Patricia F. Lewis
RTV 5702 -- Telecommunications Regulation
1 December 1995

Universal Service: How States are Planning for the Future

A. Comments by the State of Texas
B. Comments by the State of Florida
C. Comments by the State of New York
D. Comments by the State of Iowa

Universal service has always been an important component of U.S. telecommunications policy. Recognized as a goal in Section 1 of the 1934 Communications Act, efforts over the years to change our telecommunications laws and policies have always been evaluated, at least in part, for their potential impact on universal service. In 1994, the National Telecommunications and Information Administration (NTIA) of the Department of Commerce issued a Notice of Inquiry (NOI) on universal service to address three issues. Ninety-seven respondents provided comments to the NTIA for consideration, seven of which were states.

The first issue addressed is, what is the impact of competition on universal service goals? Will competition make universal service regulation obsolete? For example, companies may try to beat the competition to be the first to introduce a new service, thus speeding the deployment of an advanced service. Also, competition usually works to lower prices, so perhaps competition will eliminate the need for universal service regulation by forcing prices downward to the point where they are affordable by all. These are just two of the positive impacts that could result from this new environment. Are there also potential negative impacts that need to be mitigated?

Second, should universal service be redefined to reflect advances in telecommunications technology? Currently defined as "basic voice-grade telephone service at affordable rates," there are some who would like to expand that definition to include access to more advanced services. What criteria would be used to do so?

Finally, how will states fund universal service while introducing competition to the local loop? Until now, local telephone monopolies have been solely responsible for the implementation of universal service in their individual service areas. Funding was provided by states' universal service funds and through internal cross-subsidization. As laws begin to allow local residential telephone competition, however, the status quo will no longer be effective. New ways of financing universal service funds must be developed and internal cross-subsidization will have to be replaced by some other funding mechanism. What will that mechanism be?

This paper reviews the NTIA NOI and the comments provided by Texas, New York, Florida, and Iowa. California's July 1995 rulemaking on universal service will also be reviewed. Although not drafted in response to the NTIA NOI, the California rulemaking addresses the same issues and is very relevant to this discussion. These states were selected because of the availability of their comments, their representation of both rural and urban areas, and geographical distribution across the country.

As states begin introducing competition to the local loop, it is critical that policies be developed thoughtfully to ensure we do not lose sight of universal service goals. States are also being forced to confront demands from the public interest community to expand the definition of universal service. This demand comes as technological advances, such as the World Wide Web and electronic mail, are becoming more widely used for everyday business and threaten to leave disadvantaged groups even further behind. Additionally, competition is forcing states to develop new funding mechanisms to promote universal service.

Section II of this paper presents the issues outlined by the NTIA NOI and discusses the comments by the states of Texas, Florida, New York, and Iowa and Section III explains the State of California's Rulemaking on Universal Service. Section IV synthesizes the information discussed in the previous two sections and suggests possible implementations of universal service at the state level. Finally, Section V offers final comments on this subject and suggests an analogy for expanding the concept of universal service as we now define it.

II. The National Telecommunications and Information Administration Notice of Inquiry

The NTIA NOI was issued to allow government, industry, public interest groups, and other entities to provide recommendations on preserving universal service while introducing local telephone competition. In the NOI, the NTIA summarizes the United States' "long-standing commitment to universal service." It cites the emergence of information as a vital economic resource and recent technological advances as causing some to call for redefining universal service to include more advanced telecommunications services. The NTIA goes on to say that even without these changes, this reconsideration of universal service would be needed as another factor is considered: the introduction of competition to the local loop. It explains that such competition weakens traditional pricing structures that incorporate internal cross-subsidization between profitable and less profitable services and high-cost and low-cost service areas.

What is the impact of competition on universal service goals?

The NTIA asks for comment on whether competition will encourage the introduction of new technologies to the public, thereby reducing the need for universal service mandates, or if less desirable effects could occur, such as "electronic redlining." At best, however, competition would spur companies to begin offering services, such as integrated services digital network (an advanced service which, while technically mature, has taken years to be introduced in a monopoly environment), before their competition. Further, fears about redlining must be balanced with legitimate economic concerns associated with the deployment of any new service.

Should universal service be redefined to reflect advances in telecommunications technology?

