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 local 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 addresses a small portion of the problem and leaves to the states problems associated with intrastate cross subsidies. In this paper we examine several alternative universal service programs that states may adopt. Overall, we find that universal service programs that base subsidy dollars on the cost of providing service have little effect on telephone penetration rates and result in large taxes, which distort market outcomes and drive those paying into the system from the network. Large universal service programs also cause competitive distortions. Furthermore, we find that cost-based mechanisms do an equally poor job when we use normative criteria, such as the effect the programs have on the distribution of income.