The 'state' of universal service

The introduction of competition forces regulators to address the historical practice of using of implicit cross subsidies to maintain uniformly low lo cal telephone service rates. The Federal Communications Commission recently adopted rules to remove a portion of these implicit subsidies by adopting an explicit universal service program. This program, however, only addresse s a small portion of the problem and leaves to the states problems associat ed with intrastate cross subsidies. In this paper we examine several altern ative universal service programs that states may adopt. Overall, we find th at universal service programs that base subsidy dollars on the cost of prov iding service have little effect on telephone penetration rates acid result in large taxes, which distort market outcomes and drive those paying into the system from the network. Large universal service programs also cause co mpetitive distortions. Furthermore, we find that cost-based mechanisms do a n equally poor job when we use normative criteria, such as the effect the p rograms have on the distribution of income. (C) 2000 Elsevier Science B.V. All rights reserved.