Next, the NTIA discusses whether the definition of universal service needs to be expanded to include more than just "plain old telephone service" (POTS). It reviews the success of the Nation's universal service policy as it now exists and addresses how to draft an expanded definition of universal service for the future. The NTIA sees the universal service definition as an ever-evolving entity. It illustrates its point with a brief history of universal service since 1934, singling out the progression from party line service to single line service and the recent inclusion by many states of touch-tone service into their lists of basic services. Further, the NTIA states that the current interest in redefining universal service is "consistent with past practice." The difference today is the rapidly growing list of possible elements that could possibly be redefined as "basic" and the speed at which new services are being developed and deployed. In the NOI, the NTIA also seeks specific comment on defining a set of mechanisms to select basic services and inquires into whether universal service policies should address or possibly mandate the provision of access to customer premises equipment (CPE).

How will states fund universal service while introducing competition to the local loop?

Finally, the NTIA asks how to fund universal service in a competitive environment, including sources of fund contribution, distribution of subsidies to service providers and customers, transition measures, and the appropriate role of the federal and state governments in developing universal service policies. While the definitional questions pose one sort of problem, migrating to a new financial structure poses an even greater challenge to the future of universal service.

Some possible sources of contributions have been identified by the National Association of Regulatory Utility Commissioners (NARUC), Metropolitan Fiber Systems (MFS), and by Professor Eli Noam of Columbia University. The NARUC proposal would require all service providers using the public switched network (PSN) to contribute proportionally to any universal service fund. MFS, itself a provider of competitive telecommunications services to businesses, has suggested that all service providers should contribute, regardless of their use of the PSN. Finally, Professor Noam has developed a plan that would require all providers of "transmission path services" to pay a share, based on revenues, of universal service funds. Noam also suggested imposing a tax on telecommunications services or equipment.

A. Comments by the State of Texas

A recent analysis of POTS penetration in Texas found that the goals of universal service in Texas have "clearly not been met." For example, in 1990, only 8 percent of the states counties met or exceeded the national average. In fact, some areas of Texas have less than a 70% penetration rate for basic service! It is for this reason that the Public Utility Commission of Texas (PUCT) firmly believes universal service should be measured in terms of penetration, not availability.

What is the impact of competition on universal service goals?

The PUCT does not believe relying on competition to foster universal service will be successful. In fact, it states in its comment, "competition tends to increase pressure on service providers to deaverage rates for services that may have originally been averaged to foster universal services. This pressure. . . may occur within services or between geographic areas [and cause a] disparity between rates in rural areas and urban areas. . . for the foreseeable future." One reason for this is that competitors will likely not rush to serve rural areas where profits will not be high.

Another problem is defining "reasonable rates." One definition would be cost plus some rate of return. Such a definition would be likely to provide reasonable rates to most customers, but customers in rural and other high cost areas would likely be left with high prices even for basic service. Conversely, if price caps were imposed to ensure a "reasonable" rate, competitors would be less likely to emerge. Why invest in a high cost area with little chance of earning back that investment? The PUCT believes, however, that even in a fully competitive environment, federal and state governments must have a continued role in implementing universal service.

Will competition facilitate the deployment of more advanced telecommunications technologies? No, according to the PUCT, because competition will drive implementation only in areas where there is demand, defined as the willingness and ability to pay. This will cause high cost areas and areas with lower than average income to be left out. Although the PUCT does not explicitly call this electronic redlining, that, in effect, is what it is.

Should universal service be redefined to reflect advances in telecommunications technology?

The PUCT begins its discussion on this topic by providing background on the original reasons for universal service, "positive externality" and "merit good." Positive externality is the idea that the more people that are connected to the network, the more benefit it will provide to all. Merit good is the premise that "all citizens should have basic telephone service because each should have the equal ability to contact emergency services, seek and respond to employment opportunities, communicate with friends and relatives, and participate in society." The PUCT, therefore, supports the implementation of policy that will ensure the ubiquity of basic telephone services.

The PUCT also sees the concepts of positive externality and merit good as applying, although in a somewhat different way, to advanced telecommunications services. Further, the PUCT supports the NTIA's assertion that information has emerged "as a vital economic resource and source of individual empowerment" and that the government should prevent the stratification of telecommunications 'haves' and 'have-nots.' The PUCT, however, believes universal service should not be expanded, but "bifurcated" into two parts. The first would be basic service, the second "advanced telecommunications network and information services. The PUCT goes on to say that while basic services should be available in every household, "the same degree of availability [might not] be necessary to consider a universal implementation policy for advanced telecommunications and information services [a success]."

The PUCT directly addresses the CPE issue by saying it does not support mandating CPE as part of an expanded definition of universal service. Such a policy could end up being so cost prohibitive that no competitor would want to offer services of this type! Therefore, the PUCT concludes, it might be more reasonable to mandate the provision of these advanced services on a community level -- at a community center, for example.

