Is it Time to Tax the Internet?

There is a law advancing in the Maryland legislature that would tax Internet advertising. The law, if enacted would collect taxes from online advertising done by Google, Facebook, and others. The tax would immediately be challenged in court due to our history of not taxing things related to the Internet.

The idea of not taxing the Internet began with the Internet Tax Freedom Act in 1998. That law grandfathered taxes imposed in 13 states on Internet access but prohibited it elsewhere. The law also prohibited local governments from imposing taxes on electronic commerce. The law imposed a 3-year moratorium on such taxes and was extended eight times until the tax prohibition was made permanent in the Trade Facilitation and Trade Enforcement Act in 2015.

There are other precedents for not taxing electronics commerce. For example, the Supreme Court ruled in 1967 that requiring remote vendors to collect sales taxes would impose an undue constraint on interstate commerce. The prohibition against sales taxes for out-of-state sellers was strengthened in 1992 in the Supreme Court’s ruling in Quill Corporation v. North Dakota that prohibited a state from collecting sales taxes unless a business has a physical presence in a state. These prohibitions were assumed to also apply to sales made over the Internet if the seller lived in a different state than the buyer.

However, such rulings change over time and the Supreme Court reversed the older decisions in 2018 in the case of South Dakota v Wayfair, Inc. The Court effectively ruled that states can require remote sellers of any kind, including online sellers to collect state sales taxes. Since that ruling, many states have imposed sales taxes on Internet sales.

Opponents of the tax on advertising say that the proposed law would violate the intent of the Internet Freedom Act to not tax electronic commerce. The application of a tax to advertising is different enough from a sales tax that the Supreme Court ruling won’t automatically apply. If the law is passed it will likely have to go to the Supreme Court. To a non-lawyer like me, it seems the issue is similar enough to sales taxes that there is a good chance that at tax on advertising would be allowed. Even if it allowed, such a tax has the significant challenge of identifying the advertising revenue that applies to a given state. For example, what portion of nationwide advertising for Ford trucks would apply to Maryland?

The Maryland law does freshly raise the question of whether it’s time to tax the Internet. The original Internet Tax Freedom Act was an attempt by Congress to protect the fledgling broadband business. It’s debatable if the growth of the Internet would have been slowed had there been a few dollars of taxes applied to broadband bills like were applied to landline telephone bills. But the new Internet companies were the darlings of Wall Street, and Congress decided to keep broadband products free from taxation.

The broadband tax that’s most needed is a surcharge on broadband to help fund the FCC’s Universal Service Fund. Many states also have similar funds. The USF is currently being funded by fees charged to landlines and cellphones. The purpose of the fund is currently to promote broadband for places that don’t have it. The fund will be paying for the $20.4 billion RDOF grants for rural broadband and the $9 billion 5G Fund grants to improve rural cellular coverage. It’s silly that we aren’t charging a small fee onbroadband users to help pay for rural broadband – everybody in the country benefits when there is broadband everywhere. I can’t fathom a justification for having landlines users pay for rural broadband but not broadband customers.

Congress is often mystifying. I can understand the initial ban against Internet taxes, although I don’t believe such taxes would have hampered the explosive growth of broadband. But I can’t think of any justification in 2015 for making the ban on Internet taxes permanent. Considering the huge problems that lack of rural broadband just caused during the COVID-19 crisis, there is no justification for not increasing the funding for the Universal Service Fund, and the easiest way to do so is to tax broadband customers.

Auditing the Universal Service Fund

I recently heard FCC Commissioner Geoffrey Starks speak to the Broadband Communities meeting in Alexandria, Virginia. He expressed support for finding broadband solutions and cited several examples of communities that don’t have good broadband access today – both due to lack of connectivity and due to the lack of affordable broadband.

One of his more interesting comments is that he wants the FCC to undertake a ‘data-driven’ analysis of the effectiveness of the Universal Service Fund over the last ten years. He wants to understand where the fund has succeeded and where it has failed. Trying to somehow measure the effectiveness of the USF sounds challenging. I can think of numerous successes and failures of USF funding, but I also know of a lot of situations that I would have a hard time classifying as a success or failure.

Consider some of the challenges of looking backward. Over the last decade, the definition of broadband has changed from 4/1 Mbps to 25/3 Mbps. Any USF funds that supported the older speeds will look obsolete and inadequate today. Was using USF funding nine years ago to support slow broadband by today’s standards a success or a failure?

One of the biggest challenges of undertaking data-driven analysis is that the FCC didn’t gather the needed data over time. For example, there has only been a limited amount of speed testing done by the FCC looking at the performance of networks built with USF funding. A more rigorous set of testing starts over the next few years, but I think even the new testing won’t tell the FCC what they need to know. For example, the FCC just changed the rules to let the big telcos off the hook when they decided that USF recipients can help to decide which customers to test. The big telcos aren’t going to test where they didn’t build upgrades or where they know they can’t meet the FCC speed requirements.

