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The ABC's of Universal Service: Arbitrage, Big Bucks and Competition

Apr 1999
Working Paper
98-004
By  Bradley Wimmer, Gregory Rosston
The introduction of competition requires a re-thinking of policies. Current proposals for a new universal service, however, contain many problems that create artificial incentives that will cause firms to waste money and do not necessarily reward firms that best serve customers. The problems are inherent in the methods to collect taxes to fund the universal service programs and the manner in which universal service funds will be disbursed. The majority of these problems stem from attempts to create artificial regulatory and jurisdictional distinctions and will only disappear when regulators and politicians realize the efficiency and consumers are better served in a competitive environment by an economically rational system of transparent subsidies rather than the web of implicit cross subsidies. In this paper, we examine the sources for these inefficient distortions and propose changes to the current and proposed programs that will better achieve a goal of universal service with a minimum of distortion in the marketplace. Distortions arise from arbitrary categorizations of services. For example, services are labeled "interstate" or "intrastate." Because each jurisdiction imposes its own taxes, firms have an incentive to reconfigure their service offerings simply to minimize taxation. Both tax rates and distribution mechanisms create incentives for wasteful arbitrage. There are two ways to cure the problem: to prevent arbitrage through regulation or to reduce the incentive for arbitrage by minimizing the level of taxes. We argue that the second solution will be much better for communications competition and universal service.