How will states fund universal service while introducing competition to the local loop?

Overall, the PUCT supports NTIA's attempt to reexamine universal service funding policies in a changing industry. The PUCT does not provide a detailed examination of how it plans to implement new funding mechanisms, but does offer its set of guiding principles for developing a new system. These include targeting subsidies to the narrowest practical level, making those subsidies competitively neutral, and developing disbursement plans. Concerning disbursement, the PUCT stated that it supports a two-tiered system by which funds would be allocated at the federal level based on measures such as population size but disbursed further by the states according to factors such as population density, terrain, competitive prospects, and service quality.

B. Comments by the State of Florida

The Florida Public Service Commission (FPSC) begins its response by stating that "the NTIA [NOI] contains numerous questions and proposals suggesting a regulatory philosophy . . .counter to the current trend toward more competitive telecommunications markets." Overall, the FPSC does not appear to agree with either the philosophy or many of the policy goals promulgated by the NTIA.

What is the impact of competition on universal service goals?

The FPSC believes market forces should be relied on to shape the future of the telecommunications marketplace, including the provision of universal service. Regulations should only be implemented to ease the transition from monopoly to competitive environment. Specifically, the FPSC believes regulation will be required in five areas: (1) identifying and preventing anticompetitive practices; (2) prohibiting restrictive practices by carriers which limit customer access to services on an unbundled basis; (3) establishing and enforcing bill itemization standards to ensure that distinctions between and among regulated, unregulated, bundled, unbundled and non-telecommunications services are clear to consumers; (4) protecting consumers in markets where choices are limited (e.g., hotels and pay phones); and (5) ensuring that consumers have access to information necessary to make informed choices.

The FPSC does not provide further explanation or detail about these five principles. For example, it would be helpful to know exactly how anticompetitive practices would be identified and prevented. This level of detail is required to assess whether Florida's proposal will effectively eliminate protections for consumers or facilitate the provision of universal service in a competitive environment.

Should universal service be redefined to reflect advances in telecommunications technology?

The FPSC next considers NTIA's suggestion that the definition of universal service should be reviewed and possibly expanded to include more services. It calls NTIA's proposition that information has become a vital economic resource and source of individual empowerment, "not a new development," while conceding that "information may be growing at a more rapid rate than in the past." It states further that demand for these information services will increase as the public realizes their worth -- the government should not be put in the position of mandating when a service becomes necessary. Concerning the NTIA's statement that technological advances "promise to make telecommunications networks the highways of the Information Age" and "the principal means by which individuals and businesses access and distribute essential information resources," the FPSC replies that simply providing a service to an individual will not ensure that individual will be better off.

The FPSC goes on to say that traditional definitions of basic and universal service should be sustained for the present. In response to NTIA's question of how universal service should be defined, the FPSC says it supports allowing the market primarily to determine which services should be defined as basic, but wants to reserve the final decision of defining what is in the public interest for the government. It also believes that universal service is analogous to universal availability, "since 100% penetration may not be an achievable objective."

The FPSC is against mandating the deployment of services that have not yet gained wide-spread acceptance by consumers. This belief is based on the premise that wide-spread acceptance and usage will not automatically result from early service deployment. Also, the FPSC does not believe that the demand for specific services can be predicted by either government or industry. Advanced information services, according to the FPSC, will evolve as consumer habits change. For example, as consumers begin using teleconferencing as a substitute for travel, services supporting teleconferencing will become more popular, thereby decreasing costs and increasing deployment.

The FPSC states that when a new service is introduced, there is always a transition period where the service will not be available to the entire public. For example, the service provider may not be able to afford to enter all markets simultaneously or prices for the new service will be higher as the provider is recovering its investment causing some potential customers to be priced out of the service. To require providers to offer new services in all areas simultaneously at a price affordable to all would keep many services from ever being offered.

The FPSC believes that consumer and community demand for advanced services should evolve naturally. It rejects the NTIA's premise that access to these services is actually a way to aid personal economic development and gain individual empowerment. Government intervention and funding should be provided only to ensure "some level of access in all areas." For example, "centers of technology," at schools, community centers or libraries, could be established to provide access for the rural and urban poor. This would spare the providers the expense of ubiquitous deployment while offering those communities the benefits of advanced technologies. These centers could also drive up demand by exposing populations to services they would normally not know or learn about.