The FCC will find many successes from USF funding. I’m aware of many rural communities that have gotten fiber that was partially funded by the ACAM program. These communities will have world-class broadband for the rest of this century. But ACAM money was also used in other places to build 25/3 DSL. I’m sure the rural homes that got this DSL are thankful because it’s far better than what they had before. But will they be happy in a decade or two as their copper networks approach being a century old? Are the areas that got the DSL a success or a failure?

Unfortunately, there are obvious failures with USF funding. Many of the failures come from the inadequate mapping that influenced USF funding decisions. There are millions of households for which carriers have been denied USF funding because the homes have been improperly classified as having broadband when they do not. Commissioner Stark said he was worried about using these same maps for the upcoming RDOF grants – and he should be.

Possibly the biggest failures come from what I call lack of vision by the FCC. The biggest example of this is when they awarded $11 billion to fund the CAF II program for the big telcos, requiring 10/1 Mbps speeds at a time when the FCC had already declared broadband to be 25/3 Mbps. That program was such a failure that the CAF II areas will be eligible for overbuilding using the RDOF grants, barely after the upgrades are slated to be completed. The Universal Service Fund should only support building broadband to meet future speed needs and not today’s needs. This FCC is likely to repeat this mistake if they award the coming RDOF grants to provide 25/3 Mbps speeds – a speed that’s arguably inadequate today and that clearly will be inadequate by the time the RDOF networks are completed seven years from now.

I hope the data-driven analysis asks the right questions. Again, consider CAF II. I think there are huge numbers of homes in the CAF II service areas where the big telcos made no upgrades, or upgraded to speeds far below 10/1 Mbps. I know that some of the big telcos didn’t even spend much of their CAF II funding and pocketed it as revenue. Is the audit going to look deep at such failures and take an honest look at what went wrong?

Commissioner Stark also mentioned the Lifeline program as a failure due to massive fraud. I’ve followed the Lifeline topic closely for years and the fraud has been nowhere near the magnitude that is being claimed by some politicians. Much of the blame for problems with the program came from the FCC because there was never any easy way for telcos to check if customers remained eligible for the program. The FCC is in the process of launching such a database – something that should have been done twenty years ago. The real travesty of the Lifeline program is that the big telcos have walked away. For example, AT&T has stopped offering Lifeline in much of its footprint. The FCC has also decided to make it exceedingly difficult for ISPs to join the program, and I know of numerous ISPs that would love to participate.

I try not to be cynical, and I hope an ‘audit’ isn’t just another way to try to kill the Lifeline program but is instead an honest effort to understand what has worked and not worked in the past. An honest evaluation of the fund’s problems will assign the blame for many of the fund’s problems to the FCC, and ideally, that would stop the current FCC from repeating the mistakes of the past.

Broadening the USF Funding Base

The funding mechanism to pay for the Universal Service Fund is broken. The USF is funded from fees added to landline telephones, cell phones and on large business data connections that are still billed using telco special access products (T1s and larger circuits). The USF fee has now climbed to an exorbitant month tax of 20% of the portion of those services that are deemed to be Interstate by the FCC. This equates to a monthly fee of between a dollar or more for every landline phone and cellphone (the amount charged varies by carrier).

The funding mechanism made sense when it was originally created. The fee at that time was assessed on landlines and was used to built and strengthen landline service in rural America. When the USF fee was introduced the nationwide penetration rate of landlines in urban America was over 98%, and the reasoning was that those with phone service ought to be charged a small fee to help bring phone service to rural America. The concept behind universal service is that everybody in the country is better off when we’re all connected to the communications network.

However, over time the use of the Universal Service Fund has changed drastically and this money is now the primary mechanism that FCC is using to pay for the expansion of rural broadband. This pot of money was used to fund the original CAF II programs for the big telcos and the A-CAM program for the smaller ones. It’s also the source of the Mobility Fund which is used to expand rural cellular coverage.

Remember the BDAC? That’s the Broadband Deployment Advisory Committees that was created by Chairman Ajit Pai when he first took the reins at the FCC. The BDAC was split into numerous subcommittees that looked at specific topics. Each BDAC subcommittee issued a report of recommendations on their topic, and since then little has been heard from them. But the BDAC subcommittees are still meeting and churning out recommendations.

The BDAC subcommittee tasked with creating a State Model Code has suggested the broadening of the funding for the USF. This is the one committee that is not making recommendations for the FCC but rather suggesting ideas that states ought to consider. The Committee has suggested that states establish a fee, similar to the federal USF fee and use the fee to expand broadband in each state. Many states have already done something similar and have created state Universal Service Funds.

The recommendation further suggests that states tax anybody that benefits from broadband. This would include not just ISPs and customers of ISPs, but also the big users of the web like Netflix, Google, Amazon, Facebook, etc. The reasoning is that those that benefit from broadband ought to help pay to expand broadband to everybody. The BDAC recommended language has been modified a few times because the original language was so broad that almost everybody in the country would be subject to the tax, and we’ve learned over years that taxation language needs to be precise.

