Program enriches cell phone companies operating in rural areas

WASHINGTON -- A decade-old telephone tax intended to help bring affordable service to rural areas has instead turned into something quite different: a bottomless and politically protected well of cash for cell phone companies that do big business in rural America.

Over the past four years, there has been nearly a tenfold increase in government-ordered subsidies paid to a few "competitive" providers -- cellular phone companies paid by the fund to offer service in rural areas where an existing carrier already receives a subsidy.

The Universal Service Fund has collected $44 billion over its 10-year lifetime from a surcharge on the phone bills of nearly every American.

Regulators and lawmakers have long viewed the fund as inherently flawed. Even a member of the federal-state board that runs the program calls it "bizarre." But efforts to change it have been derailed repeatedly by companies that benefit from the largesse and by supporters in Congress who represent sparsely populated states.

Now there are new calls for change, driven by the dramatic increase in money flowing to the cellular companies competing for rural business. Payments have gone from $131 million in 2003 to an expected $1.1 billion this year, according to an Associated Press analysis.

Increased demands by these carriers recently pushed the fee paid by telephone customers to the highest level in program history. The Federal Communications Commission will decide soon whether to cap payments while it considers options for long-term changes -- again.

The subsidy's roots

The Universal Service Fund was created by Congress in 1996 as part of an overhaul of the nation's communications laws designed to create competition.

Specifically, Congress ordered that consumers -- including those in "rural, insular and high-cost areas" -- have access to telecommunications and information services at rates comparable to those charged in urban areas. That was to be financed by a fee added to long-distance bills. The charge may only be a few dollars per month, but it adds up fast.

In 2006, the fund collected $6.6 billion, money that flows to four programs. About $1.7 billion paid for schools and libraries to connect to the Internet; two smaller funds subsidized telephone service for the poor and rural health-care facilities.

The largest chunk -- about $4.1 billion last year -- flows to the aptly named "high cost" program, the source of the current controversy. That money is paid directly to telephone companies that do business in mostly rural areas where the cost of delivering service is high.

In the early years of the fund, subsidies went almost exclusively to old-fashioned wired phone companies -- large and small -- that had served rural areas for decades. To spur competition, Congress wanted to make subsidies available to other companies.

Initially, the lure of a handout wasn't enough to attract new entrants. But the dramatic growth of the cellular telephone industry changed all that.

Wireless providers discovered that the subsidy -- based on what the wired companies were getting per customer -- would cover their costs and then some.

"No losers support system"

Critics say the cellular companies are enjoying a windfall because their networks are much cheaper to build and maintain than miles of wires and telephone poles. They say logic dictates the subsidy should be based on actual cost.

Making the system more expensive, companies are compensated on a per-subscriber basis. Each time a cell phone company signs up a new customer, it collects a subsidy.

If the customer keeps his land line, the fund pays a subsidy to both carriers. If the customer opts to drop his land line and keep his cellular phone (the goal of competition), the per-subscriber subsidy for the land line carrier actually goes up, keeping the overall subsidy unchanged. In some high-cost areas, the subsidy can amount to several hundred dollars per customer per month.

Since the cellular competitor's rates are based on the incumbent's per-customer subsidy, the cell company gets more money, too. And so does every other cellular competitor that does business in the area. In some places there are two, three or more.

"This is the essential irrationality of the system, says Billy Jack Gregg, a consumer advocate and member of the federal-state board that helps set fund policy. "It makes no sense to subsidize multiple carriers in a high-cost area."

Gregg has testified to Congress that the "bizarre" program amounts to a "no-losers support system" in which participants are paid "for all lines they serve in high-cost areas, no matter how duplicative or costly this additional support may be."

Mississippi tops the list

Mississippi's competitive cellular carriers received more than $314 million from 2003 through the first four months of 2007, the most of any state, according to an AP analysis of more than 20,000 disbursement records.

Second was Puerto Rico, at $236 million, Kansas third at $139 million. At the bottom of the list, receiving no funding for competitive carriers, were South Carolina, Rhode Island, Ohio, Massachusetts, Idaho and Delaware.

The most highly compensated company, according to AP's analysis, was Little Rock, Ark.-based Alltel Communications Corp. Alltel collected at least $386 million over the study period for wireless services. Second was Western Wireless Corp., bought by Alltel in 2005, with $274 million.

Those two companies, combined with Midwest Wireless, also bought by Alltel, account for 30 percent of all funds paid to competitive carriers over the study period.

Of the $2.45 billion that has been paid to competitive carriers from 2003 through April 2007, 75 percent of the cash went to 10 companies, according to AP's analysis.

