CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

JUNE 2006

Factors That May 

Increase Future 

Spending from the 

Universal

Service Fund

CBO

© Bill Horn/Acclaim Images
Pub. No. 2695
The Congress of the United States O Congressional Budget Office

CBO

Factors That May Increase Future 

Spending from the Universal Service Fund

June 2006

A

PAPER
Notes

Unless otherwise indicated, the years referred to in this report are calendar years. 

Numbers in the text and tables may not add up to totals because of rounding.
Preface

To encourage greater access to telephone and other telecommunications services, the Universal Service Fund (USF) provides financial support to some producers and consumers of 

those services. Spending for USF programs rose by 50 percent between fiscal years 2000 and 

2005. Much of that increase went to support companies that offer telephone service in rural 

locations and other areas where the cost of providing such service is higher than the national 

average. 

This Congressional Budget Office (CBO) paper—prepared at the request of the Senate Budget Committee—examines recent trends in spending by the USF’s High-Cost Program, which 

subsidizes telecommunications providers in high-cost areas. The paper examines factors that 

may increase such spending in the future and discusses options to restrict the growth of outlays. In keeping with CBO’s mandate to provide objective, impartial analysis, this report 

makes no recommendations.

Philip Webre of CBO’s Microeconomic Studies Division wrote the paper under the supervision of Joseph Kile and David Moore. Douglas Hamilton, Melissa Petersen, Sarah Puro, and 

Dennis Zimmerman of CBO offered helpful suggestions, as did Billy Jack Gregg of the Consumer Advocate Division of the West Virginia Public Service Commission; John Nakahata of 

Harris, Wiltshire, and Grannis, LLP; Greg Rosston of Stanford University; and others. (The 

assistance of external reviewers implies no responsibility for the final product, which rests 

solely with CBO.)

Christian Howlett edited the manuscript; Loretta Lettner and John Skeen proofread it. Angela 

Z. McCollough prepared tables and drafts of the paper. Maureen Costantino designed the 

cover and prepared the paper for publication. Lenny Skutnik produced the printed copies, 

and Simone Thomas prepared the electronic version for CBO’s Web site (www.cbo.gov).

Donald B. Marron

Acting Director

June 2006

Contents

Summary vii

1 Introduction 1

The Structure and Operations of the Universal Service Fund 1

The Universal Service Fund and the Federal Budget 2

Potential Sources of Future Spending Increases for the USF 3

Paying for Spending Increases 4

2 The Structure and Operations of the USF’s High-Cost Program 5

The Structure of High-Cost Support 5

Types of Carriers and Eligibility for Funding 8

3 Policies for Supporting New Competitive Entrants 11

The Structure of Funding for Incumbents and Their Competitors 11

Recent Growth in the Number and Funding of Competitive Carriers 12

The Potential for Future Growth 12

Policy Options That Could Limit the Growth of USF 

Spending for New Entrants 14

4 Policies for Restructuring Intercarrier Compensation 17

The Current State of Intercarrier Compensation 17

Effects of Changing Intercarrier Compensation 19

5 Policies for Funding Broadband Internet Access 23

The Prevalence of Broadband Connections and 

Prospects for Growth 23

Funding for Rural Broadband Under Current Policy 25

Broadband Proposals and the USF Budget 27
VI FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Tables

S-1. Receipts and Outlays for Universal Service Fund Programs, 2000 to 2005 ix

S-2. Additional Spending for the High-Cost Program in 2011 from Various Sources x

1-1. Receipts and Outlays for Universal Service Fund Programs, 2000 to 2005 3

2-1. Disbursements for the High-Cost Program, by Mechanism, 1998 to 2005 9

3-1. Funding for Incumbent Carriers and Competitive Entrants Under the 

High-Cost Program, 1998 to 2005 13

3-2. Potential Increase in USF Spending from the Growth of Wireless 

Subscriptions to New Entrants 14

4-1. Intercarrier Compensation Rates 18

4-2. Sources of Revenue for Rural Incumbent Carriers 19

4-3. Incumbent Carriers’ Long-Distance Traffic and Intercarrier Compensation, 

2000 to 2004 19

4-4. Cost to the Universal Service Fund of Alternative Plans to Restructure

Intercarrier Compensation 20

5-1. Local Loop Investment by Carriers, 1999 and 2004 26

5-2. Budget for the Rural Utilities Service’s Broadband Loan Program 27

Figures

1-1. The Structure of the Universal Service Fund 2

2-1. The Structure of the Universal Service Fund’s High-Cost Program 6

5-1. Number of Residential and Small-Business Subscribers to Broadband

Internet Access, 1999 to 2005 24

5-2. Number of Broadband Providers per Zip Code Area, 1999 to 2005 25
Summary

The Universal Service Fund (USF) subsidizes certain 

producers and consumers of telecommunications services. Under its High-Cost Program, a majority of the 

USF’s spending goes to companies that provide voice 

telephone connections in areas where the cost of offering 

such service is higher than the nationwide average. That 

program aims to ensure that the prices charged to telephone customers in such high-cost areas—mainly rural 

and insular (island) locations—are comparable to prices 

charged to urban customers. Smaller USF programs subsidize telephone service for qualified low-income people 

(urban or rural) and Internet and other advanced telecommunications services for schools, public libraries, and 

rural nonprofit health care providers.

Annual outlays from and revenues to the Universal Service Fund have grown by more than 50 percent since fiscal year 2000, to around $7 billion. The main source of 

growth has been the High-Cost Program, whose spending has doubled in the past six years. Spending for that 

program could more than double again in the next few 

years, the Congressional Budget Office (CBO) estimates, 

depending on the outcome of various legislative and regulatory changes that are under discussion. If such an 

increase occurred, the fees that are levied on telephone 

companies and customers to finance the USF would, by 

law, have to rise significantly as well.

This paper focuses on factors that may increase the budgetary pressures facing the High-Cost Program in the 

future. Those factors include legislative and regulatory 

decisions about how to fund telephone providers (particularly wireless companies) that are entering rural markets 

to compete with traditional telephone providers; how to 

use the USF to compensate rural telephone companies 

for revenues lost from changes in regulated telephone 

rates; and whether to include rural broadband (highspeed) Internet access among the services subsidized by 

the USF. This paper also discusses some potential policies 

to control future increases in spending by the High-Cost 

Program.

The Universal Service Fund’s

Structure and Financing

The Universal Service Fund supports four main programs 

that are designed to help achieve the federally mandated 

goal of universal service in the United States. The HighCost Program makes payments to eligible local telephone 

companies that serve customers in remote or rural areas 

where the cost of providing service comparable to that 

available in urban areas is substantially greater than the 

national average. The Low-Income Program provides 

funding to local telephone companies that enables them 

to offer discounts to low-income consumers on the installation of standard residential telephone service or assistance with monthly service charges. The Schools and 

Libraries Program reimburses providers for giving discounts to schools and libraries for the purchase and 

installation of advanced telecommunications services, 

such as high-speed Internet access. The Rural Health 

Care Program serves the same function for nonprofit 

health care providers in rural areas.

The USF operates by collecting mandatory payments 

from all providers of interstate and international telecommunications services in order to subsidize local services 

and providers. Those payments are based on a percentage 

of the revenue that telecommunications companies derive 

from providing interstate and international services (subject to certain adjustments).1

 Companies may recover all 

or part of their payments to the USF by passing the cost 

on to their customers.

1. For more information, see Congressional Budget Office, Financing Universal Telephone Service (March 2005).
VIII FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Summary Table 1.

Receipts and Outlays for Universal Service Fund Programs, 2000 to 2005

(By fiscal year, in billions of dollars) 

Source: Congressional Budget Office based on data from the Federal Communications Commission.

Notes: * = less than $50 million. 

The numbers shown here are for receipts and outlays of the Universal Service Administrative Company, which administers Universal 

Service Fund (USF) programs. Actual USF program commitments differ from these figures. 

Under the USF, fees paid by some telecommunications 

service providers and their customers are directed to other 

providers so that certain groups of people can connect to 

telephone networks at lower prices than they would otherwise face. Because those transfers are required by law, 

payments into and out of the USF are counted as revenues and outlays in the federal budget. However, USF 

fees are adjusted regularly to match expected spending, so 

the fund is basically budget-neutral. (In practice, the USF 

runs a small surplus because of the lag between commitments to projects and payments for them.)

The benefits provided by the USF’s programs impose a 

cost on the economy, regardless of how those programs 

are treated in the budget. Both consumers’ purchasing 

decisions and providers’ investment decisions are influenced by the way the USF collects its receipts and spends 

its resources. As is the case with any tax or fee, the effects 

of USF fees vary with their size and structure.

Current Spending and Future

Pressures on the Universal 

Service Fund

The outlays and receipts flowing through the USF have 

grown substantially in recent years. Between fiscal years 

2000 and 2005, annual outlays from the fund rose from 

$4.0 billion to $6.3 billion, while receipts grew from $4.5 

billion to $7.0 billion (see Summary Table 1).2 Outlays 

may not be the best measure of the yearly claims that universal service programs make on the telecommunications 

sector. The revenues that telecommunications companies 

(and ultimately their customers) are required to pay into 

the USF better represent those programs’ anticipated 

claims on the economy, since they take into account commitments that have been made but not yet paid for.

In the past six years, growth in spending for the HighCost Program has accounted for 83 percent of the rise in 

USF outlays, or roughly $1.9 billion of the total $2.3 billion increase. Growth in the Low-Income Program has 

accounted for another $300 million, whereas spending 

for the other support programs has not changed much.

Two main factors have caused the growth in spending for 

the High-Cost Program. Increases since 2003 represent 

additional resources being devoted to rural telecommunications, mainly to support cell phone companies that are 

new competitive entrants to rural markets. Earlier increases in spending were essentially accounting changes 

mandated by the Telecommunications Act of 1996. That 

law required telephone regulators to convert subsidies 

that had been included in the prices of long-distance and 

other services (called implicit subsidies) into payments 

from the USF (explicit subsidies). 

2000 2001 2002 2003 2004 2005

Receipts 4.5 5.2 5.4 5.7 6.4 7.0

Outlays

High-Cost Program 1.9 2.6 2.8 3.3 3.4 3.8

Low-Income Program 0.5 0.6 0.7 0.7 0.8 0.8

Schools and Libraries Program 1.6 1.7 1.6 1.6 1.5 1.7

Rural Health Care Program * * * * * * ___ ___ ___ ___ ___ ___

Total 4.0 4.9 5.1 5.6 5.7 6.3

2. Those figures are for outlays and receipts of the Universal Service 

Administrative Company (USAC), the not-for-profit agency that 

administers USF programs on behalf of the Federal Communications Commission. USF program commitments differ from those 

numbers. In addition, USAC’s fiscal year is different from the federal fiscal year in that it begins on July 1 rather than October 1.
SUMMARY IX

Possible Sources of Future Spending Growth

Disbursements for the High-Cost Program have doubled 

since 2000, from $1.9 billion to $3.8 billion. CBO estimates that such spending could continue to increase rapidly depending on legislative and regulatory decisions 

about three potential sources of budgetary pressure on the 

program:

B Further increases in the number of telephone carriers—predominantly wireless telephone companies—

eligible to receive universal service subsidies for highcost regions;

B Possible changes in the structure of the rates that telephone companies charge one another for connecting 

and transferring calls (known as intercarrier compensation); and

B Possible inclusion of broadband Internet connections 

in an expanded definition of universal service.

The first two factors could add between $1.4 billion and 

$4.0 billion to the annual outlays of the High-Cost Program by 2011, CBO estimates (see Summary Table 2). 

The lower end of that range represents an increase of 

about one-third from current spending; the higher end 

implies that spending would double. If, instead, outlays 

for the High-Cost Program continued to grow at the 

average annual rate of the 2000-2005 period, they would 

be roughly $2.2 billion higher by 2011—or in the middle 

of that range.

CBO’s 10-year baseline budget projections for the Universal Service Fund account for some of the budgetary 

pressures described above, but not others.3

 The baseline 

assumes moderate growth in funding for wireless companies entering the market in high-cost areas, on the basis 

of trends from previous years and anticipated increases. 

However, because CBO’s baseline is predicated on current law and policies, it does not account for new legislative or regulatory actions, such as a restructuring of intercarrier compensation rates and payment flows or new 

initiatives in rural broadband.

Continued Increases in the Number of Eligible Telephone Companies. Following the 1996 TelecommunicaSummary Table 2.

Additional Spending for the High-Cost 

Program in 2011 from Various 

Sources

(Billions of dollars)

Source: Congressional Budget Office.

Note: n.a. = not applicable. 

a. The numbers shown here are CBO’s extrapolations of estimates 

by the National Exchange Carrier Association.

b. Increased spending for broadband (high-speed) Internet access 

in rural areas is likely to be determined through legislative activity, which CBO has no basis for predicting.

tions Act, the Federal Communications Commission 

(FCC) made more telephone companies eligible for support under the High-Cost Program, and a growing number of companies began to apply to be designated as eligible to receive USF funds. The result is that the amount of 

funding going to new “competitive eligible telecommunications carriers” has risen dramatically. Funding for those 

carriers—usually wireless companies—accounts for about 

94 percent of the increase in spending by the High-Cost 

Program since 2003.

Both the number of carriers receiving payments under 

the High-Cost Program and the amount of funding given 

to competitive entrants have grown over the past several 

years. In 2000, just two competitive telecommunications 

carriers were eligible for high-cost support. By 2005, that 

number had risen to 263 (some carriers are counted more 

than once in that figure because of the way the data are 

tallied). 