This is not the first time that this idea has been floated. There are many who suggested in the past to the FCC that USF funding should be expanded to include broadband customers. Just as telephone customers were charged to fund the expansion of the telephone network it makes sense to tax broadband customers to expand broadband. But this idea has always been shot down because early in the life of the Internet the politicians in DC latched onto the idea of not taxing the Internet. This made sense at the time when we needed to protect the fledgling ISP industry – but that concept is now quaintly obsolete since Internet-related companies are probably collectively the world’s biggest industry and hardly need shielding from taxation.

AT&T is a member of this BDAC subcommittee and strongly supports the idea. However, AT&T’s motivations are suspect since they might be the biggest recipient of state USF funds. We saw AT&T lobbyists hijack the state broadband grant program in California and grab all of the money that would have been used to build real rural broadband in the state. The big carriers have an overly large influence in statehouses due to decades of lobbying, and so there is a concern that they support this idea for their own gain rather than supporting the idea of spreading broadband. We just saw AT&T lobbyists at the federal level sneak in language that makes it hard to use the e-Connectivity grants from competing with them.

But no matter how tainted the motivation of those on the BDAC committee, this is an idea with merit. It’s hard to find politicians anywhere who don’t think we should close the broadband gap. It’s clear that it’s going to take some government support to make this work. Currently, there are a number of state broadband grant programs, but these programs generally rely annually on allocations from the legislature – something that is always used annually as a bargaining chip against other legislative priorities. None of these grant programs have allocated enough money to make a real dent in the broadband shortfalls in their states. If states are going to help solve the broadband gap they need to come up with a lot more money.

Setting up state USF funds with a broad funding base is one way to help solve the rural broadband divide. This needs to be done in such a way that the money is used to build the needed fiber infrastructure that is needed to guarantee broadband for the rest of the century – such funds will be worthless if the money is siphoned instead to the pockets of the big telcos. It makes sense to assess the fees on a wider base, and I can’t see any reasonable objection against charging broadband customers but also charging big broadband-reliant companies like Netflix, Google, Amazon, and Facebook. The first state to try this will get a fight from those companies, but hopefully the idea of equity will win since it’s traffic from these companies that is driving the need for better broadband infrastructure.

Funding the USF Broadband Programs

A number of telecom advocacy groups came together recently to ask the FCC to increase the budget for the high-cost portion of the Universal Service Fund to at least $2.4 billion for the next fiscal year just begun on October 1. The joint filing was by ITTA – The Voice of America’s Broadband Providers, USTelecom – The Broadband Association, NTCA – The Rural Broadband Association and WTA – Advocates for Rural Broadband.

Small telcos are specifically asking that the FCC fully fund the commitments made to them in 2016 for the A-CAM program. This is the fund that is providing money to rural telcos to upgrade their networks to at last 25/3 Mbps – although it seems like most companies are using the money to upgrade to fiber. That program is bringing a permanent broadband solution to numerous rural communities.

The A-CAM and other high-cost support programs are not currently fully funded. This is due to several factors. First, more small telcos accepted A-CAM funding than the FCC anticipated, creating a bigger financial commitment than was expected. But more importantly, the FCC has been tapping the Universal Service Fund for other broadband commitments such as the CAF II program that gave billions to the large telcos to upgrade to only 10 Mbps. This same fund is also used to provide e-rate funding for schools to get affordable broadband, to support libraries, to support rural healthcare and to provide the lifeline program to make telephone and broadband more affordable for low-income households.

It would be a challenge for the FCC to meet the request and I’m not sure there is an easy way for them to do so. The Universal Service Fund is funded by fees assessed against landline telephone service, cellphone service and against broadband connections that are deemed to be interstate in nature – these are generally broadband connections sold by regulated telcos using the soon-to-be-obsolete TDM technology.

This fee is an additive to these services and the rate being charged has climbed over the years as the number of both landline telephones and special access transport circuits has dropped. In the last quarter the assessment topped 20% for the first time and has climbed over the years. I can recall when the assessment was under 5%.

This all creates a dilemma for the FCC. The revenues against which USF can be assessed are shrinking. Landline use continues to plummet; cellphone prices are trending downward and special access is being displaced by other kinds of transport. As much as the FCC might want to fully fund rural broadband, it has numerous other obligations to meet from the same pile of money like the e-rate program and rural healthcare broadband.

There has been talk for years of expanding the USF base. If the USF fee was assessed against home and business broadband the overall percentage would plummet from today’s 20% rate. However, Congress nixed the idea of assessing USF against broadband by sticking to the philosophy that we should not tax the Internet. This was a concept that was introduced when broadband was a fledgling industry, which somehow became a mantra that is outdated. Broadband revenues dwarf the fees for products like landline telephone service.