The FPSC does not agree with the NTIA's treatment of the CPE issue, calling it "confusing." It says that while the NTIA declares the deregulation of CPE markets very successful, it also "warns that they are 'subject only to market forces.'" The FPSC sees any requirement by government to include CPE in the universal service package as a "serious step backward for competitive provision of communications-related goods and services." and "strongly opposes" it. Further, the FPSC questions the practicality of mandating the provision of CPE when the infrastructure required to use it may not be ubiquitous. It believes the market demand for more sophisticated CPE will develop simultaneously with the demand for advanced telecommunications services.

How will states fund universal service while introducing competition to the local loop?

The FPSC supports providing assistance to individuals with financial need as well as local providers that serve high-cost areas. Assistance to the latter will keep rates affordable for customers in these areas. The FPSC points out that it also filed a response to a Federal Communications Commission NOI on modifying high-cost assistance provided through the universal service fund. In those comments, the FPSC advocated allocating the funds at the federal level, but allowing the states to distribute them to the high-cost providers. This system, according to the FPSC, could be competitively neutral by allowing the states to distribute funds to any local provider, not just the incumbent local exchange carrier (LEC). The FPSC also claims such a system would be "administratively simpler and less costly than end user vouchers or credits,"although it never substantiates this assertion.

Finally, the FPSC states that is opposed the use of proxies. Proxies are determined by examining a sample of actual costs from areas of varied population densities and terrains around a state. From this sample, a proxy factor is developed and applied to areas of the state where actual costs cannot been used. Rather, the FPSC supports the use of actual costs (with limits on executive and administrative expenses) as a reasonable basis for determining eligibility for high cost assistance.

C. Comments by the State of New York

The New York Department of Public Service (NYDPS) submitted comments to the NOI as it was working on its own proceeding to develop a regulatory framework to transition from a monopoly environment to a competitive one. The NYDPS has a stated commitment to continue providing "high quality, affordable access" to give citizens the opportunity to benefit from "an advanced telecommunications infrastructure and a competitive marketplace." It believes universal service should be defined using established principles, but that these principles should also guide policy concerning service availability, affordability, accessibility, and, very importantly, future funding mechanisms. The NYDPS says that it has specifically sought to "target the subsidy more efficiently and provide fair ways to assess universal service charges."

What is the impact of competition on universal service goals?

The NYDPS believes that competition and universal service can coexist and says the New York Public Service Commission (NYPSC) has supported for the past 20 years policies that "encourage economic efficiency and foster open, competitive markets, consistent with universal service objectives." For example, New York was the first state to mandate that competitive local service providers be given direct central office connections to provide service.

It points to Rochester Telephone's "Open Market" plan as proof that universal service objectives can be satisfied while introducing local competition. That plan ensures that rates will not increase for any reason through December 31, 2001. It also made touch-tone part of basic service on January 1, 1995. Since rates will not be raised, even due to inflation, over the next seven years, the result will be a decline in basic service prices in real terms. Also, the plan shifts the risk of local competition to Rochester Telephone's shareholders from "captive ratepayers." Compensation for the company is provided by way of maximum earnings flexibility, which will also encourage Rochester Telephone to modernize its network and operate efficiently. The NYDPS claims ratepayers will benefit from increased competition by paying lower rates, and gaining expanded choices and improved customer service -- all outcomes consistent with universal service objectives.

Should universal service be redefined to reflect advances in telecommunications technology?

The NYDPS agrees with the NTIA's assertion that some set of principles must be established to assist in redefining universal service. In September 1994, the NYDPS released the following set of proposed universal service principles: (1) the list of basic services should be evaluated and revised as necessary to meet evolving needs; (2) basic services should be available to all who wish to use them; (3) basic services should be reasonably priced; (4) basic services should be accessible; and (5) funding mechanisms to achieve universal service objectives should be fair and equitable. Additionally, it proposed six criteria for defining basic service: (1) customer need/demand for the service or capability; (2) public benefit associated with the service or capability; (3) whether there is an underlying capability required for customers to access other services; (4) level of subscription to the service or capability; (5) costs to include the service or capability in the list of basic services; and (6) whether the service/capability will be generally available and affordable without government action.

Based on its six criteria, the NYDPS proposed eight elements -- voice grade access line, tone dialing, access to local and toll calling, access to emergency services (e.g., 911/E911), access to assistance service (e.g., operator, directory assistance), statewide relay services, directory listing, privacy protections (e.g., call blocking-restrict options) -- that would compose the list of basic services for today's marketplace. Finally, the NYDPS suggests that the goals of availability, accessibility, and affordability will not necessarily be best met through regulation, but through competition. However, to the extent the conditions may not be met in a competitive marketplace, the principles would establish a regulatory mandate.