Similarly, funding for competitive entrants has grown 

from $130 million in 2003 to an estimated $640 million 

in 2005. Typically, about 95 percent of that funding in 

any given year goes to wireless companies. By contrast, 

3. Those projections were published in Congressional Budget Office, 

The Budget and Economic Outlook: Fiscal Years 2007 to 2016

(January 2006), Tables 3-3 and 4-9.

Low End High End

of Range of Range

0.6 1.2

0.8 2.9

___ ___

Total (Excluding broadband)b 1.4 4.0

Compensation Ratesa

Restructuring of Intercarrier 

Additional Spending

Estimated Range of

Further Growth in the Number of 

High-Cost Markets

Wireless Companies Entering
X FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

funding for the first carrier in each market (the “incumbent” service provider) has been nearly constant in the 

past three years at between $3.1 billion and $3.2 billion, 

probably because of the cap currently imposed on one 

type of high-cost support for incumbents. Early projections for 2006 suggest a substantial rise in spending for 

new entrants and continued stability in spending for 

incumbents.

In the absence of policy changes, that pattern appears 

likely to continue. Less than one-third of the cellular telephone connections in rural areas currently receive USF 

subsidies. If the companies serving the unsubsidized 

connections apply for funding, subsidies for those competitive entrants may increase substantially. The main 

source of uncertainty about the extent and timing of that 

increase is how rapidly all of the potentially eligible carriers will apply for and be granted eligibility.

On the basis of data from the Bureau of Labor Statistics, 

CBO projects that rural cell phone subscribers will number about 22 million in 2011. Competitive entrants 

received subsidies on some 4.6 million rural cellular connections last year. The most likely scenarios are that the 

current level of subsidized connections could double or 

triple by 2011. If subsidy costs moved in tandem with 

subscription counts, USF spending to support competitive entrants would also double or triple, rising by between $600 million and $1.2 billion (see Summary 

Table 2).

Changes in the Structure of Intercarrier Compensation 

Rates. Regulators have often set some of the per-minute 

rates that telephone companies charge one another for 

the interconnection and transfer of long-distance and 

other calls above the cost of those activities in order to 

provide an implicit subsidy to local telephone companies 

and their customers. Such payments flow primarily from 

long-distance companies to local telephone companies. 

The level of intercarrier compensation has declined in 

recent years. One reason is that consumers are increasingly substituting e-mail and wireless long distance 

(which often bypasses the landline system) for traditional 

long-distance calling. Another reason is that regulators 

have reduced some of the rates charged for intercarrier 

compensation. 

At the same time, technological improvements in telecommunications equipment have decreased the costs that 

carriers incur in routing and connecting telephone calls. 

Because the prices that customers pay—which include 

intercarrier compensation payments—have not fallen as 

rapidly, those prices do not reflect the underlying economic costs of providing different types of service and 

thus distort consumers’ choices. For example, consumers 

may choose to make long-distance calls on a cell phone 

despite its inferior coverage or voice quality because their 

plan offers such calls at no extra cost, whereas their landline service costs them 5 cents or 10 cents per minute. 

However, the difference in actual costs to the telephone 

network between completing a long-distance call from a 

landline and completing one from a wireless telephone is 

not as great as the difference in prices charged to customers. That disparity has prompted a number of proposals 

to restructure intercarrier compensation rates.

Most of the restructuring proposals that are being discussed would reduce revenues to the smaller companies 

that often serve high-cost and insular areas. One way to 

offset those companies’ revenue losses would be to provide supplemental payments through the Universal Service Fund. In the past, when cuts in long-distance access 

rates reduced the income flowing to rural telephone companies, the USF increased its payments correspondingly. 

As in earlier instances, such a change in intercarrier 

compensation would convert regulated payments among 

carriers into regulated payments into and out of the Universal Service Fund and could alter the distribution of 

costs and subsidies among consumers.

Restructuring intercarrier compensation has substantial 

budgetary implications for USF spending. Depending on 

the proposal selected, changing the intercarrier compensation system could add between $800 million and $2.9 

billion to annual outlays for the High-Cost Program by 

2011 (see Summary Table 2). Much of that increase 

could occur under current law. The FCC has the legal 

authority to alter the interstate portion of intercarrier 

compensation. However, there is disagreement about 

whether it could adjust intercarrier compensation rates 

within a state without additional legislation.4

4. See National Association of State Utility Consumer Advocates,

Initial Comments of the National Association of State Utility Consumer Advocates Before the Federal Communications Commission in 

the Matter of Developing a Unified Intercarrier Compensation 

Regime, CC Docket No. 01-92 (May 23, 2005), pp. 40-43, available at www.nasuca.org/Intercarrier%20Compensation%20

Comments.pdf.
SUMMARY XI

In a filing to the FCC, the National Exchange Carrier 

Association (NECA) compared various proposals for restructuring intercarrier compensation to determine how 

they would split the burden among the different revenue 

sources—intercarrier compensation itself, telephone subscribers, and the Universal Service Fund. NECA’s analysis 

looked at the records of a sample of its member companies and determined how much of the $8.0 billion in 

income they received in 2003 came from subscribers’ fees, 

intercarrier compensation, and universal service subsidies. 

(Those NECA members, which are incumbent telephone 

companies, received about three-quarters of the subsidies 

paid by the High-Cost Program that year.) The association then modeled the various proposed rate changes to 

see how much they would lower revenues relative to a 

baseline estimate of the calls and minutes handled by 

NECA members.

In the three proposals that NECA modeled, the majority 

of the revenues lost from restructuring intercarrier compensation would be made up through increases in spending by the Universal Service Fund. For example, under 

the first proposal, intercarrier compensation payments 

were estimated to fall from $2.3 billion to $1.4 billion. 

To compensate, the proposal would raise subscribers’ 

rates to collect an additional $0.3 billion in revenue and 

would increase USF payments by $0.6 billion, a 25 percent rise. The increase in USF support would be much 

higher under the other two proposals that NECA examined: more than 60 percent. (The analysis was static and 

did not account for changes from the 2003 baseline in 

the number of calls and minutes of use.)

To estimate the total impact on USF spending from 

restructuring intercarrier compensation, CBO adjusted 

NECA’s estimates to account for carriers that were not in 

the sample. That extrapolation suggests that the three 

proposals analyzed by NECA would increase spending 

for the High-Cost Program in 2011 by $0.8 billion to 

$2.9 billion. (The latter figure includes $0.8 billion in 

additional USF spending from removing the cap on certain high-cost support payments to incumbent providers, 

which was part of one of the proposals.)

Inclusion of High-Speed Internet Access in Universal 

Service. The 1996 Telecommunications Act requires that 

the basket of services included in the definition of universal service—and thus eligible for USF support—be 

reviewed and updated periodically. The law assigns that 

task to the Federal-State Joint Board on Universal Service 

(composed of regulators from the FCC and the states), 

which makes recommendations to the FCC. Many analysts and interested parties have argued that broadband 

Internet access should be one of the residential services 

paid for by the High-Cost Program. (It is already subsidized by the much smaller Schools and Libraries and 

Rural Health Care Programs.)

Broadband is penetrating into rural areas at a rapid pace, 

albeit more slowly than in urban and suburban areas. 

Currently, some 920 rural telephone carriers offer broadband service under terms set forth by NECA. Only onequarter of the carriers participating in the association do 

not yet offer broadband service. Furthermore, according 

to one recent survey, rural areas are only about two years 

behind urban areas in their broadband subscription 

rates.5

Some of that rural expansion is already being supported 

by the High-Cost Program. Telephone network investments subsidized by the program often allow for both 

conventional telephone service and broadband, because 

most modern telephone equipment is capable of providing voice and data services. In addition, the Department 

of Agriculture’s Rural Utilities Service has begun making 

low-interest loans to companies that invest in broadband. 

(The Agriculture Department’s credit program for conventional telephone service has long made low-interest 

loans to carriers that invest in telephone networks capable 

of providing broadband as well as voice telephone service. 

Many of those loans were made for equipment that subsequently formed part of the cost basis for USF support.)

Including broadband in the definition of universal service 

would represent a new commitment of economic resources, as well as an increase in the amount of funds 

transferred among different groups of consumers. Those 

new resources could come directly from the USF (as was 

the case in the Schools and Libraries Program) or indirectly, through the expansion of other initiatives, such as 

the Rural Utilities Service’s program of loans and loan 

guarantees for rural broadband. Even the expansion of 

such indirect programs, however, could ultimately increase USF spending if those programs were used to 

5. John Horrigan, “Rural Broadband Internet Use” (data memo, Pew 

Internet and American Life Project, Washington, D.C., February 

2006), available at http://207.21.232.103/pdfs/PIP_Rural_ 

Broadband.pdf.
XII FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

expand the broadband-capable telephone networks of 

carriers that receive USF support.

Members of Congress have introduced various proposals 

to increase the availability of broadband in rural areas. 

One approach would be to spend a limited amount each 

year on supporting the deployment of broadband and 

distribute that funding among unserved areas through a 

competitive selection process, as is done in the Schools 

and Libraries Program. A bill before the Congress, S. 

2686, would direct the FCC to collect and spend up to 

$500 million a year in that way to encourage the spread 

of broadband service. 

Paying for Spending Increases

The possibility of future increases in USF spending raises 

the question of how such expenditures would be paid for. 

At present, the USF is financed through a percentage fee 

on the value of interstate telecommunications services, 

including long-distance revenues, a portion of cell phone 

revenues, and part of the basic subscriber charges that 

customers pay to local telephone companies. That fee is 

calculated quarterly and is generally set to keep the USF 

budget-neutral. 

Telecommunications spending is rising in the economy as 

a whole, but the revenues that are subject to universal service fees have declined since 2000. Because USF spending 

has been growing while the telecommunications base 

from which its receipts are drawn has been shrinking, the 

percentage used in calculating the fee on eligible telecommunications revenues has risen. In 2000, the quarterly fee 

rate never exceeded 6 percent; in 2005, it never fell below 

10 percent.

Further increases in spending by the USF would drive up 

the fee percentage even higher, unless either a different 

revenue mechanism was devised or the base of telecommunications services subject to the fees was broadened. 

Higher fee levels might cause consumers to shift more of 

their spending to telecommunications services that are 

not subject to USF fees—such as e-mail and instant messaging—thus reducing receipts for the fund.

Options for Curtailing the Growth of 

USF Spending

To illustrate how lawmakers or regulators might alleviate 

some sources of budgetary pressure on the Universal Service Fund, this paper examines several policy options, 

each geared toward one of the aforementioned sources of 

spending growth: 

B Under the structure of the High-Cost Program, more 

wireless carriers are likely to be designated as eligible 

to receive support payments for providing service in 

high-cost areas. Spending for that program could be 

curbed by limiting high-cost support to one connection per household, by basing support on each carrier’s 

own costs rather than on a cost standard set by the 

incumbent carrier, or both. 

B In other instances, regulatory processes can put pressure on the USF, as is the case with intercarrier compensation. Reducing the subsidies that are implicit in 

current intercarrier compensation rates would create 

pressure for higher explicit USF support. However, 

that support could be structured in such a way as to 

reduce the flow of resources from the USF.

B The legislative process can also create budgetary pressures on the USF, as would be the case if pending legislation was enacted to accelerate the deployment of 

broadband into high-cost areas. The growth of USF 

spending could be slowed by not adding special programs, such as one for broadband, to the Universal 

Service Fund but rather by keeping any such programs 

part of discretionary spending.

Limit Support to One Connection per Household or 

Base Support on Carriers’ Own Costs

Two of the most commonly discussed options for curbing 

growth in the funding for wireless entrants are restricting 

support to only one telecommunications connection per 

household or basing support on the actual costs incurred 

by the eligible carrier, regardless of whether it is the incumbent telephone company or a competitive entrant.

In response to prospective growth in spending for the 

High-Cost Program, the Federal-State Joint Board on 

Universal Service recommended in 2004 that the FCC 

limit support to one telecommunications connection for 

each household. Before the FCC could act, however, the 

Congress restricted the commission from carrying out the 

board’s recommendation, thus allowing the USF to fund 

multiple connections to a single household. 

In addition, under current policy, a company that is 

entering the market to provide service in a high-cost area 

receives an amount of subsidy per connection equal to 
SUMMARY XIII

that received by the existing telephone company. Because 

the competitive entrants are almost all wireless companies—whose cost of providing service is likely to be lower 

than that of the incumbent landline provider—the subsidy paid to new entrants is likely to be higher than the 

amount needed to attract new providers who will offer 

services in rural areas at rates comparable to those 

charged in urban areas. 

Proposals that would peg subsidies to a provider’s own 

cost of offering service would thus probably lower payments to new entrants. The FCC could make that change 

without any legislative action being required. However, 

basing support on a company’s own costs might lessen the 

incentive that current policy gives wireless entrants to 

expand their telephone networks and to produce services 

at the lowest possible cost.

Restructure Intercarrier Compensation and USF 

Payments to Reduce Cross-Subsidies

The more that intercarrier compensation rates are reduced by eliminating the subsidy element they contain, 

the more pressure there is to increase USF payments to 

telephone companies serving rural areas. As noted above, 

CBO estimates that under the proposals being considered, restructuring intercarrier compensation rates could 

increase annual costs for the USF by $800 million to $2.9 

billion. Those proposals have been put forth by groups of 

large and small telephone companies and other concerned parties, such as regulators. So far, those groups 

have not reached a consensus on the best way to restructure rates.