The FCC’s hands are tied from assessing USF against broadband by Congress. But even if Congress changed their mind, the FCC has now given up regulation of broadband and they might not have the authority to assess a fee on a product they declare they don’t regulate.

It’s to everybody’s benefit that the FCC finds a way to fund commitments they made for rural broadband just a few years ago. The FCC has some latitude and they could probably apply all fund shortfalls against another program like CAF II – but with the lobbying power of the big telcos that’s unlikely.

The FCC also has another huge source of revenue they could tap. The agency has been collecting gigantic fees for the auction of spectrum in recent years and there is no reason that all or part of this money couldn’t be diverted to rural broadband. However, this also would require action by Congress, which directly diverted auction fees to the US treasury earlier this year when they enacted the Ray Baum bill.

The funding shortfalls are mostly the result of the FCC committing more funds than are available in the fund. Since the USF is funded by fees on services, the fund can’t have cost overruns and spend more money than it has – unlike many other government programs. Every time I hear the FCC announce a new initiative out of the Universal Service Fund I always wonder which other parts of the fund will be raided. I think we now know that it’s funding for rural broadband.

Means Testing for FCC Funding – Part II

Yesterday I wrote about the recent blog by FCC Commissioners Michael O’Rielly and Mignon Clyburn that suggests that there ought to be a means test for anybody accepting Universal Service Funds. Yesterday I looked at the idea of using reverse auctions for allocating funds – an idea that I think would only serve to shift broadband funds to slower technologies, most likely rural cellular service for broadband. Today I want to look at two other ideas suggested by the blog.

The blog suggests that rural customers ought to pay more for broadband since it costs more to provide broadband in sparsely populated areas. I think the FCC might want to do a little research and look at the actual prices charged today for broadband where commercial companies have built rural broadband networks. It’s something I look at all of the time and all over the country, and from what I can see the small telcos, cooperatives, WISPs and others that serve rural America today already charge more than what households pay for broadband in urban areas – sometimes considerably more. I am sure there are exceptions to this and perhaps the Commissioners have seen some low rural pricing from some providers. But I’ve looked at the prices of hundreds of rural ISPs and have never seen prices below urban rates.

The small rural ISPs have to make a commercial go of their broadband networks and they’ve realized for years that the only way to do that is to charge more. In most urban areas there is a decent broadband option starting around $40 per month and you rarely see a price close to that in rural America. If you see a low price in rural America it probably offers a very slow speed of perhaps a few Mbps, which certainly doesn’t compare to the 60 Mbps I get from Charter for $44.95 per month.

The issue of rural pricing does raise one policy issue. Historically the Universal Service Fund was used for precisely what this blog seems not to like – to hold telephone rates down in rural America so that everybody in the country could afford to be connected. That policy led to the country having telephone penetration rates for decades north of 98%. I’m not advocating that USF funds ought to be used to directly hold down rural broadband rates, but it’s worth a pause to remember that was the original reason that the Universal Service Fund was started and it worked incredibly well.

The second idea raised by the blog is that Universal Service Funds ought not be used to build broadband to wealthy customers. They suggest that perhaps federal funding ought not to be used to bring broadband to “very rich people who happen to live in the more rural portions of our nation.”  The blog worries that poor urban people will be subsidizing ‘some of the wealthiest communities in America.’  I am sure in making that statement that the Commissioners must have a few real-life communities in mind. But I work all over the country and there are not very many pockets of millionaires in rural America, except perhaps for farmers.

Farmers are an interesting case when it comes to broadband. By definition farmers are rural. But US agriculture is the largest industry in the country and the modern farmer needs broadband to be effective. We are headed soon towards a time when farm yields can increase dramatically by use of IoT sensors, farm robots and other high technology that is going to require broadband. I know that a lot of the rural communities that are clamoring for broadband are farming communities – because those farms are the economic engine that drives numerous counties and regions of the country. I don’t think it’s unreasonable if we are going to rethink policy to talk about bringing broadband to our largest industry.

The FCC blog suggests that perhaps wealthier individuals ought to pay for the cost of getting connected to a broadband network. It’s certainly an interesting idea, and there is precedent. Rural electric companies have always charged the cost of construction to connect customers that live too far from their grid. But with that said we also have to remember that rural electric grids were purposefully built to reach as many people as possible, often with the help of federal funding.

This idea isn’t practical for two reasons. It’s already incredibly hard today to finance a fiber network. I picture the practical problem of somehow trying to get commitments from farmers or other wealthy individuals as part of the process of funding and building a broadband network. As somebody who focuses mostly on financing fiber networks this would largely kill funding new networks. To get the primary borrower and all of the ‘rich’ people coordinated in order to close a major financing is something that would drive most lenders away – it’s too complicated to be practically applied. The FCC might want to consult with a few bankers before pushing this idea too far.