How will states fund universal service while introducing competition to the local loop?

The NYDPS doubts that current methods of funding universal service in a monopoly environment can survive the transition to a competitive environment. Intercompany and intracompany subsidies will simply not remain viable as competition develops. Until full competition is reached, the NYPSC has implemented an interim rate structure that will be applied to competitive interconnection. This structure is aimed at ensuring that potential competitors pay their share to support universal service objectives in the transition to competition. Once full competition is achieved, this rate structure will be phased out and a new funding scheme will be developed and implemented. This new scheme must be equitable to ratepayers, the incumbent local exchange carriers and new entrants." Additionally, "[i]t must ensure that no one segment of the telecommunications industry bears a disproportionate share of the funding responsibilities.

The NYPSC has also addressed concerns about some new entrant proposals that target only profitable customers, a practice called "cream skimming." Such practices would leave New York Telephone and other independent providers now acting as the carrier of last resort to bear all of the universal service obligations while being denied the traditional sources of universal service funds. To prevent such occurrences in New York, in June 1994, the NYPSC decided that any provider agreeing to assume universal service obligations will not be required to "pay contributory access rates and universal service element charges for all interconnections with incumbent LECs."

Finally, the NYDPS believes that the states should have the most control over universal service issues, such as the authority to institute and manage assistance programs for low income customers and high-cost areas. The NYDPS also believes that federal policies should be funded by interstate providers while leaving intrastate funding to the states.

D. Comments by the State of Iowa

The Iowa Utilities Board (IUB) is primarily interested in the effects of competition on rural areas, currently the most underserved populations in the country. It is also concerned with the possible exclusion of such rural, low-volume areas from investment by service providers and how funding mechanisms will continue to support these areas in a competitive environment.

What is the impact of competition on universal service goals?

Generally, the IUB believes competition will have the beneficial effects of increasing the number and type of telecommunications services available. The IUB believes regulation will be needed to prevent dominant service providers from impeding competition during the transition to deregulation. Further, regulatory mandates are the only way to ensure that investment in "non-competitive low volume areas will be made at the same pace as in high volume urban areas" -- to minimize the likelihood of electronic redlining. The IUB believes that universally available basic services must continue to expand to meet customer needs. Such improvements will only be made with continued oversight.

Concerning the possible effects of competition on the achievement of universal service goals in rural areas, the IUB states that "we should not make the assumption that all rural areas will not be competitive. Many rural areas have the potential of being competitive if they are given the same benefits of advanced services as in urban areas." Accordingly, new regulations governing universal service must be crafted so competition is not deterred. Keeping rates low by providing assistance to a monopoly provider will inhibit competition, but providing support directly to end users would place all competitors on a "level playing field." The IUB believes states must have the power to ensure that high quality service is provided in less competitive markets less attractive for investment.

The NTIA asks in its NOI whether the demand for advanced telecommunications services will be sufficient in rural areas to create a competitive market in those areas. The IUB supports the premise that demand for services should be the primary driver of deployment, but that "individuals living in rural areas may have a greater need for services provided by the superhighway than those living in urban areas with local sources of information not usually found in rural areas. However, because low population density delays the introduction of services in rural areas, there should be a regulatory policy in place that will encourage deployment at affordable rates." The IUB suggests that deployment to places such as schools and libraries in both rural and urban areas will create demand.

Should universal service be redefined to reflect advances in telecommunications technology?

According to the IUB, the definition of universal services should evolve according to the demands of a free marketplace. Basic services should be redefined only when "a majority of customers have a given service available or when a given service becomes an integral part of the way people carry on their day to day business." Such a process would not make a distinction between urban and rural or high and low density areas. However, to be successful, a combination of both government regulation and market demand should be used to define the basic services to be included in the definition of universal service. "Government should set a minimal definition," upgrading it as necessary, while the marketplace should be the "primary determinant for the change in the definition."

How will states fund universal service while introducing competition to the local loop?

The IUB offers fairly extensive comments about appropriate funding mechanisms for the future of universal service. As it stated earlier, the IUB supports the implementation of competitively neutral generation and disbursement of universal service funds. The basis on which contributions are made must be from readily accessible and verifiable criteria for both federal and individual state levels. Finally, the IUB believes that all "telecommunications service providers should share equitably in the responsibility for maintaining universal service. Federal support mechanisms should be primarily funded by interstate providers for interstate support. The IUB says that each state must retain its ability to develop intrastate support mechanisms to support the concept of universal service." Concerning the use of proxies, the IUB believes their use would be "preferable to the current procedure" of using actual costs.