Lowering intercarrier compensation rates would improve 

economic efficiency in that prices for long-distance service would more closely match the actual cost of providing that service. In general, resources are allocated better 

when people base their decisions about how much to 

consume on the cost of the service provided. But the increase in USF fees that would be imposed to pay for USF 

support would introduce distortions of its own on consumers’ choices, offsetting much of the gain in economic 

efficiency.6

Restructuring intercarrier compensation rates would also 

alter which groups make payments to rural telephone 

companies. Under the current structure, only people or 

companies that originate or terminate calls on the networks of rural telephone companies make intercarrier 

compensation payments to those companies. If intercarrier compensation payments were converted to USF support, long-distance customers as a whole would pay for it.

In addition, converting intercarrier compensation payments into USF support could fix the transfer of funds to 

rural telephone companies at current levels, even though 

competition from other telecommunications providers 

and technologies is gradually reducing such payments. 

Thus, restructuring intercarrier compensation could protect rural telephone companies from the competition that 

is occurring in other telecommunications markets and 

thereby deny consumers the benefits of that competition.

If USF payments increased because of reductions in intercarrier compensation, however, the payments could be 

structured in such as way as to avoid committing any new 

resources to cross-subsidies or even to reduce crosssubsidy amounts. Currently, competitive entrants are eligible for the same per-line payments from the USF as the 

incumbent serving the same area. That equivalence 

means that wireless entrants receive payments from the 

USF that were originally designed to compensate incumbents for reducing their long-distance access rates during 

a period before most new entrants had entered the market. Careful design of USF payments to partly replace lost 

intercarrier compensation could result in a reduced flow 

of resources to competitive entrants, on net. That change 

would require at least partly decoupling the support given 

to incumbents from the support given to competitive 

entrants.

Limit Broadband Subsidies

The discussion now taking place about how best to promote rural broadband spans a wider range of policy options than the USF budget. Under current law, for a new 

telecommunications service to qualify for USF support, a 

substantial majority of residential consumers nationwide 

must subscribe to it—a condition not yet achieved by 

broadband. Consequently, new legislation would be necessary to expand USF subsidies for rural broadband beyond those currently provided to schools, libraries, and 

rural nonprofit health care providers. Such legislation has 

been proposed. 

6. One option under consideration at the FCC and in the Congress 

is to convert USF fees from the current revenue-based charge into 

an access-based charge, such as one based on telephone numbers 

or connection capacity. That shift would reduce such price distortions. For more details, see Congressional Budget Office, Financing Universal Telephone Service.
XIV FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

One option for controlling USF spending would be to 

keep special programs such as broadband separate from 

the Universal Service Fund. USF programs are not subject to the annual scrutiny of the Congressional appropriation process, as discretionary spending programs are. As 

a result, the size of USF programs can grow or remain 

stable while discretionary programs’ funding is altered as 

national priorities change.

Even if lawmakers do not explicitly authorize the expansion of rural broadband service, the USF will continue to 

provide financing for the development of broadband in 

rural areas. Such funding goes to pay for infrastructure 

investments by carriers that let them provide both conventional telephone service and advanced digital services, 

including broadband.
CHAPTER

1

Introduction

The Universal Service Fund (USF) was created in 

1997 to follow the directive of the Communications Act 

of 1934, as amended by the Telecommunications Act of 

1996. That law specifies that “quality [telecommunications] services should be available at just, reasonable and 

affordable rates.” It also directs the Federal Communications Commission (FCC) to ensure that “consumers in all 

regions of the Nation, including low-income consumers 

and those in rural, insular, and high cost areas, should 

have access to telecommunications and information services . . . at rates that are reasonably comparable to rates 

charged for similar services in urban areas.”1

 Those goals 

have been referred to under the general heading of “universal service.”

The Telecommunications Act expanded the definition of 

universal service to include funding for Internet and 

other advanced telecommunications services for schools, 

public libraries, and rural nonprofit health care providers.2

 Although some universal service policies and programs had existed before, the 1996 law codified and 

expanded them.

Outlays from the Universal Service Fund have grown by 

more than 50 percent in the past six years and now total 

about $7 billion annually. The main source of that 

growth has been the USF’s High-Cost Program, whose 

spending has doubled since 2000. Spending for that program could double again in the next few years, the Congressional Budget Office estimates, depending on the 

outcome of various legislative and regulatory changes 

now being discussed. If such an increase occurred, the 

fees that are levied on telephone companies and customers to finance the USF would, by law, have to rise significantly as well.

This paper focuses on factors that may increase spending 

for the High-Cost Program in coming years. The potential for further expansion results not only from the evolution of the telecommunications market but also from 

decisions made in the 1996 law and from legislative and 

regulatory actions taken since then.

The Structure and Operations of the

Universal Service Fund

The USF has four main programs, which focus on supporting different groups or entities (see Figure 1-1). The 

largest, the High-Cost Program, is responsible for reducing the prices charged to consumers for telephone service 

in rural and insular areas where costs for such service 

would otherwise be much higher than in urban areas. 

The Low-Income Program aims to reduce the cost of telephone service for certain low-income households. The 

Schools and Libraries Program provides subsidies for 

schools and libraries across the country to purchase advanced telecommunications services. The Rural Health 

Care Program aims to ensure that qualified rural health 

care providers pay no more than their urban counterparts 

for similar advanced telecommunications services.

1. Communications Act of 1934, as amended, section 254(b). For 

an extended discussion of the implication of those goals, see 

David E.M. Sappington, “Harnessing Competitive Forces to Foster Economical Universal Service,” attachment to the letter from 

Tina M. Pidgeon, Vice President, Federal Regulatory Affairs, 

GCI, to Marlene H. Dortch, Secretary, Federal Communications 

Commission, filed in CC Docket No. 96-45 (December 19, 

2003), available at http://gullfoss2.fcc.gov/prod/ecfs/

retrieve.cgi?native_or_pdf=pdf&id_document=6515382829.

2. Telecommunications relay services (TRS) for people with 

impaired hearing are also considered part of universal service. Support for those services is funded through dedicated fees paid by 

telephone companies and their customers, and the TRS program 

is administered separately from the other universal service programs by the National Exchange Carriers Association. This report 

does not address the TRS program or its funding. In addition, 

some states have universal service programs, which are also outside 

the scope of this analysis.
2 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Figure 1-1.

The Structure of the Universal 

Service Fund

Source: Congressional Budget Office.

Under current law, telecommunications companies are 

required to pay the USF a percentage of the revenues they 

derive from providing long-distance and other interstate 

and international services. In turn, the USF subsidizes 

most eligible telecommunications carriers on the basis of 

the costs they incur in making approved services available. The USF fees that long-distance and other providers 

of interstate services pay are usually passed on to their 

customers and in that way have the same effects on consumers as a tax on telecommunications services. As with 

any tax or fee, those effects vary with the size and structure of the fees.

Overall responsibility for providing and funding universal 

service lies with the Federal Communications Commission. In conjunction with state utility regulators, the 

FCC determines the level of spending necessary to meet 

the requirements of the Communications Act and ensures that telecommunications companies pay into the 

Universal Service Fund. The FCC has delegated the 

administration of the fund’s support programs to an independent not-for-profit corporation, the Universal Service 

Administrative Company (USAC).3 The chairman of the 

FCC appoints the board of directors of that company, 

and the board in turn hires the chief executive officer.

Rate-making policies under the jurisdictions of the states 

and the FCC also further the objective of universal service by establishing cross-subsidies (pricing some services 

to some customers above cost so that other services to 

other customers can be priced below cost). Those subsidies, which are implicit in the rate-making process, usually flow from business customers to residential customers, from urban customers to rural customers, and from 

high-usage customers to low-usage customers. Unlike the 

payments made by the Universal Service Fund, those 

implicit subsidies do not appear in the federal budget.

The Universal Service Fund and the 

Federal Budget

Because the payments that the USF effectively transfers 

between telecommunications providers and parties receiving support are required by law, monies coming into 

and out of the USF are counted as revenues and outlays 

in the federal budget. However, the fees that finance the 

USF are adjusted four times each year to match expected 

spending, so the fund is basically budget-neutral. (In 

practice, the USF runs a small surplus because of the lag 

between making commitments to projects, mainly in the 

Schools and Libraries Program, and paying for them.)

Although the USF’s programs do not increase the federal 

budget deficit, they impose costs on the economy and 

create cross-subsidies. Some consumers pay more than 

the economic cost of telecommunications services in 

order to provide funding to other consumers and to the 

companies that provide their telecommunications

services.

The annual outlays and receipts flowing through the USF 

have grown substantially in recent years. Outlays rose 

from $4.0 billion in fiscal year 2000 to $6.3 billion in 

2005, while receipts grew from $4.5 billion to $7.0 billion (see Table 1-1).4 Outlays may not be the best measure of the claims that universal service programs make 

on the telecommunications sector. The revenues from 

USF fees are a better measure because they take into 

account commitments that have been made but not yet 

paid for. 

3. For more information, see Universal Service Administrative Company, 2005 Annual Report, available at www.universalservice.org/

_res/documents/about/pdf/annual-report-2005.pdf.

Universal Service Fund

Schools and Libraries Program

Low-Income Program

Rural Health Care Program

High-Cost Program

4. Those figures are for outlays and receipts of the Universal Service 

Administrative Company. USF program commitments are different from those numbers. In addition, USAC’s fiscal year differs 

from the federal fiscal year in that it begins on July 1 rather than 

October 1.
CHAPTER ONE INTRODUCTION 3

Table 1-1.

Receipts and Outlays for Universal Service Fund Programs, 2000 to 2005

(By fiscal year, in billions of dollars) 

Source: Congressional Budget Office based on data from the Federal Communications Commission.

Notes: * = less than $50 million. 

The numbers shown here are for receipts and outlays of the Universal Service Administrative Company, which administers Universal 

Service Fund (USF) programs. Actual USF program commitments differ from these figures. 

The High-Cost Program was responsible for 83 percent 

of the rise in USF outlays since 2000—$1.9 billion of the 

total $2.3 billion increase. The Low-Income Program 

accounted for another $300 million of that increase, 

whereas spending for the other support programs did not 

change significantly. (Some of the growth in low-income 

support is tied to the growth in the High-Cost Program.)

Two main factors have driven the rise in spending for the 

High-Cost Program. Increases since 2003 have occurred 

mainly because wireless telephone companies have become eligible to receive support and have chosen to enter 

markets formerly served by older wireline monopolies. 

Earlier increases resulted from the implementation of 

accounting changes mandated by the 1996 Telecommunications Act. That law required telephone regulators to 

convert subsidies that had been included in the prices of 

long-distance and other services (called implicit subsidies) 

into payments from the USF (explicit subsidies).5

Potential Sources of Future Spending 

Increases for the USF

A variety of forces are exerting pressure to raise expenditures by the Universal Service Fund—and particularly the 

High-Cost Program—in the future. Among the most 

significant ones are further increases in the number of 

telephone carriers eligible to receive universal service subsidies; possible changes in the structure of rates that telephone companies charge one another to interconnect and 

transfer long-distance and other calls; and possible inclusion of high-speed Internet connections in an expanded 

definition of universal service.

Continued Growth in the Number of Eligible 

Telephone Companies

In an effort to increase competition in local telephone 

markets following the 1996 Telecommunications Act, the 

FCC made more telephone companies eligible for support under the High-Cost Program. Consequently, a 

growing number of companies have applied to be designated as eligible to receive USF payments. The result is 

that the amount of funding going to new “competitive eligible telecommunications carriers” has risen dramatically. Funding for those carriers—usually wireless companies—accounts for more than 90 percent of the 

increase in spending by the High-Cost Program since 

2003. In the absence of policy changes by the Congress 

or the FCC, such growth appears likely to continue.

Changes in the Structure of Intercarrier

Compensation Rates

Regulators have often set some of the per-minute rates for 

intercarrier compensation—the charges that telephone 

companies pay each other for initiating and completing 

one another’s calls—above the cost of those activities in 

2000 2001 2002 2003 2004 2005

Receipts 4.5 5.2 5.4 5.7 6.4 7.0

Outlays

High-Cost Program 1.9 2.6 2.8 3.3 3.4 3.8

Low-Income Program 0.5 0.6 0.7 0.7 0.8 0.8

Schools and Libraries Program 1.6 1.7 1.6 1.6 1.5 1.7

Rural Health Care Program * * * * * * ___ ___ ___ ___ ___ ___

Total 4.0 4.9 5.1 5.6 5.7 6.3

5. Part of the spending increase for the Low-Income Program can 

also be attributed to that change. As implicit subsidies were 

reduced, some of the burden was shifted onto consumers in the 

form of higher prices for telephone service. Consequently, the 

USF’s assistance to low-income telephone subscribers rose.
4 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

order to provide an implicit subsidy to local telephone 

companies and their customers. Such payments primarily 

flow from long-distance companies to 

local telephone companies. 

Over time, changes in technology and the telephone market have made the intercarrier compensation system less 

sustainable. Telephone companies and other parties with 

an interest in the system have been attempting to redesign it. Most of the proposals being discussed involve 

reducing intercarrier compensation rates and making up 

the revenue losses that some telephone companies might 

incur as a result through increased payments from the 

High-Cost Program.

A similar situation occurred when the subsidies implicit 

in long-distance access charges were reduced and made 

an explicit part of the USF budget, following the dictates 

of the Telecommunications Act. Those additional payments, which continue today, drove much of the increase 

in USF spending in the early years of this decade.

