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The FCC Asks the Right Questions on USF: Reverse Auctions a Promising Way to Distribute Funds

Progress Snapshot
Release 2.20 August 2006

By Raymond Gifford and Thomas Lenard *

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Last week, the FCC in a Public Notice took the bold step of asking whether "reverse auctions" might be used to reform the High-Cost-Fund subsidy program. Despite inevitable catcalls from the current program’s corporate welfare recipients, Chairman Martin and the Commission are to be commended for exploring this very important idea for bringing rural consumers lower costs, more competition and greater innovation.

The cost of universal service telephone subsidies has exploded in recent years, from about $4 billion in 1998 to almost $7 billion currently. Most of this increase is due to increases in the High-Cost Fund, which has more than doubled, from about $1.7 billion to $3.7 billion, over the same period as the full costs of universal service once embedded in access charges become explicit. Serious reform is needed to curb these rising costs.

Reverse auctions are potentially one of the most promising mechanisms. Though there are important details to be explored, a reverse-auction system would essentially invite communications providers to compete for universal service subsidies by bidding for the subsidy. Though rules may vary and transitions may be necessary, the lowest bidder in a reverse auction would 'win.' Such a system would lower burdens on taxpayers, promote cost efficiency for providers, and encourage innovation among competing bidders.

As its name implies, the purpose of the Universal Service Fund is to make telephone service available to individuals who would not otherwise be able to afford it, either because they are low income or because they live in areas of the country where the cost of providing service is disproportionately high - generally rural areas. It is the latter program - the High-Cost Fund - that is out of control.

The basic problem is that the High-Cost Fund subsidizes small rural local exchange carriers (RLECs) on the basis of their reported costs of providing service. This cost-plus system provides no incentive to reduce costs or to provide service using the most efficient technology. On the contrary, it rewards inefficiency. As a result, according to a recent study by George Mason University economist Thomas Hazlett, subsidies can be as much as $13,000 per year per line. Hazlett estimates that yearly savings of $1 billion are easily achievable using standard mobile and satellite phone subscriptions to provide service to people in sparsely populated areas.

How can reverse auctions help? Reverse auctions are a way of introducing competition into the market for universal service and providing the needed services more efficiently - for example, using mobile or satellite phones as Hazlett and others have suggested. Yet, a reverse auction need not spell ruin for current recipient rural phone companies. Rural phone companies often have low actual incremental service costs. That these companies should be confronted with incentives to act on their cost advantages should be celebrated, by taxpayers and rural customers.

To be sure, the details of a reverse auction method are critically important. Reliance interests on the current system will have to be taken into account. That auctions reward the right bidders, for the right terms, in the right areas, will determine the success or failure of any distribution system.

There is, however, some experience from elsewhere in the world to go on. For example, the use of competitive bidding by Chile starting in the mid-1990s appears to have been successful in extending telephone access to rural areas in a cost-effective manner. Other South American countries, including Brazil, Columbia and Peru also have achieved good results using this approach. The U.S., meanwhile, lags these other nations in bringing to rural consumers the benefits of a reverse auction system.

The political economy hurdles to actually realizing a reverse auction method for universal service distribution remain formidable. The current beneficiaries of the system will fight hard to retain their welfare payments, and the beneficiaries of this reform - taxpayers as a whole - are a diffuse and unorganized constituency. Nonetheless, Chairman Martin’s interest in the idea is an important first step to building a more sustainable, more innovative and less costly subsidy system.

* Raymond Gifford is a Senior Fellow and President of The Progress & Freedom Foundation. Thomas Lenard is a Senior Fellow and Senior Vice President for Research at The Progress & Freedom Foundation. The views expressed here are their own, and are not necessarily the views of the PFF Fellows, its staff or board.



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