Funding should support both companies and customers. According to the IUB, in contrast to current support methods, the major emphasis should be on support to customers; "however in extremely high cost areas, support should be to both customers and companies. In situations where a given area is served by a carrier of last resort (COLR), or where rates would be so high that they would deter economic development, universal support to the company would be appropriate.

Finally, in response to NTIA's request for comments on the appropriate roles of federal and state government and the private sector in defining and funding universal service, the IUB believes that federal universal service policies should set a minimum definition to ensure that all citizens have access to those basic telecommunications services that are generally available to most citizens around the country." However, the IUB believes that the states should be allowed to define universal service beyond the minimum federal definition and develop their own funding mechanisms.

III. The State of California's Rulemaking on Universal Service

California began its current examination of the effect of competition on universal service in January 1995, one month after the NTIA NOI comment period had ended. However, it's rulemaking procedure has been very thorough and deserves discussion here. Since the proposed rules were not issued in response to the NTIA NOI, the document does not directly address the question of the impact of competition on universal service. The California Public Utility Commission (CPUC) does, however, ask for comment on the potential for electronic redlining, saying it seeks to eliminate, as much as possible, the development of "information poor" communities. Specifically, the rulemaking asked: (1) Will an explicit prohibition against redlining be effective? (2) What economic or market factors should be considered to determine whether lack of service availability is due to redlining or some other cause? (3) If redlining is detected, what should be the consequences?

Should universal service be redefined to reflect advances in telecommunications technology?

The CPUC proposes that the universal service definition, as a baseline for future modification, include access to single party local exchange service, access to interexchange carriers, and the ability to place and receive calls. It plans to establish a review procedure for expanding this definition in the future and to implement its proposed criteria for evaluating when a service should be added. After considering the advantages and disadvantages of both a periodic review and a "triggered" review (a trigger could be a certain service penetration rate), the CPUC decided a periodic, formal review of the definition of the basic service package every three years would most benefit the state.

The CPUC's proposed criteria for evaluating the definition of universal service are based on the premise that a service should be defined as basic if a substantial majority of residential subscribers use the service and access to the service is determined to be essential for participation in society. For the purpose of determining whether a service should be included as part of basic service, the CPUC decided that a minimum of 65% of residential customers must subscribe to the service. The CPUC chose the 65% figure because it indicates that the service has gained wide acceptance among consumers. The CPUC advocates assessing both the quantitative and qualitative benefits of adding a service to the basic service package. In all cases, the benefits must clearly outweigh the costs.

How will states fund universal service while introducing competition to the local loop?

There are currently two mechanisms for funding universal service in California. The first program is the California High Cost Fund (CHCF) which allows high cost companies -- small and medium size LECs -- to recover the costs associated with providing service in areas that produce low revenues. This fund ensures that both residential and business customers in these areas have access to telephone services at reasonable prices by keeping those rates priced below the actual cost of providing service. Rates are averaged between high and low cost areas, and profitable and less profitable areas. The two major LECs, Pacific Bell and GTE California, do not receive funds from the CHCF. Instead, they are allowed to engage in internal cross-subsidization -- the subsidization of less profitable business areas with the more profitable ones.

The second method of funding is the Universal Lifeline Telephone Service (ULTS) program created in 1983 to assure that low income households have access to telephone services at a fixed and affordable price. These customers receive basic exchange services at significantly reduced prices.

The CPUC asked for input as to whether the two funding mechanisms could be combined in the future. The majority of respondents stated that the mechanisms will be easier to implement and maintain if they remain separate.

In addition to the CHCF, high-cost areas will be ensured service through the designation of a COLR -- carrier of last resort. Currently, the LEC is the de facto COLR as the monopoly provider. However, how will this responsibility be assigned when there is more than one carrier? Two methods are available: the voucher method and the auction method. The CPUC plans to institute a combination of the two.

The CHCF will be replaced with a "high cost voucher fund" which will be available for use by any carrier willing to offer COLR service (there may be more than one). The CPUC will implement an auction system as a backup method in case no carrier is willing to accept the COLR obligation. This will guarantee that all geographic areas will be provided telephone service.