Inclusion of High-Speed Internet Access in

Universal Service

The Telecommunications Act requires that the basket of 

services included in the definition of universal service—

and thus eligible for USF support—be reviewed and updated periodically. Under the law, that process 

begins with the Federal-State Joint Board on Universal 

Service, which is composed of regulators from the FCC 

and the states. The Joint Board makes recommendations 

to the FCC, which can accept, reject, or modify them. 

Many analysts and interested parties have argued that 

broadband Internet access should be one of the services 

paid for by the High-Cost Program. Alternatively, some 

people have proposed creating a new program within the 

USF, similar to the Schools and Libraries Program, to 

promote residential broadband in rural areas.

Paying for Spending Increases

The possibility of future increases in USF spending raises 

the question of how such expenditures would be paid for. 

As noted above, the Universal Service Fund is currently 

financed through a percentage fee on the value of interstate telecommunication services, including long-distance 

revenues, a portion of cell phone revenues, and part of 

the basic subscriber charges that customers pay to local 

telephone companies.6

 That fee is calculated quarterly 

and is generally set to keep the USF deficit-neutral 

(although the lag between commitments and disbursements makes strict deficit-neutrality impossible). 

Telecommunications spending is rising in the economy as 

a whole. But the portion of such spending that is subject 

to universal service fees has decreased in the past decade 

as the Internet, e-mail, and other advanced telecommunications have reduced the amount of long-distance revenues that telephone companies take in. Because USF 

spending has been growing while the telecommunications base from which its revenues are drawn has shrunk, 

the percentage used in calculating the fee on eligible telecommunications revenues has been rising. In 2000, that 

quarterly fee rate never exceeded 6 percent, whereas in 

2005, it never fell below 10 percent.

Further increases in spending by the USF would drive up 

the fee percentage even higher, unless either a different 

revenue mechanism was devised or the base of telecommunications services subject to the fees was broadened. 

Higher fee levels might cause consumers to shift more of 

their spending to telecommunications services that are 

not subject to USF fees (such as e-mail), reducing receipts 

for the fund.

The next chapter describes the various support mechanisms that make up the High-Cost Program and the 

types of companies that are eligible for support. The 

remaining chapters focus on the three factors mentioned 

above that are driving the growth of high-cost support. 

Those chapters also discuss policy options for limiting 

future spending increases.

6. For more information, see Congressional Budget Office, Financing Universal Telephone Service (March 2005).
CHAPTER

2

The Structure and Operations of the

USF’s High-Cost Program

The largest and most rapidly growing component of 

the Universal Service Fund is the High-Cost Program. It 

is designed differently from the USF’s other support programs, and much of its complexity flows from its unique 

design. Whereas the other programs provide funds 

directly on behalf of their targeted groups, high-cost 

support is provided indirectly through telephone companies.1 The support is not matched directly to the costs of 

providing service to specific individuals but rather to the 

cost of providers’ telephone networks. Proponents maintain that by supporting a network as a whole, the HighCost Program can keep prices low for all of the network’s 

customers.

The fact that the High-Cost Program is the oldest USF 

support mechanism combines with its indirect nature to 

add more complexity. Over the years, tensions have often 

arisen between regulators, who sought to ensure the delivery of supported services at the lowest cost to the USF, 

and telephone companies, which claimed that the level of 

support provided by the fund was inadequate for their 

needs.

In a competitive market (even one with direct subsidies to 

consumers), such tensions would usually be solved 

through normal market mechanisms: suppliers would 

compete with each other on the basis of price and quality, 

and consumers would choose among them. But the monopolies on local telephone service that continue to exist 

in most of the United States and the indirect nature of 

the High-Cost Program have kept an efficient market 

solution from emerging. Together, those two factors have 

ensured that the budgetary resources devoted to supporting telephone service in high-cost areas are greater than 

support delivered directly through the consumer would 

be—and that they are subject to continual upward 

pressure.

The Structure of High-Cost Support

Currently, the High-Cost Program funds telephone carriers through five separate mechanisms (see Figure 2-1). 

The first three provide support that is primarily directed 

at carriers’ costs. The other two, which result from policy 

changes that followed the 1996 Telecommunications Act, 

are intended to compensate providers of universal service 

for lost revenues.

B High-cost loop support underwrites some of the costs 

that rural companies incur in connecting with their 

customers.

B High-cost model support pays nonrural companies’ 

costs of connecting to customers (similar to high-cost 

loop support but for larger companies).2

B Local switching support helps fund small rural companies’ telephone switches (electronic equipment that 

connects callers to each other).

B Interstate common line support compensates mainly 

rural carriers for the revenue they lost when longdistance access charges were reduced in 2002.

1. Spending for the Low-Income Program, for example, also flows to 

telephone companies, but it reflects a one-to-one matching with 

the companies’ low-income subscribers.

2. According to the Universal Service Administrative Company, “for 

purposes of high cost support, a rural carrier is one that serves a 

relatively small number of lines or a relatively small area.” Nonrural companies, by contrast, serve both rural and nonrural areas. 

For a more extended definition, see www.universalservice.org/hc/

incumbent-carriers/step01/. Also see section 153(37) of the Communications Act of 1934, as amended.
6 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

B Interstate access support compensates mainly larger 

companies for the revenue they lost when longdistance access charges were reduced.

High-Cost Loop Support

High-cost loop support aims primarily to help rural telephone companies with the cost of the connections (called 

local-loop or last-mile connections) between the central 

offices where switching equipment is located and customers’ premises.3 Such aid is limited to areas where the cost 

of those connections exceeds 115 percent of the national 

average cost per line. 

High-cost loop payments are based on costs of the incumbent telephone carrier in a particular market. At the 

requirement of the Federal Communications Commission, the National Exchange Carrier Association collects 

data from all incumbent local exchange carriers on their 

line counts, investments, and expenses. Using those data, 

the association estimates the costs of the local loop for 

each individual study area, as well as the national average. 

(Study areas are local exchange carriers’ service areas in a 

single state. A single carrier usually has a single study area 

in any given state, but some have several.) On the basis of 

those statistics, the association submits a filing each fall to 

the FCC and the Universal Service Administrative Company on the loop costs of all incumbent telephone 

providers.4

The formula used to calculate support depends on the 

number of loops within a service area. For example, for 

study areas with 200,000 or fewer working loops, an eligible carrier would receive payments equal to 65 percent 

of its costs between 115 percent and 150 percent of the 

national average and 75 percent of its costs over 150 percent of the national average. The formulas for larger carriers are less generous.

Since 2003, total high-cost loop funding for incumbents 

has been capped at the 2002 level, but each year the cap is

Figure 2-1.

The Structure of the Universal Service 

Fund’s High-Cost Program

Source: Congressional Budget Office.

adjusted by what is called the rural growth factor.5 That 

factor is calculated by adding the annual percentage increase in the gross domestic product (GDP) chained price 

index to the percentage growth rate in the total number 

of working local loops of incumbent rural exchange carriers. Because the number of such loops has been declining 

faster than the GDP price index has been rising, the cap 

has reduced rather than increased support for incumbent 

telephone carriers—contrary to what had been anticipated. In implementing that reduction, the administrator 

of USAC is required by the FCC to lower funding to subsidized companies so as to favor the carriers with the 

highest costs.

For that reason, although the cap restrains overall spending for high-cost loop support, it does not provide an incentive for recipients with relatively high costs to control 

3. For purposes of calculating the level of support, a portion of the 

costs of the switching equipment is included in addition to the 

costs of the wires that typically connect a company with its

customers.

4. The FCC requires rural carriers to submit data annually, but a carrier may voluntarily update its data as frequently as each quarter. 

Nonrural carriers must file line-count data quarterly. The 

National Exchange Carrier Association’s annual filings are available on the FCC’s Web site at www.fcc.gov/wcb/iatd/neca.html.

5. The cap was established much earlier but was changed by the 

FCC when it modified the high-cost loop support mechanism in 

2001.

High-Cost Loop Support

Local Switching Support

High-Cost Model Support

Interstate Common

Line Support

Interstate Access Support

Universal Service Fund

Schools and Libraries Program

Low-Income Program

Rural Health Care Program

High-Cost Program
CHAPTER TWO THE STRUCTURE AND OPERATIONS OF THE USF’S HIGH-COST PROGRAM 7

their costs. Because the cap transfers funds from lowercost eligible incumbent carriers to higher-cost eligible 

incumbent carriers, the carriers that serve higher-cost 

areas do not see their payments bound by the cap, and so 

their costs continue to rise.

In addition, the cap covers only basic high-cost loop 

funding for rural incumbents. The total funding available 

for competitive entrants in rural markets—mainly providers of wireless telephone service—is not constrained 

by the cap. Rural incumbents also have two small programs that provide additional assistance in exceptional 

circumstances (called safety-net additive support and 

safety-valve support).

High-Cost Model Support

High-cost model support (sometimes also known as 

forward-looking support) provides funds to nonrural carriers in states where average forward-looking costs—the 

costs of providing service with the best available landline 

technology—are substantially above the national average.6

 Specifically, that mechanism aids nonrural carriers 

in study areas of states where the forward-looking costs of 

providing supported services are more than two standard 

deviations above the national average cost per line.7

Unlike other high-cost mechanisms, high-cost model 

support is not based on historical costs; rather, payments 

are determined by a cost model. The model estimates the 

cost of the most cost-effective available technology that a 

firm entering the market might deploy. In that way, 

model support is meant to mimic the effects that competition would have on the cost structure and rates of nonrural carriers.

The model begins by producing a cost per line for each 

study area, from the bottom up (that is, based on the loop 

costs of each central office). It then calculates a statewide 

average cost for all nonrural study areas, which is compared with the national average to determine eligibility 

for support. The model is updated regularly with new 

information about line counts, but the information about 

equipment does not change. In states that qualify, support is targeted to central offices in high-cost nonrural 

study areas. All eligible telecommunications carriers that 

provide service in the same areas receive the same amount 

of support per line. 

In 2005, nonrural carriers in 10 states—Alabama, Kentucky, Maine, Mississippi, Montana, Nebraska, South 

Dakota, Vermont, West Virginia, and Wyoming—were 

eligible to receive high-cost model support. Those states 

exceeded the two standard deviations of the national cost 

benchmark by having costs that were at least 136 percent 

of the national average.

As in the other mechanisms of the High-Cost Program, 

competitive entrants are eligible for high-cost model support to the extent that the incumbent in their service area 

is eligible. But unlike in those other mechanisms, because 

a competitor’s line count is a variable in the model, the 

presence of competitive entrants changes the level of 

assistance for the incumbent and consequently changes 

the competitors’ payments as well.

Local Switching Support

Local switching support provides assistance with local 

switching costs for companies that serve fewer than 

50,000 lines. Such assistance is intended to give those 

predominantly rural companies the same economies of 

scale enjoyed by larger urban companies, which have 

lower average costs for telephone switching because they 

can distribute the costs over a greater number of customers. As in the other parts of the High-Cost Program, competitive entrants receive the same per-line payment that 

incumbent carriers do.

Interstate Common Line Support

This mechanism, which began in July 2002, is the newest 

component of the High-Cost Program. The FCC created 

interstate common line support to comply with requirements in the 1996 Telecommunications Act to make implicit subsidies explicit. As a consequence of that law, the 

FCC reduced the long-distance and other access charges 

that long-distance companies had paid to local telephone 

companies. To compensate for the reduction, the FCC 

also raised the maximum rate on one type of subscriber 

fee—the subscriber line charge—that customers pay to 

their local telephone company for access to interstate 

service. 

6. Transitional USF programs, which helped companies that had 

received support under previous programs, have now ended.

7. A standard deviation measure is used to capture the wide variation 

of costs around each state’s average cost. If the costs per line within 

a state are clustered around the average, the standard deviation 

will be small. If the costs per line vary widely, the standard deviation will be larger.
8 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Interstate common line support is designed to supplement the revenues of rural carriers when the subscriber 

line charges that their customers pay do not cover certain 

of the carriers’ costs, including an 11.25 percent rate of 

return for many rural carriers. Interstate common line 

support is not subject to a cap, and competitive entrants 

receive the same amount per line as incumbents. (An earlier mechanism—long-term support—was merged into 

interstate common line support in mid-2004.)

Interstate Access Support

Interstate access support began in 2000 as a way of making explicit formerly implicit subsidies that had been provided to some nonrural companies through intercarrier 

charges. At that time, the FCC lowered some access 

charges that nonrural local telephone companies were 

allowed to charge long-distance companies, eliminating 

an estimated $1 billion in intercarrier access charges 

received by those carriers annually. Funding for interstate 

access support was initially set at $650 million, but additional payments to competitive entrants drove it up to 

$691 million by 2005.

Funding is calculated using a series of formulas that measure the difference between the amount of revenue that 

will be collected under the current rules for subscriber 

line charges and the amount of revenue that would be 

adequate to cover certain of a carrier’s costs. 

Growth of the Different High-Cost Mechanisms

In calendar year 2000, the High-Cost Program paid out 

$2.2 billion to eligible telecommunications carriers. By 

2005, those payments had risen to $3.8 billion (see Table 

2-1).8 By far the largest growth has occurred in interstate 

common line support, even after adjusting for that mechanism’s merger with the now-discontinued long-term 

support mechanism. With that adjustment, interstate 

common line support grew by $700 million between 

2000 and 2005. Interstate access support—which performs a similar function for nonrural carriers—was second with $410 million in growth over the 2000-2005 

period. 