Alltel, which recently announced the sale of the company, reported a $230 million profit in the first three months of 2007, a total boosted by the $65 million to $70 million in universal service funds the company says it receives each quarter.

"We are the largest wireless recipient of [universal service funding] because we are the largest rural carrier," company spokesman Andrew Moreau told the AP in an e-mailed response to questions.

Next on the list of recipients is AT&T Inc. with $239 million, followed by U.S. Cellular Corp. at $212 million and Mississippi's Cellular South Inc. with $156 million.

Problems are no surprise

The system's potential flaws have been well documented since it was created.

The federal-state board recommended in 1996 that the subsidy be limited to a single connection per household, but the FCC at first disagreed.

By November 2002, however, the agency took notice of the growing problem and asked the joint board how to fix it. The board again recommended, in February 2004, a one-line-per-household solution. But before the FCC could act, a handful of senators from rural states used their budget power to block implementation.

A trade group that represents rural carriers singled out Sens. Byron Dorgan, D-N.D.; Conrad Burns, R-Mont., and Ted Stevens, R-Alaska (representing the 48th, 44th and 47th most-populous states, according to the Census Bureau) for playing instrumental roles in blocking the provision.

The maneuver occurred during a House-Senate conference committee hearing on Nov. 22, 2004. The same scenario played out a year later, with rural telephone company trade groups again singling out Dorgan and Stevens for their "extraordinary efforts" to block the FCC from enacting the changes.

Dorgan has received $15,000 from Western Wireless Corp.'s political action committee (now part of Alltel) making him the former rural cellular company's favorite senator at the time. The senator's leadership PAC picked up an additional $8,000.

Dorgan and Stevens say they oppose the primary line restriction because it would put rural businesses at a competitive disadvantage to their urban counterparts.

The core challenge for Congress is the law itself, which is vague regarding what specific services should be subsidized.

"What is it we're willing to pay for?" Dorgan asks. "That's why there needs to be some sort of resolution for what is the Universal Service Fund and what it should cover going forward."

Big contributions from a small company

In Mississippi, the top recipient of cash among cellular providers is Cellular South Inc., a 900-employee private company, whose executives have been prolific in their giving. Officers of the company and its corporate parent have dealt at least $142,550 in contributions to federal campaign committees, according to records.

Favorites include Mississippi Republican Rep. Charles E. "Chip" Pickering and Sen. Trent Lott. Pickering is a former member of Lott's staff and helped shape the 1996 telecommunications law, according to his congressional biography.

The company's executives also gave heavily to the successful gubernatorial campaign of Republican Haley Barbour in 2003. Barbour is a former lobbyist who worked on behalf of BellSouth Corp. (now part of AT&T) and the U.S. Telecom Association.

Sherry P. Stegall, senior vice president at Cellular South, noted in an e-mail to AP that the company's political activity "pales in comparison to larger carriers." She said Cellular South has received no windfall.

The company is required to "reinvest all support" from the fund and file quarterly reports with regulators. For every dollar the company receives from the fund, it has invested $1.20 in developing its networks, she said.

With the contribution percentage from consumers having recently reached an all-time high and costs continuing to spiral, the sustainability of the fund is in doubt, and pressure is on the FCC and Congress.

The FCC is considering a recommendation by the federal-state board to cap funds paid to competitive carriers. There is considerable opposition among members of Congress, including Stevens and Pickering, and rural wireless carriers.

"It would be a Band-Aid or stopgap that would prevent us from getting to the comprehensive reform," Pickering said in an interview. He supports funding for wireless carriers because, he says, they are the most efficient providers when it comes to serving rural areas.

The joint board is considering long-term change. But with so many vested interests involved, progress has been difficult. "They tend to checkmate each other," board member Gregg said. He likens the fund to "a machine that somebody's created but nobody can find the 'off' switch to."

AT&T, even though it collects huge subsidies for both its wired and wireless operations, supports a temporary cap and the creation of pilot programs to fund cellular and broadband services.

FCC chairman Kevin Martin, a persistent critic of the universal service system, says the challenge is to keep everyone connected and move toward offering more advanced services like broadband. "But we've got to do that in an efficient way," he says.

Martin has been pushing a "reverse auction" approach that he says would accomplish that. Potential providers would bid against one another to offer a set of services, with the low bidder winning the subsidy. An auction would end the inefficient practice of subsidizing multiple carriers in a single rural area, he argues.

Alltel has indicated it would support a reverse-auction trial. The company would also support a separate fund for wireless services. Verizon Communications Inc. is a major proponent of the concept.

But Martin acknowledged the idea hasn't yet caught on among lawmakers. "I'm always optimistic," he said.