But there is a more fundamental issue and the FCC blog touches upon it. I’m trying to imagine the FCC passing a law that would require people to disclose their income to some commercial company that wants to build a fiber network. I’m not a lawyer, but that sounds like it would bump against all sorts of constitutional issues, let alone practical ones. For example, can you really picture having to report your income to AT&T?  And I then go back to the farmers again. Farmers don’t make a steady income – they have boom years and bust years. Would we put them on or off the hook for contributing towards a fiber network based upon their most recent year of income?

I certainly applaud the Commissioners for thinking outside the box, and that is a good thing when it leads to discussions of ways to improve the funding process. I will be the first to tell you that the current USF distributions are not always sensible and equitable and there is always room for improvement. Some of the ideas suggested by the blog have been discussed in the past and it never hurts to revisit ideas. But what most amazes me about the suggestions made by this blog is that the proposed solutions would require a heavy regulatory hand – and this FCC, or at least its new Chairman has the goal of reducing regulation. To impose a means test or income test would go in the opposite direction and would require a new layer of intrusive regulations.

Means Testing for FCC Funding – Part I

A recent blog by FCC Commissioners Michael O’Rielly and Mignon Clyburn asks if there should be a means test in federal high cost programs. This blog is something every telco, school, library or health care provider that gets any form of Universal Service funding needs to read.

There is already some means testing in the Universal Service Fund. For instance, the Lifeline program brings subsidized voice and broadband only to households that meet certain poverty tests. And the Schools and Libraries program uses a mean test to make certain that subsidies go to schools with the most low-income students. The FCC blog talks about now applying a means test to the Universal Service Funds that are used to promote rural broadband. There are several of these programs, with the biggest dollar ones being the CAF II funding for large telcos and the ACAM program for small telcos to expand rural broadband networks.

The blog brings up the latest buzzword at the FCC, which is reverse auction. The FCC embraces the concept that there should be a competition to get federal money to expand broadband networks, with the funding going to the carrier that is willing to accept the lowest amount of funding to expand broadband into an area. On the surface that sounds like a reasonable suggestion in that it would give money to the company that is the most efficient.

But in real-life practice reverse auctions don’t work, at least for building rural broadband networks. Today these FCC infrastructure programs are aimed at bringing broadband to places that don’t have it. And the reason they don’t have it is because the areas are largely rural and sparsely populated, meaning costly for building broadband infrastructure. In most of these places nobody is willing to build without significant government subsidy because there is no reasonable business plan using commercial financing.

If there was a reverse auction between two companies willing to bring fiber to a given rural area, then in my experience there wouldn’t be much difference between them in terms of the cost to build the network. They have to deploy the same technology over the same roads to reach the same customers. One might be slightly lower in cost, but not enough to justify going through the reverse auction process.

And that is the big gotcha with the preference for reverse auctions. A reverse auction will always favor somebody using a cheaper technology. And in rural broadband, a cheaper technology means an inferior technology. It means using federal funding to expand DSL or cellular wireless as is being done with big telco CAF II money instead of building fiber, as is being done by the small telcos accepting ACAM money.

Whether intentional or not, the FCC’s penchant for favoring reverse auctions would shift money from fiber projects – mostly being done by small telcos – to the wireless carriers. It’s clear that building cellular technology in rural areas is far cheaper than building fiber. But to use federal money to build inferior technology means relegating rural areas to dreadfully inadequate broadband for decades to come.

Forget all of the hype about how 5G cellular is going to bring amazing broadband speeds – and I hope the FCC Commissioners have not bought into cellular company’s press releases. Because in rural areas fast 5G requires bringing fiber very close to customers – and that means constructing nearly the same fiber networks needed to provide fiber into homes. The big cellular companies are not going to invest in rural 5G any more than the big telcos have ever invested in rural fiber. So a reverse auction would divert federal funds to Verizon and AT&T to extend traditional cellular networks, not for super-fast wireless networks.

We already know what it looks like to expand rural cellular broadband. It means building networks that deliver perhaps 20 Mbps to those living close to cell towers and something slower as you move away from the towers. That is exactly what AT&T is building with their CAF II funding today. AT&T is taking $426 million per year for six years, or $2.5 billion in total to expand cellular broadband in rural areas. As I’ve said many times in the past this is perhaps the worse use of federal telecom funding I have ever seen. Customers on these cellular networks are getting broadband on day one that is too slow and that doesn’t even meet the current FCC’s definition of broadband. And in the future these customers and rural communities are going to be light-years behind the rest of the country as household demand for broadband continues to grow at a torrid pace while these customers are stuck with an inadequate technology.

The FCC blog also mentions the concept of possibly re-directing future USF payments, and if I am a small telco that scares me to death. This sounds like the FCC may consider redirecting this already-committed ACAM funding. Numerous small telcos just accepted a 10-year commitment to receive ACAM funding from the USF Fund to expand broadband in rural areas, and many are already borrowing matching funds from banks based upon that commitment. Should that funding be redirected into a reverse auction these small companies will not be able to complete their planned expansion, and if they already borrowed money based upon the promise of that ACAM funding they could find themselves in deep financial trouble.