As noted above, the FCC created both interstate common line support and interstate access support in response to the Telecommunications Act’s mandate that 

implicit subsidies be made explicit. Together, those mechanisms account for $1.1 billion of the $1.6 billion growth 

in spending for the High-Cost Program since 2000 (including long-term support as part of interstate common 

line support.)

The other factor accounting for substantial growth in the 

High-Cost Program is the emergence of significant numbers of competitive entrants that are eligible for support 

payments. Compared with virtually no support in 2000, 

those carriers now receive more than $600 million per 

year. Some support for competitive entrants is included 

in the $1.1 billion in spending for interstate common 

line and access support. Even so, those figures suggest 

that almost all of the growth in the High-Cost Program 

over the past six years is attributable to the two factors 

previously mentioned: making implicit subsidies explicit 

and providing support to carriers that are entering highcost markets to compete with incumbent telephone 

companies.

Types of Carriers and Eligibility for 

Funding

As described above, different parts of the High-Cost Program are designed to help different types of carriers or to 

provide funding for only some types of costs. Eligibility 

for various kinds of support may depend on the geographic area served by the carrier or on whether the 

carrier is a competitive entrant. 

Rural and Nonrural Companies

The Universal Service Fund provides high-cost support 

both to rural companies (those that serve only rural areas) 

and to nonrural companies (which serve both rural and 

nonrural areas). In its most recent filing, USAC reported 

that of the roughly 1,900 study areas receiving funding 

from the High-Cost Program, more than 80 percent were 

served by rural carriers and the rest by nonrural carriers.9

8. The High-Cost Program usually reports disbursements, which are 

typically spent immediately and count as federal outlays. Other 

programs of the Universal Service Fund (most notably the Schools 

and Libraries Program) typically report commitments, which may 

take years to be converted into disbursements. Another factor that 

complicates comparisons between USF programs is that different 

programs report data in different program years.

9. See Universal Service Administrative Company, Safety Net Additive Support, Second Quarter 2006, Appendix HC-06, and High 

Cost Model Support Projected by Study Area, Second Quarter 2006, 

Appendix HC-17, available at www.universalservice.org/about/

governance/fcc-filings/2006/quarter2/default.aspx.
CHAPTER TWO THE STRUCTURE AND OPERATIONS OF THE USF’S HIGH-COST PROGRAM 9

Table 2-1.

Disbursements for the High-Cost Program, by Mechanism, 1998 to 2005

(By calendar year, in billions of dollars)

Source: Congressional Budget Office based on data from the Universal Service Administrative Company.

Note: n.a. = not applicable; * = less than $50 million. 

a. Includes disbursements for safety-net additive support.

b. Long-term support was merged into interstate common line support on July 1, 2004. 

Many telecommunications companies—usually smaller, 

rural ones—are subject to traditional rate-of-return regulation. Under that type of regulation, the regulatory body 

examines a firm’s reported costs, accepts or rejects their 

accuracy, and then allows the firm to charge rates that will 

yield a percentage return on the accepted costs. Analysts 

often argue that by guaranteeing a particular yield, rateof-return regulation gives a company no incentive to hold 

down its costs. 

Larger nonrural telecommunications companies, by contrast, are most often subject to price-cap regulation, in 

which the regulator and the regulated firm agree on a 

price to charge for service without direct reference to 

costs. Regulated companies can keep the difference 

between their costs and the prices charged, so they have 

an incentive to reduce costs. In some cases, companies 

face price caps that decline over time, and accordingly, 

they share cost reductions with their customers.

Incumbent Carriers and Competitive Entrants

Most of the study areas that receive funding from the 

High-Cost Program are still served by a single incumbent 

telephone company. Only about one-quarter of the 

roughly 1,900 study areas were considered competitive by 

USAC.10 However, all funding provided by the HighCost Program is “portable,” meaning that competitive 

entrants receive the same per-line subsidy as does the 

incumbent with which they compete. Because support 

payments are based on the incumbent’s cost, not their 

own, competitive carriers do not have the same datafiling requirements as incumbents.

1998 1999 2000 2001 2002 2003 2004 2005

0.8 0.8 0.9 0.9 1.0 1.1 1.1 1.2

High-Cost Model Support n.a. * 0.2 0.2 0.2 0.2 0.3 0.3

Local Switching Support 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4

0.5 0.5 0.5 0.5 0.5 0.5 0.3 n.a.

Interstate Common Line Supportb n.a. n.a. n.a. n.a. 0.2 0.4 0.7 1.2

Interstate Access Support n.a. n.a. 0.3 0.6 0.6 0.6 0.6 0.7 ___ ___ ___ ___ ___ ___ ___ ___

Total 1.7 1.7 2.2 2.6 3.0 3.3 3.5 3.8

High-Cost Loop Supporta

Long-Term Supportb

10. Ibid.

CHAPTER

3

Policies for Supporting

New Competitive Entrants

Virtually all of the growth in spending for the Universal Service Fund’s High-Cost Program in the past three 

years reflects payments to an increasing number of competitive eligible telecommunications carriers. Most of 

those new entrants to rural markets use wireless technologies to provide either cellular telephone service or personal communications services (which are similar to cellular transmissions but use a higher frequency in the radio 

spectrum). Those telecommunications carriers became 

eligible to receive USF payments following regulatory 

changes by the Federal Communications Commission in 

2000. 

Over the next several years, more new entrants are likely 

to become eligible for and receive USF payments, and 

spending for the High-Cost Program is likely to increase 

accordingly. Unless current policies change, the growth in 

spending will subside only when the demand for wireless 

services is fully satisfied.

Concerned about upward pressure on USF spending 

from support for new wireless entrants, the Federal-State 

Joint Board on Universal Service advised the FCC in 

2004 to limit such support to one connection per household (with the household deciding which connection, 

and thus which provider, would receive the subsidy).1

However, the Congress inserted language in the FCC’s 

appropriation law for 2005 to restrict the agency from 

spending appropriated funds to carry out the Joint 

Board’s recommendation.2 That language has also been 

incorporated in the appropriation act to fund the FCC in 

2006.

The growth of spending for new entrants could be curtailed by lifting that legislative ban. In addition, the FCC 

could limit spending growth by basing support for new 

entrants on those companies’ actual costs rather than on 

the costs of incumbent carriers and by applying the current cap on high-cost loop support for rural telephone 

providers more broadly.

The Structure of Funding for

Incumbents and Their Competitors

Under the High-Cost Program, competitive entrants 

receive the same amount of support per line as the existing telephone company with which they are competing, 

although typically they do not have the same costs, serve 

the exact same area, or have the same obligations as the 

incumbent carrier.

For rural incumbents, USF payments are based on the 

actual costs incurred in providing telecommunications 

services. Those rural carriers mainly use wired telephone 

technology, which requires them to string and maintain 

telephone wires throughout their service area. By contrast, the majority of new entrants receiving payments are 

wireless carriers, according to the Universal Service Administrative Company. The costs that those carriers incur 

are lower, on average, than the costs experienced by incumbents because, in the aggregate, cellular towers and 

spectrum are likely to be less expensive than the wirebased infrastructure devoted to wired local loops. 

1. The board, which consists of FCC and state regulators, is responsible for studying and making recommendations to the FCC 

about universal service. See Federal-State Joint Board on Universal 

Service, Recommended Decision in the Matter of CC Docket No. 

96-45 Before the Federal Communications Commission, FCC 04J-1 

(February 27, 2004), paragraph 3, available at http://hraunfoss. 

fcc.gov/edocs_public/attachmatch/FCC-04J-1A1.pdf.

2. Consolidated Appropriations Act, 2005 (Public Law 108-447), 

div. B, title VI, section 634; 118 Stat. 2922.
12 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Although some advocates of the policy of encouraging 

competition in high-cost markets originally envisioned 

wireless service being a substitute for wireline service, 

connections provided by wireless entrants are typically 

complements to the current landline provided by the 

incumbent. Consumers who subscribe to cable-based or 

other landline-based telephone service usually cancel 

their service with the incumbent telephone company. But 

most people who subscribe to a wireless service maintain 

their landline connection. The fact that wireless entrants 

are providing additional telephone service rather than 

replacement service in many cases is part of the reason 

that total spending for support grows when wireless carriers enter a market covered by the USF.

Incumbent rural carriers are typically required to offer 

service to every household in their service area. In the 

past, wireless entrants have not had a similar requirement, 

and in fact, they may not have been able to meet such a 

requirement because their spectrum license may not cover 

an area identical to the service area of the incumbent. 

Some observers maintain that in the absence of such a requirement, wireless entrants have tended to serve only the 

most densely populated portions of a service area, where 

the revenue potential is greatest. Moreover, even in parts 

of a service area covered by a wireless provider, “dead 

zones” may exist because providers have not found it 

profitable to build additional cellular transmission and 

reception sites. 

In February 2005, the FCC issued an order aimed at 

reducing the disparities in coverage between incumbent 

carriers and their wireless competitors.3 That order 

required competitive entrants to correct the most severe 

problems with coverage of their designated service area 

over a five-year period. In the meantime, however, wireless entrants can resell the incumbent’s service in areas not 

reached by their own networks.

A subset of competitive entrants is wireless subsidiaries 

owned by incumbent wireline carriers. In some instances, 

an incumbent and its wireless subsidiary serve the same 

area. When such subsidiary companies apply to become 

eligible for USF support, state regulators find it hard to 

deny their application because they are experienced and 

have credible business plans. But the entrance of such carriers does not directly increase competition. And in many 

cases, subsidiaries were already operating in a high-cost 

area before they received USF support, raising questions 

about whether universal service subsidies for such carriers 

are contributing to the expansion of telephone service.4

Recent Growth in the Number and 

Funding of Competitive Carriers

Both the number of carriers receiving payments under 

the High-Cost Program and the amount of funding

given to competitive entrants have risen over the past

several years. In 2000, just two competitive telecommunications carriers were eligible for high-cost support (see 

Table 3-1). By 2005, that number had risen to 263.5

Typically, about 95 percent of funding for competitive 

entrants in any given year goes to wireless companies.

Competitive entrants have accounted for more than 90 

percent of new funding in the High-Cost Program since 

2003. Funding for incumbents has been nearly constant 

in the past three years at between $3.1 billion and $3.2 

billion, probably because of a combination of the cap on 

high-cost loop support and a decline in rural incumbents’ 

line counts. (As explained in the previous chapter, the cap 

on high-cost loop support for incumbents is adjusted by 

their number of rural subscribers.) Spending for competitive entrants has grown from $131 million in 2003 to an 

estimated $640 million in 2005. Early projections for 

2006 suggest a substantial rise in funding for new entrants and continued stability in funding for incumbents.

The Potential for Future Growth

Currently, wireless entrants serve only a small percentage 

of the number of subscribers that incumbent carriers do. 

Thus, the potential for future growth is substantial. The 

Bureau of Labor Statistics has made surveys of cell phone 

ownership and estimates that about 15.4 million people 

in nonmetropolitan statistical areas purchased wireless

3. Federal Communications Commission, Report and Order in the 

Matter of the Federal-State Joint Board on Universal Service, CC 

Docket No. 96-45 (February 25, 2005).

4. Such subsidiaries present additional regulatory problems. By shifting any joint costs to the incumbent, companies can increase the 

level of USF support for their incumbent arm, which will then be 

matched for their wireless arm.

5. Some carriers have become eligible for support in several states 

and are counted multiple times in that figure.
CHAPTER THREE POLICIES FOR SUPPORTING NEW COMPETITIVE ENTRANTS 13

Table 3-1.

Funding for Incumbent Carriers and Competitive Entrants Under the High-Cost 

Program, 1998 to 2005

(By calendar year, in billions of dollars) 

Source: Congressional Budget Office based on data from the Universal Service Administrative Company.

Note: n.a. = not applicable; * = less than $5 million. 

telephone service in 2004.6 If rural cell phone subscribership grew at the same rate that all wireless telephone subscriptions did in 2005 (14.8 percent), the number of 

rural subscribers at the end of last year would amount to 

about 17.7 million. Wireless subscriptions appear 

unlikely to keep growing that quickly in coming years.7

But if cell phone subscribership grew by 25 percent overall during the next five years—slower than the recent 

trend—the number of rural cell phone subscribers would 

total 22 million by 2011. 

Although all of those subscribers live outside metropolitan statistical areas, not all of the wireless carriers serving 

them are likely to be eligible for subsidies under the 

High-Cost Program. For example, the incumbent with 

which those wireless carriers compete may not be eligible, 

perhaps because its costs are too low. Consequently, the 

number of subscribers to service provided by wireless 

entrants that receive subsidies is likely to be smaller than 

22 million in 2011.

The Universal Service Administrative Company does not 

publish data in such a way as to allow for a complete 

count of subsidized telephone subscriber lines. On the 

basis of USAC filings with the FCC, the Congressional 

Budget Office estimates that USAC subsidized competitive entrants with a total of 4.6 million subscribers in the 

fourth quarter of 2005.8

 CBO based that estimate on the 

number of telephone lines (or their wireless equivalents) 

operated by competitive entrants that received interstate 

common line support or high-cost model support. The 

estimate undercounts subscribers to a small extent 

because some competitive entrants that receive high-cost 

loop support or interstate access support do not receive 

interstate common line support or high-cost model 

support. 