The voucher system essentially pays the difference between the actual cost of service and the rate considered affordable by the CPUC for customers. California will implement a "virtual voucher" system, wherein after a customer selects a provider, that carrier would collect a subsidy from the fund on behalf that customer and apply it to his or her monthly bill. The transaction would be transparent to the customer. The auction system will ensure that a COLR is available for every area. In an auction situation, qualified service providers will bid a fixed amount of subsidy they would require to serve a high cost area. COLR designation would be awarded for a set period of time to the provider bidding the lowest amount.

California's second fund, the ULTS, will also be changed with the introduction of local competition to allow all carriers providing basic exchange service to low income customers access its funds. The funding level for the ULTS is not expected to increase when competition begins. The CPUC proposes that the existing ULTS program remains in place as competition is introduced. However, it may be necessary to reconsider this decision in the future.

The CPUC plans to replace the ULTS with a virtual voucher system similar to that proposed for replacing the CHCF. Under the virtual voucher approach, the ULTS customer only needs to choose a provider of local exchange service. The local exchange provider may not charge a ULTS customer any more than the statewide ULTS rate as determined by the CPUC.

The CPUC requested comments on its proposed rules and invited all California residents to attend hearings on the matter during the months of September and October 1995. It is also preparing to release two follow-up reports on universal service, one dealing with funding issues and the other a status report to the state legislature.

IV. Discussion

This paper introduced three questions concerning the future of universal service. As we have seen from the comments provided by the states sampled, there is diverse opinion about this future. The remainder of this paper will discuss the information presented by the states and suggest direction for implementation and future study.

A. What is the impact of competition on universal service goals?

The advent of competition in the local loop will have a significant impact on universal service. Both positive and negative effects can be expected. For the most part, the states examined in this paper agree that competition will be largely beneficial to the continued provision and expansion of universal service. Competition generally results in lower prices for consumers and leads to the introduction of a wider variety of services. Conversely, however, practices such as electronic redlining must be discouraged -- with regulation if necessary.

Some organizations promote the idea that the marketplace should drive the competitive market with limited or no intervention by government. Large corporations, however, left alone with only competition to regulate them, are not likely to satisfy the public interest. To be fair, of course, companies are not in business for this purpose. They are in business to maximize profits. The key is to demonstrate to these firms how serving the public interest will also be in their own interest. For example, electronic redlining, while potentially profitable in the short term, should be discouraged not only on legal and ethical grounds, but because it will also hurt service providers in the future by limiting their pool of potential customers. A segment of the population never exposed to a technology is not likely to buy enhanced services based on that technology.

B. Should universal service be redefined to reflect advances in telecommunications technology?

The answer to this question is yes, but carefully and more slowly than most advocates would probably like to see. California suggested that states should use their current definition of basic service as a baseline to be reviewed periodically. States should also define a set of criteria on which to base that review. Also, services should reach some predetermined level of penetration before they are considered for inclusion on the basic service list -- the 65 percent recommended by the CPUC seems to be a workable figure. Community technology centers and community-based networks, i.e., "FreeNets," have a central role in promoting increased penetration. Again, corporations need to be shown how their support of these centers and FreeNets will lead to greater demand for their services, and therefore, greater profits.

We also need to remember that telephone service has long been considered a utility -- a necessity -- rather than a luxury. Telephone service is too important for the public good for the government to remove regulation in favor of pure competition. As Texas stated, one way to address this issue is to bifurcate universal service into basic and advanced services. While it is not advisable to define advanced services as luxuries not subject to public interest regulation, we probably do not need to provide these advanced services in every home as we seek to do with basic services. Again, community technology centers and FreeNets have a role in making bifurcation a success, not a means of denying service to the disadvantaged.

As mentioned earlier, one reason to support competition is that it will drive prices downward toward actual costs, reducing the amount of money needed to subsidize high-cost areas and low income customers. The money saved by the government could then, in turn, be invested in the community technology centers and FreeNets, further increasing citizens' exposure to advanced technologies and continuing to drive up demand. As Florida suggested, this will lower costs to make those services more affordable. Or, as California pointed out, the centers could aid in putting a service on the "basic" list more quickly by boosting penetration rates.

The states agree that a mandate for service providers also to furnish CPE is impractical at this time. Such a mandate could hinder the deployment of advanced services altogether because of the cost involved with CPE. Obviously, this is not a desirable effect. Community centers of technology cannot be the final answer to providing advanced services to those customers unable to afford their own CPE (usually a computer when we speak of advanced services), however, these centers will be a good interim measure. This issue will require continued examination.

Another way of looking at the current debate is through analogy. Telephone service has long been accepted as a necessity in much the same way as electricity. Would we trust competition alone to provide consumers with electricity? Hopefully not. Competition will not change the status of telephone service -- it will only mean rethinking how society guarantees it.

