My previous blog post examined how a wireless provider like AT&T mobility ended up getting money from the Federal Universal Service Fund (USF), and why AT&T continues to receive money from a fund which it has been urging the FCC to reform for years. In this blog, I take a closer look at the USF funding that AT&T receives for its wireline operations in rural and high cost areas.

As I mentioned last time, AT&T’s USF receipts are split about 50/50 between its mobility business and its traditional wireline local phone business.  And, on the wireline side, well over half of the money AT&T receives is for just two of the twenty-two states where AT&T provides traditional wireline phone service – Mississippi and Alabama. (You can get all the gory details here.)

If that seems odd to you, be assured that you’re not alone. In fact, you’re in the good company of the U.S. Court of Appeals for the 10th Circuit, which has twice told the FCC to fix the program that creates this situation. The FCC in turn has made no changes to this program, but has most recently told the court that the program is in fact serving the policies set out by Congress, and, by the way, the FCC plans to phase the program out entirely as it transitions universal service support to broadband.

From an analytical perspective, the FCC’s mistake was to base the availability of universal service money on, among other things, a comparison of costs that are averaged, in AT&T’s case, on a statewide basis. As a consequence, little to no support is provided in states like California or Texas that have a combination of large, densely-populated metropolitan areas and sparsely populated rural areas. In contrast, states like Mississippi and Alabama, that have no cities comparable to Los Angeles or Houston, receive significant support.

For the curious souls wanting to know why the FCC determined a state’s USF support based in part on statewide averaging, a quick primer. The use of statewide averaging for a provider like AT&T is a throwback to the days before the local voice market was opened to competition. Then, the phone company’s various rates were set so as to create a series of cross-subsidies. Business and long distance services subsidized basic local service, and the provision of service in urban areas subsidized the provision of service in rural areas. Indeed, to this day, regulated local phone rates are often lower in rural areas than in urban areas.

The 1996 Act was supposed to end all of this. In a market where other providers’ rates are not regulated, cross-subsidies are not economically sustainable. But the FCC has never fully implemented the vision of the 1996 Act with respect to cross-subsidization — not in its universal service programs, and not in its intercarrier compensation rules.  And, that is why one frequently hears the refrain, “We urge the Commission to finally fix the broken USF.”

Ok, now back to our regularly scheduled programming…. It is noteworthy that smaller local phone companies, in particular those still subject to rate-of-return regulation, are not as affected by this averaging problem as companies like AT&T. This is in part because they typically don’t serve very large metropolitan areas and, perhaps more importantly, because their relevant costs are measured over much smaller areas, often over a single wire center. The effects of this difference are dramatic. AT&T‘s wireline footprint covers about 30% of the country’s rural homes, yet AT&T receives about 4% of the total USF high cost support for it doing so. A group of smaller companies, which collectively cover about 38% of the country’s rural homes, receive almost 60% of the total USF high cost support. In some cases, these companies receive thousands of dollars in support for every line that they serve.

I want to be clear that AT&T is not seeking to change the fund so that it would receive support similar to that received by these smaller companies. What AT&T has advocated for is a system where support is determined for all providers based on geographic areas relevant to investment decisions. And happily, this is exactly the approach endorsed by the National Broadband Plan.

In the next blog post in our series on the USF, I’ll explain what the FCC’s recent 706 report has to do with the pathologies of its universal service policies.

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