In the calculations that follow, CBO assumes that all of 

the telephone lines of competitive entrants being subsi1998 1999 2000 2001 2002 2003 2004 2005

1.70 1.72 2.52 2.58 2.93 3.14 3.15 3.19

n.a. * * 0.02 0.04 0.13 0.32 0.60

n.a. * * * * * 0.01 0.03 ____ ____ ____ ____ ____ ____ ____ ____

0 * * 0.02 0.05 0.13 0.33 0.64

All Carriers 1.70 1.72 2.52 2.60 2.98 3.27 3.49 3.82

Number of Eligible Competitive Entrants 0 2 2 23 58 113 202 263

Subtotal

Memorandum:

Incumbent Carriers

Competitive Entrants

Wireless

Wireline

6. Clyde Tucker, J. Michael Brick, and Brian Meekins, “Household 

Telephone Service and Usage Patterns in the U.S. in 2004: Implications for Telephone Samples” (unpublished draft by Westat and 

the Bureau of Labor Statistics, under review). The numbers cited 

above were based on separate runs of the same survey databases. 

Not all nonmetropolitan subscribers will be eligible for high-cost 

support, but these numbers provide an upper bound.

7. If they did, total cell phone subscribership would reach 275 million in 2011, or 87 percent of the total U.S. population of 315 

million projected for that year. That subscription rate seems high 

given that the population includes substantial numbers of very 

young children and very old people, who are unlikely to have cell 

phones. 

8. Calculated from Universal Service Administrative Company, 

Interstate Common Line Support Projected by State by Study Area, 

Fourth Quarter 2005, Appendix HC-09, and High Cost Model 

Support Projected by Wire Center, Fourth Quarter 2005, Appendix 

HC-15, available at www.universalservice.org/about/governance/

fcc-filings/2006/quarter2/default.aspx.
14 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Table 3-2.

Potential Increase in USF Spending from the Growth of Wireless Subscriptions to 

New Entrants

Source: Congressional Budget Office.

dized are wireless connections. As noted above, 95 percent of USF funding for competitive entrants goes to 

wireless companies. Consequently, the estimate that follows overstates the impact of wireless on future spending 

growth. Nevertheless, the prospect for such growth is the 

primary incentive drawing new wireless entrants into 

areas eligible for high-cost support.

To provide a sense of the possible scale of such growth, 

CBO estimated the costs that the High-Cost Program 

would incur (under current law and policies) if subscriptions with new wireless entrants doubled, tripled, or quadrupled the current number of supported wireless connections and if costs rose proportionally (see Table 3-2). 

Subscriptions with competitive entrants have almost tripled over the past several years, but that growth has 

occurred from a very small base. To quadruple, wireless 

entrants in the High-Cost Program would have to account for more than 80 percent of all nonmetropolitan 

cell phone subscribers. Although possible, that share 

seems implausibly high because some rural subscribers 

would be likely to have providers that were not receiving 

USF subsidies.

CBO projects that a result somewhere between a doubling and a tripling of the current number of supported 

wireless subscriptions is the most likely outcome by 2011. 

In that case (assuming that the current ratio of subscribers to costs continued), the increase in USF spending 

associated with new entrants would amount to between 

$600 million and $1.2 billion above the 2005 level.

Although recent history points to wireless providers as the 

main recipients of new spending from the High-Cost 

Program, alternative telephone providers—such as carriers who offer voice telephone service over the Internet—

may also apply for USF funding in growing numbers. 

With the maturation of wireless broadband technology 

and the expansion of cable broadband into rural areas, 

more carriers are likely to consider it worthwhile to apply 

for USF payments, even though those payments subject 

them to increased regulation. The cost difference between 

new telecommunications technologies and mature wireline technologies may outweigh the costs of complying 

with the regulation typically imposed on eligible telecommunications carriers, which are greater than the costs 

faced by Internet service providers and cable companies.

Policy Options That Could Limit the 

Growth of USF Spending for 

New Entrants

The recent increase in the number and funding of wireless entrants has prompted various proposals to curb that 

growth. Otherwise, as USF spending rises, the fees 

charged to telephone companies (and passed on to consumers) will have to rise as well—possibly causing come 

people to reduce their telephone service. The policy 

changes discussed below are illustrative of the range of 

options that have been proposed.

Limiting USF Funding to a Single Connection

As noted above, the Congress has restricted the FCC 

from limiting USF support to a single line per household. 

Rural 3.6 7.2 10.8 14.4

Nonrural 1 2 3 4 ___ ___ ____ ____

Total 4.6 9.2 13.8 18.4

0.6 1.2 1.8 2.4

0 0.6 1.2 1.8

2005 Level Double Triple Quadruple

Potential Increase from 2005 Level

Subscribers to New Entrants (Millions)

USF Spending for New Entrants (Billions of dollars)

Spending Increase Relative to 2005 Level (Billions of dollars)
CHAPTER THREE POLICIES FOR SUPPORTING NEW COMPETITIVE ENTRANTS 15

Proponents of USF support for multiple lines argue that 

the Communications Act set forth a vision of universal 

service in which service and prices in rural and insular 

areas would be roughly comparable to those in urban 

areas. According to those proponents, urban households 

are not limited to one telecommunications connection at 

affordable rates; thus, rural households should have the 

same option. 

In recommending the restriction on connections, the 

Federal-State Joint Board on Universal Service argued 

that other goals of the Communications Act would be 

jeopardized by continuing to fund multiple lines per 

household. Most important, they posited that continued 

growth in the number of providers being funded threatened the sustainability of the USF.9

The Joint Board also maintained that the second and 

third connections being supported under the current system are being used for faxes, Internet access, and mobile 

service, none of which are explicitly eligible for support 

by the USF. In the opinion of the board, funding a single 

connection—be it wireless or wireline, provided by an 

incumbent or a new entrant—is not inconsistent with the 

mandate of current law. To the extent that households 

chose a wireless service as their primary connection, wireless carriers would receive USF funding and the USF 

would be supporting the expansion of wireless connections to rural areas.

Furthermore, the board stated that supporting a single 

connection per household would fulfill the statutory 

principle of sufficiency included in the Communications 

Act. “The Joint Board and the [FCC] have defined sufficiency as enough support to achieve relevant universal 

service goals without unnecessarily burdening all consumers for the benefit of support beneficiaries.”10 By 

increasing the funding for high-cost connections, the 

Joint Board added, the USF would be raising costs for all 

other consumers beyond the necessary level and possibly 

pricing some current telephone subscribers out of the 

market.

Basing Funding on an Entrant’s Own Costs

Many proposals to change the High-Cost Program start 

with the fact that funding for competitive entrants is 

based not on the costs they incur to provide service but 

on the costs that incumbents incur.11 One way to slow 

the growth of that program would be to base payments to 

competitive entrants on their own incurred costs (including some normal rate of profit) whenever those costs were 

lower than the incumbent’s. How much savings that 

change would produce is uncertain because competitive 

entrants are not required to file cost data that can be 

compared with the data filed by incumbents. However, 

the savings could be large, since the costs of wireless carriers are likely to be lower than those of landline carriers. 

Advocates of basing USF support on each carrier’s own 

costs argue that such a system would give wireless entrants enough incentive to provide consumers in rural 

areas with wireless service at rates and on terms roughly 

comparable to those that urban consumers receive. With 

support linked to each carrier’s own costs, every company—incumbent or new entrant—would still have an 

incentive to invest in rural areas. 

Supporters of the current system maintain that by paying 

each eligible carrier in a service area the same amount per 

line, the High-Cost Program gives every company the 

same opportunity to serve rural customers. With equal 

support, lower-cost providers have more incentive to invest in high-cost areas, which may offer beneficial competition in some locations.12

In other circumstances, however, equal payments may 

not be a cost-effective way to support universal service. 

That is the case when new entrants are applying for support in markets that they have already entered or that 

they intend to enter regardless of receiving a subsidy 

9. See Federal-State Joint Board on Universal Service, Recommended 

Decision in the Matter of CC Docket No. 96-45 Before the Federal 

Communications Commission, FCC 04J-1 (February 27, 2004), 

paragraphs 67 and 68, available at http://hraunfoss.fcc.gov/

edocs_public/attachmatch/FCC-04J-1A1.pdf.

10. Ibid., paragraph 64.

11. See, for example, Comments of Balhoff & Rowe, LLC, Before the 

Federal Communications Commission in the Matter of Federal-State 

Joint Board for Universal Service, CC Docket No. 96-45 (September 30, 2005), available at http://gullfoss2.fcc.gov/prod/ecfs/

retrieve.cgi?native_or_pdf=pdf&id_document=6518164393.

12. For that viewpoint, see David E.M. Sappington, “Harnessing 

Competitive Forces to Foster Economical Universal Service,” 

attachment to the letter from Tina M. Pidgeon, Vice President, 

Federal Regulatory Affairs, GCI, to Marlene H. Dortch, Secretary, 

Federal Communications Commission, filed in CC Docket No. 

96-45 (December 19, 2003), available at http://gullfoss2.fcc.gov/

prod/ecfs/retrieve.cgi?native_or_pdf=pdf&id_document= 

6515382829.
16 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

(such as with wireless subsidiaries owned by incumbent 

rural wireline operators).

Expanding the Cap on High-Cost Loop Support

The current cap on high-cost loop support could be extended to cover all parts of the High-Cost Program (as is 

the case in the Schools and Libraries Program).13 Alternatively, the cap could be expanded just to cover new 

entrants’ high-cost loop support.

If spending for the entire High-Cost Program was 

capped, some allocation mechanism would have to be 

devised to determine how the capped funds would be distributed among eligible carriers. Under the current limit 

on high-cost loop support, funds are diverted from eligible incumbents with lower costs and directed to eligible 

incumbents with higher costs, though the overall level of 

support for incumbents is kept below the cap. As now 

administered, that cap offers no incentive for an incumbent carrier to restrain the growth of its costs and instead 

rewards higher-cost carriers that experience cost growth 

with even more support.

If a similar allocation mechanism was put in place for a 

cap on the entire High-Cost Program, incumbents and 

wireless entrants in lower-cost study areas could lose support. Because each wireless entrant in the highest-cost 

areas would continue to receive the same amount of support per line as the incumbent carrier, the diversion of 

support from carriers serving lower-cost areas to those 

serving higher-cost areas would be reinforced. Instead of 

redirecting funds from the lower-cost incumbent to the 

higher-cost incumbent, as happens now, the allocation 

mechanism for an expanded cap would divert funds from 

the lower-cost incumbent and its corresponding wireless 

competitors to the higher-cost incumbent and its corresponding wireless competitors. 

Capping the high-cost loop support received by wireless 

entrants would affect perhaps 7 percent of current highcost support and would save even less.14 As with other 

measures that would limit or reduce the amount of support going to competitive entrants, the cap option would 

put at risk some of the benefits that might be gained from 

competition.

13. Support for schools and libraries is currently capped at $2.25 billion. Outlays have never reached the cap, however, because of the 

lag between commitments and disbursements in that program. 

Over the 2000-2005 period, annual outlays fluctuated between 

$1.5 billion and $1.7 billion.

14. USAC reports that competitive eligible telecommunications carriers will receive more than $280 million in high-cost loop support 

in 2006. Calculated from Universal Service Administrative Company, High Cost Loop Support Projected by State by Study Area, Second Quarter 2006, Appendix HC-05, available at www. 

universalservice.org/about/governance/fcc-filings/2006/quarter2/

default.aspx.
CHAPTER

4

Policies for Restructuring

Intercarrier Compensation

Intercarrier compensation (ICC) consists of payments 

that telephone companies make to one another for connecting, terminating, or otherwise handling each other’s 

calls. The rates charged for those services, usually on a 

per-minute basis, are regulated by federal or state authorities. They vary by jurisdiction, type of carrier, and type 

of call, such as whether the call is within or between states 

(see Table 4-1). 

In many instances, ICC rates have been—and continue 

to be—set above the economic cost of the service provided. Regulators set rates in that way to produce a net 

flow of payments (or cross-subsidies) to local telephone 

companies, largely from long-distance companies. Those 

payments allow local consumer telephone rates to be set 

below their cost. At the same time, however, consumers 

pay more for long-distance service than they would if 

rates accurately reflected the economic costs of each type 

of service.

Federal and state regulators are facing new pressures to 

alter the system of intercarrier compensation. ICC payments to local telephone companies have declined in 

recent years, and those firms are seeking new revenues. 

Long-distance companies, who have been paying the bulk 

of ICC charges, are squeezed more and more by competition and would like to see the revenue flow reduced even 

further. In addition, regulators and policy analysts increasingly see current ICC rates as distorting consumers’ 

choices, especially given the decline in the underlying 

costs of completing telephone calls.1

Virtually all of the discussion about restructuring intercarrier compensation involves reducing payments to local 

telephone companies, most of whom receive support 

from the Universal Service Fund’s High-Cost Program. 

Many of the proposals for restructuring would compensate eligible carriers who lost intercarrier payments with 

payments from the USF. (A similar process of making implicit subsidies explicit occurred in 2002 when interstate 

common line support and interstate access support were 

added to the USF to compensate local carriers for the revenue they lost when long-distance access charges, another 

type of intercarrier compensation, were reduced.)

The Current State of Intercarrier

Compensation

Currently, ICC rates vary in an arbitrary way that reflects 

regulatory history more than an efficient allocation of 

costs. The rates paid to local phone companies for originating and terminating calls range from zero to 36 cents 

per minute. That span does not reflect the underlying 

range of costs of handling those calls. Instead, intercarrier 

charges are set to keep local rates to customers affordable—the stated policy goal of many state regulators. 

