommunications Services.

Click here to read a radical way to restructure USF.