An Idea for Funding Rural Fiber

eyeballI’ve been working for a long time with rural broadband and it has become clear to me that there is no way on our current path that we can build fiber everywhere in the US. The borrowing capacity of all of the small telcos and coops is not nearly large enough to fund fiber everywhere. It’s often difficult to have a business case for rural fiber that you can get funded at a bank. It certainly doesn’t look like the federal government has any plans to fund fiber, and even if they did they would probably spend too much by imposing unreasonable rules that would drive up construction costs.

But there are other ways that we could fund fiber everywhere. For example, consider the utility model. Utilities are generally able to get funded because they are guaranteed a rate of return of perhaps something like 10% on their investment. It has been the guaranteed returns that have allowed rural telephone to borrow the money needed to operate.

If fiber networks had a guaranteed return there would be many commercial lenders and other investors willing to provide the money to build rural fiber networks. There is a huge amount of money available from pension funds, insurance companies, and other large pots of money that would be attracted to a steady 10% return.

There is no reason the utility model can’t be applied to rural fiber. The primary characteristic of a regulated utility is that it is a monopoly, or nearly a monopoly. In rural America today there is no real broadband competition. Rural areas are served by a combination of dial-up, satellite, cell phone data, very poor DSL or fixed wireless systems. There are many millions of households with no other options other than dial-up or satellite.

There are two keys to making this idea work – how to pay for it and how to monitor and regulate the earnings of these new broadband fiber monopolies. We already have a historical model of how to pay for this. Rural telephone companies for years were regulated in this manner and there was a combination of funding mechanisms used to fund rural telephony. Most obvious was local revenues collected from customers. I know of rural fiber networks today with 70% to 80% broadband penetration rates, so these networks would get a significant number of customers and local revenue.

Telephone companies have also pooled some of their revenues nationally in process called cost separations. Phone companies throw all of their interstate revenues into a pot and divvy up the money according to need. There is no reason that some of the broadband revenues couldn’t be pooled.

Finally, the telcos had direct subsidies from the Universal Service Fund to make up any shortfall. The biggest complaint about the Universal Service Fund is that it isn’t paid to companies on the same basis as other revenues, and thus it enriches some companies unfairly and doesn’t give enough to others. But if USF revenues were put into the same pool as other revenues then it would be allocated each year where the financial need warrants it.

The process of pooling revenues has always been a bit complicated in practice, but simple in concept. Each company in a pool calculates their costs according to a specific formula – in the case of telcos, using rules proscribed by the FCC. Then, some external pooling body examines those calculations and administers the collection and distribution of pooled monies. This whole process of administering a pool adds only a tiny fractional additional cost onto the process – and is necessary to make sure everybody plays fair and that there is no fraud.

The basic concept of pooled revenues and some kind of broadband USF could provide the economic basis for obtaining the funding needed to build rural broadband. I would expect that rural telcos and cooperatives would jump onto this idea immediately and build more rural fiber. And there is no reason that the large telcos wouldn’t at least consider this. But since they are driven by Wall Street earnings they might pass on regulated returns.

We know this process can work because it has been in place for decades for rural telephony. The only alternative to this that I can think of is for the federal government to hand out grants to build rural broadband. But I just don’t see that happening in today’s political environment. So rather than wait for the federal government to finally decide to hand out huge grants we ought to take the model we know and get going with it.

This concept would need a boost from the federal government to get going. It would probably require an act of Congress, but this is something that is probably easier to get enacted than a huge grant program. And it is a lot more attractive politically since it provides a way for private investment to fund rural broadband rather than the government. We have too try something because the rural areas are falling quickly onto the wrong sie of the digital divide, and that is not good for any of us.

A Better Way to Fund USF

USF-logoThe Universal Service Fund (USF) is shifting its focus dramatically and this leads me to ask if there ought to be a more equitable way to fund this effort.

Historically, the USF was established to help pay for providing telephone service in high cost and remote parts of the country. Largely, it worked and telephone networks were expanded to places that certainly never would have gotten service without these funds. Then, over the years, Congress and the FCC expanded the role of the USF and it was also used to provide telecom services to schools and libraries and to bring telecom and data services to rural health care providers. And as each of these new functions was added the size of the fund grew to over $8 billion.

But now there are big shake-ups in all of the traditional functions of the USF. Subsidies for rural telephony are being phased-out and instead these subsidies are going to be used to promote rural broadband. A significant number of billions of dollars are going to be given to companies over the next seven years that are willing to build rural broadband to places that don’t have it today. The money provided for schools and libraries has been refocused on getting gigabit connections to schools and libraries.