C. How will states fund universal service while introducing competition to the local loop?

Although the first two issues raise difficult ethical questions, the funding issue is the most complex. California's plan for combining virtual vouchers with auctions appears to be the simplest implementation of a new funding mechanism. The means of distributing the funds is only part of the equation and assessing the states plans actually raises more questions than it answers.

New mechanisms for collecting funds must ensure that no one segment of the telecommunications industry bears a disproportionate share of the funding responsibilities. New York expressed a specific concern about the practice of cream skimming. Such a practice is counter to that goals of both competition and universal service. It leaves incumbent providers now acting as the COLR to bear all of the universal service obligations (i.e., providing service to less profitable areas) while being denied the traditional sources of universal service funds (i.e., providing service to more profitable areas). Iowa also stated its support of competitively neutral collection mechanisms.

Concerning fund disbursement, Texas supports the implementation of a mechanism that would target subsidies to the narrowest practical level and make those subsidies competitively neutral. Texas, Florida, and New York all explicitly state their support for a two-tiered system that would allocate funds at the federal level but disburse them at the state level.

Several other issues connected to funding also need to be resolved. For example, how will the costs to serve particular areas of the state be determined? How will the state determine which areas are "high cost" and will be subsidized? How will the COLR be selected and what criteria will be used to assess which carriers should be eligible to act as the COLR? Finally, how will subsidies be collected? These are issues for future examination.

V. Final Comments

Will the introduction of competition change universal service regulation as we now know it? Yes. As discussed earlier, funding mechanisms that work well in a monopoly environment cannot function in a competitive environment. Will the introduction of competition eliminate the need for universal service regulation altogether? Absolutely not. Companies left to compete without appropriate guidelines will treat universal service as a secondary effect rather than a primary goal.

Further, there is little doubt that telecommunications services in general are becoming more widely used. This proliferation requires that we look at new ways of defining basic services. The key is to differentiate between necessities and amenities. Whereas the government has made it a goal to provide a telephone in every home that wishes to have one, how will it determine the type and level of penetration appropriate for advanced telecommunications services? Again, an analogy comparing telecommunications services to transportation is useful to a discussion of advanced universal service goals.

Most people agree that having access to some form of transportation is required to fully participate in society. The discussion arises when defining what level of access should be guaranteed to all citizens. For example, people with sufficient money can purchase their own automobiles, whether it be a high-performance or a more practical vehicle. Either way, these people will have access to their own automobile.

Those unable to afford their own car must rely on various levels of public transportation. Buses are usually the cheapest, but also the least convenient. A metro or subway system is usually a little more expensive but often provides a more efficient level of service. Finally, there are taxis, private businesses that offer the highest level of convenience, but are also the most expensive. Taxis also free individuals from the responsibilities of automobile ownership, e.g., maintenance.

What does all this have to do with providing advanced telecommunications services? Everything. The Internet and other technologies are often referred to as the "electronic superhighway." Services, such as electronic mail or the World Wide Web, can be considered our vehicles for this highway. Whereas providing access to advanced services in every home would be like providing everyone their own automobile, establishing community technology centers or a FreeNet would be like establishing a mass transit system. There will also be room for private enterprises like taxis -- they might cost more than publicly-funded services, but the service will be more individualized and convenient.

Private involvement will be critical to the success of universal service in the future. Taking the transportation analogy one more step, consider services provided by many grocery stores to the elderly or disabled. These stores often will send a taxi to pick someone up and drop him off so he can do his shopping. Also, there are privately funded organizations that pay for such services. Similar initiatives will be developed by individuals and organizations to provide access to advanced telecommunications services as the importance of the Internet as a means of societal participation becomes more widely accepted.

Some states, such as Florida, Texas, and Tennessee, have recently passed laws requiring service providers to assist schools, libraries, and hospitals in connecting to advanced services. For example, in Florida, carriers are required to provide up to $20,000 in "infrastructure" to eligible schools, libraries and hospitals. In Texas there is a requirement for toll-free access to the Internet; fiber network links to schools, libraries and hospitals; and discounted service rates for public institutions. Additionally, service providers are required to contribute to a fund established to develop distance learning applications. In Tennessee, an economic development fund supported by service provider contributions has been established to support small businesses.

Laws such as those just mentioned are the next logical step in expanding access to advanced telecommunications services. They provide further support to initiatives already in place and will significantly increase demand. As discussed earlier, it will not be effective to simply mandate deployment of these services -- the public must want and need them.