Rural telephone companies rely on intercarrier compensation for a large part of their revenue. A survey of those 

carriers by the National Telecommunications Cooperative Association found that ICC payments accounted for 

26 percent of their total revenue—the third-largest source 

of funding behind universal service payments and reve1. Whenever prices do not accurately reflect costs, consumers’ decisions about how much to buy are less effective than they might be 

in steering resources to the most efficient use. The cross-subsidies 

traditionally provided through intercarrier compensation rates are 

even more distorting than subsidies in general. The reason is that 

ICC rates raise the price of long-distance service (whose use is 

more sensitive to changes in price) in order to lower the price of 

local telephone service (whose use is much less sensitive to price 

changes).
18 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Table 4-1.

Intercarrier Compensation Rates

(Cents per minute)

Source: Congressional Budget Office based on Intercarrier Compensation Forum, Ex Parte Brief in Support of the Intercarrier Compensation 

and Universal Service Reform Plan, CC Docket No. 01-92 (October 5, 2004), Appendix C.

Note: ISP = Internet service provider.

nue from customers (see Table 4-2).2 Large telephone 

companies, by contrast, received only 10 percent of their 

revenue from ICC payments.3

 Those companies relied to 

a much greater extent on sales of their services than on 

regulated payments.

The number of calls subject to intercarrier compensation 

has been falling in recent years (see Table 4-3). Consequently, the flow of ICC payments to local telephone 

companies declined by 13 percent between 2000 and 

2004. ICC rates have fallen too as subsidies to local service providers have become explicit parts of universal service support, although rates remain high enough in some 

cases to distort consumers’ choices.4

Rural telephone companies want to insulate themselves 

against further declines in one of their three main sources 

of income. However, long-distance companies want to 

reduce, if not eliminate, the patchwork quilt of ICC rates 

that apply to calls within or between states. Proposals to 

restructure intercarrier compensation have taken many 

forms, and the points of view of the various parties are 

often far apart. 

Large carriers 1.5 0.5 0.6

Small carriers 8.9 0.3 1.8

Large carriers 9.9 0.4 2.5

Small carriers 34.9 0.7 5.1

6.8 0.2 1.8

35.9 0.4 3.0

Non-ISP bound 0.3 0 0.2

ISP bound 0.1 0 0.1

8.9 0.2 0.6

0.3 0 0.2

Incumbent Local Exchange Carriers

Interstate calls

Competitive Local Exchange Carriers

Reciprocal Compensation Between Local Carriers

Commercial Mobile Radio Service

to Incumbent Local Exchange Carriers

Average Rate

Between metropolitan trading areas

Within a metropolitan trading area

Highest Rate Lowest Rate

Intrastate calls

Interstate calls

Intrastate calls

2. A survey by a different trade association reported that 29 percent 

of rural carriers’ total operating revenue came from intercarrier 

compensation. Ten percent of those companies received at least 

half of their revenue from ICC payments. See National Exchange 

Carrier Association, Comments of the National Exchange Carrier 

Association, Inc., Before the Federal Communications Commission in 

the Matter of Developing a Unified Intercarrier Compensation 

Regime, CC Docket No. 01-92 (May 23, 2005), available at 

www.neca.org/media/052305NECAICFinalFiling.pdf.

3. National Telecommunications Cooperative Association, Ex Parte 

Presentation to the FCC: Intercarrier Compensation and Incumbent 

Rural Exchange Carriers (January 6, 2004).

4. For that argument, see, for example, National Association of State 

Utility Consumer Advocates, Initial Comments of the National 

Association of State Utility Consumer Advocates Before the Federal 

Communications Commission in the Matter of Developing a Unified 

Intercarrier Compensation Regime, CC Docket No. 01-92 (May 

23, 2005), available at www.nasuca.org/Intercarrier%20

Compensation%20Comments.pdf.
CHAPTER FOUR POLICIES FOR RESTRUCTURING INTERCARRIER COMPENSATION 19

Table 4-2.

Sources of Revenue for Rural 

Incumbent Carriers

Source: Congressional Budget Office based on data from the 

National Telecommunications Cooperative Association.

Effects of Changing Intercarrier 

Compensation 

The process of restructuring intercarrier compensation is 

largely regulatory. There is disagreement about how 

much the Federal Communications Commission can 

accomplish alone: some analysts argue that without specific authorization by the Congress, the FCC cannot alter 

intercarrier compensation rates within a state.5 Beyond 

that stricture, however, most of the restructuring process 

is expected to occur without changes in current law.

All proposals for restructuring confront the common 

arithmetic that reducing ICC rates will further reduce 

rural carriers’ revenue and that the only alternatives available for restoring that revenue are universal service subsidies and higher consumer prices. Significantly raising the 

prices charged to rural customers may run counter to the 

goals of the Communications Act. Thus, under most proposals, the Universal Service Fund would bear much or 

all of the brunt of lowering ICC rates. 

Some analysts, however, have asked whether telephone 

carriers should also bear part of the burden of changes in 

ICC policy by reducing their revenue flows. More pointedly, moving the revenue stream from intercarrier compensation to the USF intact would shield rural carriers 

from competition. If intercarrier compensation remains 

in its current form, competition from other carriers that 

face different rates and from modes of communication 

other than telephone threatens to erode it further. But 

once incorporated into the USF, rural carriers’ revenue 

stream would no longer be subject to such competition.

Specific Proposals and Their Costs to the Universal 

Service Fund

In an FCC filing, the National Exchange Carrier Association (NECA) compared various proposals for restructuring intercarrier compensation to determine how they 

would split the burden among the different revenue 

sources—intercarrier compensation itself, telephone subscribers, and the Universal Service Fund (see Table 4-4). 

Major proposals include the following:

B The Rural Alliance proposes reducing intrastate access 

rates to a national benchmark and increasing some local residential rates to a national benchmark. The difference between local carriers’ revenues before and 

after the change in rates would be made up through 

additional USF payments.

B The National Association of Regulatory Utility Commissioners proposes to eliminate originating access 

charges and reduce terminating access charges, with 

no change in residential rates. Affected telephone 

companies would be compensated through higher 

USF subsidies.

B The Intercarrier Compensation Forum proposes eliminating most originating and terminating access rates

Table 4-3.

Incumbent Carriers’ Long-Distance 

Traffic and Intercarrier Compensation, 

2000 to 2004

(By calendar year)

Source: Congressional Budget Office based on data from the Federal Communications Commission.

Note: N.A. = not available. 5. Ibid., pp. 40-43.

Charges Paid by Subscribers 27

Intercarrier Compensation 26

Federal and State Universal Service Subsidies 30

Other 17

Percentage of

Total Revenue

2000 106.0 12.3

2001 97.8 10.7

2002 90.0 9.6

2003 81.2 10.0

2004 N.A. 10.7

Millions of Toll

Calls Reported

by Incumbents

Intercarrier

Compensation

(Billions of dollars)
20 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Table 4-4.

Cost to the Universal Service Fund of Alternative Plans to Restructure

Intercarrier Compensation

(Millions of dollars)

Source: Congressional Budget Office based on National Exchange Carrier Association, Comments of the National Exchange Carrier Association, Inc., Before the Federal Communications Commission in the Matter of Developing a Unified Intercarrier Compensation 

Regime, CC Docket No. 01-92 (May 23, 2005).

Note: NECA = National Exchange Carrier Association; USF = Universal Service Fund.

a. As the Rural Alliance had not proposed a specific plan, NECA modeled a composite of proposals by the Alliance for Rural Intercarrier 

Compensation and the Expanded Portland Group (a group of rural incumbent local exchange carriers). 

b. Members of the National Exchange Carrier Association received about three-quarters of the subsidies paid by the High-Cost Program in 

2003.

c. Includes $0.8 billion from eliminating the current cap on high-cost loop support.

and moving to a system in which each carrier would 

be responsible for recovering all of its network costs 

from its customers. The proposal would maintain 

residual per-minute charges for certain rural carriers, 

however. Revenues lost by carriers would be recovered 

through increases in all subscriber line charges and in 

USF support.

NECA’s analysis looked at the records of its member 

companies and calculated how much of the $8.0 billion 

in income they received in 2003 came from subscriber 

fees, intercarrier compensation, and universal service subsidies. NECA then modeled the various proposed rate 

changes to determine the extent to which they would 

lower revenues relative to a baseline estimate of the calls 

and minutes handled by NECA members.

The analysis was limited to the effects on a sample of the 

association’s members, which accounted for $2.5 billion 

of the $3.3 billion spent by the USF’s High-Cost Program in 2003. Changes like those described above would 

also affect other carriers; as a result, the costs to the USF 

would probably be greater than NECA’s estimates.

In the three proposals that NECA modeled, the majority 

of the revenues lost from changing intercarrier compensation would be made up through increases in spending by 

the Universal Service Fund. For example, under the Rural 

Alliance’s proposal, intercarrier compensation payments 

were estimated to fall from $2.3 billion to $1.4 billion. 

To compensate, the proposal would raise subscribers’ 

rates to collect an additional $0.3 billion in revenue and 

would increase USF payments by $0.6 billion, a 25 percent rise. The increase in USF support would be much 

higher under the other two proposals: more than 60 percent. (The analysis is static and does not account for 

changes from the 2003 baseline in the number of calls 

and minutes of use.)

2.3 1.4 0.6 0.4

3.2 3.5 3.2 3.5

2.5 3.1 4.2 4.1

___ ___ ___ ___

Total 8.0 8.0 8.0 8.0

0 0.6 1.7 1.6

To all eligible carriers 0 0.8 2.3 2.9 c

Intercarrier

To NECA members

USF support

Revenue of NECA Membersb

Intercarrier compensation

(2003)

Charges paid by subscribers

Proposals for Restructuring Intercarrier Compensation 

Relative to 2003 Level

Forum

Current Policy

National Association

of Regulatory Utility Compensation

Increase in USF Support 

Rural Alliancea Commissioners
CHAPTER FOUR POLICIES FOR RESTRUCTURING INTERCARRIER COMPENSATION 21

The proposal by the Intercarrier Compensation Forum 

also calls for removing the current cap on high-cost loop 

support. NECA estimates that in 2006, that cap will 

make support for incumbent rural carriers $0.6 billion 

lower than it would be otherwise.6

 Under current law, if 

the cap was eliminated, competitive eligible telecommunications carriers would also receive an increase in USF 

support, since their funding is tied to incumbents’ perline payments. The Universal Service Administrative 

Company projects that competitive entrants will receive 

$0.3 billion in high-cost loop support (on an annual 

basis) for 2006. If their funding rose by the same proportion as incumbents’ when the cap was lifted, they would 

receive an additional $0.2 billion. Consequently, removal 

of the cap would increase spending for high-cost loop 

support by a total of $0.8 billion, in addition to the other 

USF costs imposed by the Intercarrier Compensation 

Forum’s proposal. 

Some critics have argued that lifting the cap on high-cost 

loop support is not a necessary part of restructuring intercarrier compensation. Although removal of the cap could 

be incorporated into any plan to reduce ICC payments, it 

is not bound to any specific strategy for lowering intercarrier compensation rates.

As noted above, the NECA analysis accounted for only 

$2.5 billion of the $3.3 billion spent by the High-Cost 

Program in 2003. To extrapolate the cost of the three 

proposals to the entire program, CBO multiplied 

NECA’s estimates by 1.32 (3.3 ÷ 2.5). Based on that 

calculation, the increases in USF spending would range 

from $0.8 billion under the Rural Alliance’s proposal to 

$2.9 billion under the Intercarrier Compensation 

Forum’s proposal (see Table 4-4). That latter figure 

includes $0.8 billion for removing the cap on high-cost 

loop support.

Other options to restructure intercarrier compensation 

are available. Most notably, the system of ICC payments 

could be scrapped entirely in favor of a “bill and keep” 

system. Under that approach, each carrier would simply 

bill its own clients and make no payments to other carriers for interconnection. To implement such a system, policymakers would have to decide how to split the amount 

that rural telephone companies currently receive in intercarrier compensation among rural customers, the USF, 

and reduced company profits. (NECA did not model this 

policy option precisely because it was not sure how to 

allocate that amount.) Forcing consumers to bear the 

entire cost would require increasing their payments to 

rural telephone companies by more than 70 percent, 

which could well violate the Communications Act’s mandate of keeping rural telephone rates roughly comparable 

with urban rates. Consequently, a wholesale move to a 

bill-and-keep system would probably also lead to an 

increase in USF spending.

Economic Effects of Restructuring

Altering ICC rates would be likely to change which 

groups of consumers pay for service in rural areas. Assuming that the telephone companies that pay those rates pass 

them on to their customers in the form of higher prices, 

ICC payments now come mainly from consumers who 

place calls into and out of high-cost areas. Reducing ICC 

payments and increasing USF support would transfer the 

burden from consumers making calls in high-cost areas to 

all long-distance customers across the country. 

If subscribers’ line charges and other local rates were 

raised to compensate for a reduction in ICC charges, a 

second distributive consequence of restructuring could be 

to shift costs from high-use customers to low-use customers. At the same time, because the subscriber line charge 

is levied on local telephone access (demand for which is 

less sensitive to price changes), whereas intercarrier compensation fees are levied on long-distance calls (demand 

for which is more price sensitive), that shift in the cost 

burden should reduce the distortions imposed by current 

fees.