And so the fund is becoming very much focused on bringing better broadband to places that need it. But surprisingly, this is still being funded almost entirely by a surcharge on interstate and international telecommunications services. And there are some real problems with using interstate long distance as the base for collecting the fee.

First, the revenues used for long distance have dropped annually since the turn of the century. Long distance has gotten so cheap that it’s not something that is even noticed much by consumers any more, except perhaps in some rural communities that still charge a lot for long distance. Long distance has become such a commodity that it is often built into the base rate for telephone service. About the cheapest charge I’ve seen for this is where Charter is selling telephone lines with unlimited long distance in some of their markets for $15 per month.

The same thing has happened to interstate transport for special access service. It was routine just a decade ago to charge $4,000 – $6,000 per month for a DS3, which is about 45 Mbps of dedicated bandwidth. But today you can buy a gigabit of bandwidth for a fraction of that cost – and buy it from somebody who is not selling it as special access and who does not add a fee for USF to that charge.

As the amount spent on interstate long distance has continued to drop, the USF assessments have climbed as a percentage of the interstate revenues. I have a few clients who now have a USF assessment of over 17% of their interstate billings. Years ago this started as a rather small fee, but it is a noticeable item on customers’ bills, particularly on buyers of special access.

So if the new data-centric USF is going to work, we need to somehow expand the assessment base. Interstate telco revenues are going to continue to drop. There are only a few places that the assessment base can be expanded, but they are major sources of new revenue. First, cell phones get some USF assessment today, but not as large of a share as landlines. There is also the possibility of expanding USF to include intrastate long distance, but that gets into a messy jurisdictional fight.

The biggest way to spread out the USF fee and make it more reasonable and more sustainable is to assess it on broadband services. This is now easier to do since broadband is covered under Title II. But Congress has real heartburn against ‘taxing the Internet’ which I can’t understand. The original push to not tax the Internet came during the late 1990s as the new broadband services were growing. At that time the political wisdom was that you don’t tax a burgeoning industry and give it a chance to get on its feet.

But there is probably not a more mature industry in the country now than broadband. As far as home utilities, it now comes in third in penetration rates behind electricity and water. Adding a 50 cent per month tax on broadband would not cause any great economic burdens and would spread out the funding to the USF fund. Besides, who better to tax to get broadband to rural places and schools than all of the people who already have broadband?

Unfortunately it will take an act of Congress to change the way that the USF is funded. That is likely only to happen as part of a larger new Telecom Act, something that is overdue. But I can’t see any realistic way that this is going to happen with our split government. Republicans are likely to use a new telecom act to try to defund network neutrality and to cut back on the FCC’s powers in general. And as long as there is a democratic president a new act is not going to get signed. So I guess USF funding reform goes on hold with many other telecom issues that we ought to be addressing.

How Should We Fund Universal Service?

USACThe Universal Service Fund today is funded primarily from telephony revenues. That made a lot of sense historically because the fund was used to support programs that were mostly telephony related. Consider the following uses of USF for 2013:

High Cost Fund                      $4.17 B

Lifeline                                    $1.80 B

Rural Healthcare                    $0.16 B

Schools and Libraries            $2.20 B

Total                                         $8.33 B

The High Cost Fund and Lifeline Funds have always been used almost entirely to support telephony. And there has also always been a telephony component of the Schools and Libraries Fund even though in recent years it has been targeted more for data. With the Connect America Fund ruling of a few years ago the FCC is about to embark on a major shift in the way that USF funds are used. The High Cost Fund support, which is about half of the disbursement will be directed over time to support broadband for places that are either unserved or underserved by broadband today. This fund historically went to support rural telephony but now will support rural broadband.

Further, the Schools and Libraries program was recently redirected to use more of it’s funding to support bringing fast internet connection to schools. The goal is to bring very high-speed Internet to 99% of schools within the next five years.

Since a large portion of the USF is now being redirected towards broadband, it raises the natural question if broadband customers in the country should pay to support this fund. Years ago the FCC’s logic was that urban telephone users ought to chip in to support rural telephone users and one must ask if that same logic now makes sense for data. Today the USF is funded through surcharges on landline phones, cellular phones and special access.

The fee on landline phones has grown to as much as 16%. The USF levy on cell phones is currently around 5.8%. The surcharge on special access is also as much as 16% and this is the fee that most makes me ask the question if we are funding this correctly. These circuits are traditional TDM-based telephony and include such things as T1s, DS3s and OC48s that are sold to large customers. Consider a DS3. This is normally used to provide dedicated transport and it is equal to about 45 Mbps of dedicated bandwidth. But if a customer instead purchases a dedicated 50 Mbps Ethernet product they avoid the USF surcharge. It doesn’t make sense that two nearly identical products are treated so differently. The main reason for this difference is that the special access circuit is considered as an Interstate telephony service by the FCC while the Ethernet service is considered as an information service. Even if both are used for the identical purpose.

When DSL and cable modems were new there was a big push by the telcos and the cable companies to keep taxes away from these products. The argument made then was that the FCC should not do anything that might quash the fledgling data industry. The cry at the time was. “Do not tax the Internet”. So in response to the taxation and other issues the FCC declared that Internet connections are information services and are not telco services. This is the same classification that is causing all of the furor in the net neutrality discussion.

There have been various unsuccessful bills introduced into congress since 2006 to change the way that USF is funded. Part of this is due to the intense lobbying from the industry, but a lot of it has to do with this very sticky classification of Internet service. Congress recently asked for input to this question and got the same responses it’s gotten for a decade. Companies that sell Internet connections don’t want Internet access to be taxed and just about everybody else does.

But it makes no sense to charge as much as a 16% surcharge on landline telephones, which continue to slowly die as a product line. And it makes even less sense to penalize a company that buys a high-speed connection from a special access tariff rather than buying an alternate Ethernet product. And it makes no sense to tax the voice portion of cellphones but not the data portion. It’s time to assess the USF fee on everything telco related. In doing so the surcharge rate would be reasonably low on all products. It’s gotten out of hand now that some of the USF surcharges have grown as high as 16%.

But changing the USF formula then gets wrapped up into the whole issue of whether the FCC can regulate the Internet, because levying a surcharge in Internet product will be seen as a form of regulation. All I know is, if there is going to continue to be a Universal Service Fund that it ought to be funded as broadly as possible so as to not discriminate against some telecom products but not others. Otherwise, as landline voice continues to wane as a product the USF allocation will be shifted largely to cellphone voice. There has to be a more sensible solution.


Funding Broadband to Schools

Indianola_High_SchoolFCC Chairman Tom Wheeler recently announced that he was going to try to funnel $5 billion over the next five years to upgrade the bandwidth inside schools. He is proposing to do this as part of the E-Rate program by changing the things that fund will pay for. I think this begs the question of how and why the FCC has the funds available to pay for this sort of expenditure. So following is a bit of a primer on the E-Rate program.

The E-Rate program is part of the federal Universal Service Fund (USF). Since the 1960’s there was a universal service fund that was administered by AT&T that provided funds to support the expansion of telephony into rural places. This was funded by a small surcharge on interstate long distance calls.

But when AT&T was broken up the funding for USF got murky and so Congress changed the administrator of this funding as part of the Telecommunications Act of 1996. In the Act the Congress directed the Congress to create the Universal Service Administrative Company (USAC) who collects and disburses funding for universal service. USAC is still funded based upon interstate telecommunications. Most telcos pass these fees along to customers on their bills, although this is not mandatory and companies could fund this out of their fees.

The Universal Service Fund has four major components. The High Cost Fund pays to support providing telephony in rural places where the costs are much higher per customer than average. The Low Income Fund pays for some of the installation fees and also some of the monthly fees for telephone lines for low income subscribers. The Rural Health Care Fund provides subsidies for rural tele-health and tele-medicine. And the Schools and Library Funds provides subsidies for Internet access and telecommunications services and infrastructure for schools and libraries.

The USF is undergoing major change due changes ordered by the FCC in Docket 11-171 in 2011. The fund is being transitioned to be called the Connect America Fund and will divert the High Cost Fund to be used to support rural broadband instead of rural telephony.

The Schools and Libraries Fund is commonly referred to as the E-Rate program. This program was started in 1997 where the FCC determined that, “telecommunications services, Internet access, and internal connections, including installation and maintenance,” for schools and libraries were eligible for discounted rates. The E-Rate program will pay from 20% to 90% of the cost of eligible services based upon the poverty and the urban/rural nature of the population supported by a given school. The Fund pays the neediest schools and works its way through the list of applicants each year until it runs out of funding.

What the FCC is doing as part of Chairman Wheeler’s announcement is to look at the definition of what is eligible for reimbursement from the E-Rate program. These definitions haven’t been upgraded for a long time and the fund pays for things like pagers and telephone lines (although one has to imagine the payments for pagers must be very tiny).

The FCC now wants to divert some of the fund to help pay for the basic infrastructure at schools to deliver broadband to the classrooms. President Obama has announced a policy goal, referred to as ConnectED, of bringing faster broadband to all of the schools in the country. His goal set a near-term goal of bringing 100 Mbps connections with a near-future goal of bringing gigabit speeds to schools

The FCC is responding to those policy goals with this change in the E-Rate funding. In Docket WC 13-184 the FCC had looked at some of these issues and had noted that there was a challenge in getting bandwidth from the wiring closet of schools into the classrooms. The FCC now wants some of the E-Rate funds to be used to rewire schools or to deploy other technologies that can bring bandwidth to where students can use it. It certainly is important for this fund to keep up with the times. It makes a lot more sense to use these funds to improve bandwidth at schools rather than to continue to pay for telephone service and for T1 lines. .