Increasing USF spending to compensate for reducing 

intercarrier compensation might not produce many benefits for the economy as a whole. The current system of 

subsidies implicit in the ICC rate structure raises longdistance costs and so distorts consumers’ choices, possibly 

causing economically inefficient behavior. Moving to a 

system of explicit subsidies provided by the Universal Service Fund would distort consumers’ choices to a lesser 

degree and thus improve economic efficiency. However, 

since the current financing mechanism for the USF also 

raises long-distance costs (albeit on a wider basis since it 

6. Total support for rural incumbents is forecast to be almost $1.1 

billion with the cap, whereas without the cap it would be nearly 

$1.7 billion. See National Exchange Carrier Association, Overview 

and Analysis of 2005 USF Data Submission (September 30, 2005), 

pp. 3 and 4, available at www.fcc.gov/Bureaus/Common_Carrier/

Reports/FCC-State_Link/Monitor/usf05af.zip
22 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

includes cell phone calls), the net economic gains might 

not be substantial.7

Limiting the Impact on USF Spending

If USF payments do grow because of reductions in intercarrier compensation, the payments could be structured 

in such as way as to avoid committing any new resources 

to cross-subsidies or even to reduce cross-subsidy 

amounts. Currently, competitive entrants are eligible for 

the same per-line payments from the USF as the incumbent serving the same area. That equivalence means that 

wireless entrants receive payments from the USF that 

were originally intended to compensate incumbents for 

reducing their long-distance access rates at a time before 

most new entrants had entered the market. Careful 

design of USF payments to partly replace lost intercarrier 

compensation could result in a reduced flow of resources 

to competitive entrants, on net. That change would 

require at least partly decoupling the support given to 

incumbents from the support given to competitive 

entrants.

7. See Jerry Ellig, “Intercarrier Compensation and Consumer Welfare,” University of Illinois Journal of Law, Technology, and Policy

(Fall 2004), pp. 97-124.
CHAPTER

5

Policies for Funding Broadband Internet Access

High-speed Internet access (known as broadband) 

is not one of the services for rural households supported 

under the Universal Service Fund’s High-Cost Program.1

However, the Congress is considering ways to accelerate 

the deployment of rural broadband, and it may turn to 

the USF as a means of achieving that goal. Various legislative proposals have been introduced that would increase 

funding for rural broadband.2

Although rural broadband is not an officially supported 

service, the High-Cost Program does promote it indirectly. Such aid occurs when the program subsidizes 

investments that rural carriers make to upgrade their 

telephone networks. The upgraded networks are generally capable of offering both conventional telephone service and new digital services, including broadband. Once 

made, some of those investments become part of the historical costs that rural carriers use in filing for funding 

from the High-Cost Program.

The Prevalence of Broadband 

Connections and Prospects for Growth

Under the 1934 Communications Act, one of the criteria 

that the Federal Communications Commission and the 

Federal-State Joint Board on Universal Service are supposed to use in determining whether a telecommunications service is eligible for USF support is whether a substantial majority of residential customers nationwide 

already subscribe to it.3 Currently, only a minority of 

residential customers purchase high-speed access to the 

Internet, although the number of subscriptions has been 

growing rapidly. Between December 1999 and June 2005 

(the most recent period for which the FCC has released 

data), subscriptions for high-speed Internet access increased at an average rate of 73 percent a year among 

households and small businesses.4 (Until its most recent 

release, the FCC did not separate residential consumers 

from small businesses. As a result, its data before 2005 

overstate the amount of residential broadband access.) 

From less than 2 million at the end of 1999, the number 

of broadband subscribers rose to more than 38.5 million 

by mid-2005 (see Figure 5-1)—or about 34 percent of 

the 113 million households in the United States.5

The potential for growth in the number of households 

with a broadband connection is usually thought to be 

limited by the number of households with computers. 

According to a survey by the Census Bureau, 69.9 million 

U.S. households, or 62 percent, had a computer in 2003 

(the most recent year for which those data are available).6

The survey also found that 61.8 million, or 55 percent, of 

households had Internet access, including both broadband and dial-up connections.

1. Broadband access for public schools, libraries, and rural nonprofit health care providers is subsidized by the relevant USF

programs.

2. For a list of broadband-related legislation introduced in the current Congress, see Angela A. Gilroy and Lennard G. Kruger, 

Broadband Internet Regulation and Access: Background and Issues, 

CRS Issue Brief IB10045 (Congressional Research Service,

June 6, 2006), pp. 11-15.

3. As laid out in section 254c of the 1934 law (as amended), the 

other criteria are whether the service is essential to health, education, or public safety; is already being deployed by carriers over 

their public networks; and is consistent with public interest, convenience, and necessity.

4. Federal Communications Commission, High-Speed Services for 

Internet Access: Status as of June 30, 2005 (April 2006), Table 14, 

available at www.fcc.gov/wcb/iatd/comp.html. Earlier data were 

obtained from earlier years of the same publication.

5. Jennifer Day, Alex Janus, and Jessica Davis, Computer and Internet 

Use in the United States: 2003 (Bureau of the Census, October 

2005). The estimated number of households is for 2003.

6. Ibid.
24 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Figure 5-1.

Number of Residential and Small-Business Subscribers to Broadband

Internet Access, 1999 to 2005

(Millions)

Source: Congressional Budget Office based on data from the Federal Communications Commission.

Note: DSL = digital subscriber line.

a. Data for 2005 are for residential subscribers only.

Those various statistics suggest significant room for 

growth in the amount of residential broadband. However, 

they also indicate that a majority of households do not 

currently buy broadband service and that such service 

does not yet meet the requirements for coverage under 

the Universal Service Fund.

Even without additional support, the number of broadband subscribers in rural areas is likely to rise. According 

to FCC data, high-speed telecommunications are becoming increasingly available throughout the nation, including areas with low population densities. Fewer than 5 percent of zip code areas have no broadband provider serving 

them (see Figure 5-2). Two-thirds of zip codes have three 

or more providers, and most of those are served by at least 

five providers. (A few years ago, by comparison, fewer 

than 20 percent of zip codes had five or more broadband 

providers.) In zip code areas with a population density of 

just 15 to 25 people per mile, 95 percent had at least one 

broadband provider offering service in June 2005, up 

from 39 percent in December 2000.7

 In the case of many 

large, sparsely populated zip codes, however, broadband 

service is available in only part of the area.

The National Exchange Carrier Association sets terms 

and conditions under which its member telephone companies, the vast majority of which operate in rural areas, 

can offer Internet access. Currently, about 920, or threequarters, of the carriers operating under those terms offer 

residential digital subscriber line (DSL) service—the 

most common form of telephone-based broadband technology—for $30 per month. In addition to those rural 

providers, nonrural carriers, cable companies, and satellite companies offer broadband service to people in highcost areas.

Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05

0

5

10

15

20

25

30

35

40

Cable

DSL and Wireline

Satellite and Other

a

7. Federal Communications Commission, High-Speed Services for 

Internet Access: Status as of June 30, 2005, Table 17, available at 

www.fcc.gov/wcb/iatd/comp.html. Earlier data were obtained 

from earlier years of that publication.
CHAPTER FIVE POLICIES FOR FUNDING BROADBAND INTERNET ACCESS 25

Figure 5-2.

Number of Broadband Providers per Zip Code Area, 1999 to 2005

(Percentage of zip codes)

Source: Congressional Budget Office based on data from the Federal Communications Commission.

Although all of the indicators point to the growth of 

broadband in rural parts of the country, a gap remains 

between urban and rural subscription rates. In its most 

recent survey of Internet use, the Pew Internet and American Life Project found that 39 percent of urban and suburban households had high-speed Internet connections at 

home, compared with only 24 percent of rural households.8

 Nevertheless, rural broadband subscriptions are 

growing so rapidly that, today, subscription rates among 

rural households are at the level seen among nonrural 

households just two years ago.

Funding for Rural Broadband 

Under Current Policy

The federal government currently promotes rural broadband through two main avenues: the Universal Service 

Fund and subsidized credit programs run by the Department of Agriculture’s Rural Utilities Service (RUS).

Rural Broadband in the High-Cost Program

The USF’s Schools and Libraries Program and Rural 

Health Care Program subsidize broadband access, as well 

as other telecommunications services, among their target 

groups. The much larger High-Cost Program does not 

explicitly fund investment in broadband, but many of the 

investments that its does support allow carriers to deliver 

both conventional telephone and broadband service. Like 

carriers everywhere, rural companies are improving their 

older local loops and running more high-capacity and 

high-quality fiber-optic cable closer to their customers. 

Those upgrades are included in the historical costs that 

serve as the basis for high-cost loop support; thus, current 

policy implicitly provides funds for broadband in rural 

areas.

Whether such upgrades are motivated by the intention to 

provide broadband or better conventional telephone service is not immediately clear. However, the fact that wireline carriers as a whole have been losing subscribers and 

long-distance revenue over the past half decade suggests 

that at least part of the new investment in local loops has 

been made with the expectation of generating revenue 

from broadband subscriptions.

Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05

0

10

20

30

40

50

60

No Providers One or Two Providers Three or Four Providers Five or More Providers

8. John Horrigan and Katherine Murray, “Rural Broadband Internet 

Use” (data memo, Pew Internet and American Life Project, Washington, D.C., February 2006), available at http://207.21.232. 

103/pdfs/PIP_Rural_Broadband.pdf.
26 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Table 5-1.

Local Loop Investment by Carriers, 

1999 and 2004

(By calendar year)

Source: Congressional Budget Office based on data from the 

National Exchange Carrier Association.

According to data provided by NECA, rural carriers 

invested $20.1 billion in their lines in 1999 (excluding 

those specifically designated as broadband). By 2004, that 

investment had increased by 38 percent to $27.7 billion 

(see Table 5-1). Nonrural carriers expanded their line 

investment by only 15 percent during the same period.

Not all of the increase in investment, however, can be 

attributed to upgrading networks. Some resulted from 

increasing the number of local loops in rural areas by 3 

percent during that period (even as the overall number of 

wireline loops nationwide declined). Most of those new 

loops were in exurban areas (distant suburbs), which are 

usually less expensive to serve than isolated rural homes. 

Consequently, the 3 percent rise in the number of lines is 

unlikely to explain the entire 38 percent increase in 

investment. 

Recent surveys of investment patterns among rural carriers offer more-direct evidence of the dual purpose of such 

investments. In a survey of its rural members, the National Telecommunications Cooperative Association 

found that 81 percent of respondents were using their 

investment in fiber loop to extend the reach of DSL service.9

 Furthermore, much of that investment was devoted 

to speeding up potential connections rather than simply 

establishing basic broadband connections.

The cap on high-cost loop support for incumbent carriers 

limits USF support for broadband to only those carriers 

with very high costs. Investments made by carriers with 

lower costs are ineligible for funding.10 Nevertheless, it 

appears that almost all rural carriers have increased their 

funding for broadband.

Broadband Programs of the Rural Utilities Service

The Rural Utilities Service in the Department of Agriculture runs several broadband programs in addition to its 

conventional telephone credit programs. Those initiatives 

contribute to getting broadband more universally 

adopted; they are also likely to indirectly raise costs for 

the Universal Service Fund. 

The main RUS broadband program—the Rural Broadband Access Loan and Loan Guarantee Program—is 

designed to make credit available in eligible rural communities for construction, improvement, or acquisition 

of facilities and equipment to provide broadband services. 

The program, which includes both mandatory and discretionary spending, has approved $824 million in loans 

to 50 organizations. The interest rates on most of those 

loans are relatively low Treasury rates; a small number of 

loans are available at the even lower rate of 4 percent. In 

2006, the program is expected to make available $1.1 billion in Treasury rate loans and $64 million in 4 percent 

loans (see Table 5-2). There are no private-lender guarantees this year. Because of the high repayment rate for telephone loans, the government’s subsidy costs are low. 

Extending that credit is expected to cost $29 million in 

budget authority and $8 million in outlays in 2006.

The RUS program is intended to benefit places that have 

fewer than 20,000 inhabitants.11 Many different types of 

organizations are eligible: corporations, cooperatives, 

Indian tribes, and public bodies. Carriers that serve more 

than 2 percent of the telephone subscriber lines installed 

in the United States are not eligible for RUS broadband 

loans. 

9. National Telecommunications Cooperative Association, NCTA 

2005 Broadband/Internet Availability Survey Report (September 

2005), available at www.ntca.org/content_documents/

2005NTCABroadbandSurveyReport.pdf.

Rural Carriers 20.1 27.7 38

Nonrural Carriers 120.8 138.7 15

Investment in Percentage

Change,

1999 2004 1999-2004

Billions of Dollars

10. Since 95 percent of the support for competitive entrants goes to 

cellular providers, the amount that competitive entrants spend on 

broadband is not yet substantial. Wireless broadband service is 

still very limited among cellular companies.

11. Despite that limitation, a recent audit by the Department of Agriculture Inspector General’s office found that almost one-third of 

the RUS broadband loans that the office investigated went to suburban communities surrounding large cities. See Department of 

Agriculture, Office of Inspector General, Broadband Grant and 

Loan Programs, Audit Report 09601-4-Te (September 30, 2005), 

p. i.
CHAPTER FIVE POLICIES FOR FUNDING BROADBAND INTERNET ACCESS 27

Table 5-2.

Budget for the Rural Utilities Service’s 

Broadband Loan Program

(Millions of dollars)

Source: Congressional Budget Office based on data from the 

Office of Management and Budget.

a. No activity.

A wide array of broadband-related activities can be 

financed by such loans. Recipients can use them to buy 

new facilities or improve existing ones or to lease facilities 

for up to five years with an option to buy. Assets can be 

acquired, and some earlier RUS-financed loans can be 

refinanced. The loans cannot be used for financing installations or equipment at customers’ premises, for mergers 

and consolidations, or for administrative operating

expenses.

So far, the RUS program has not used all of its loan 

authority. Many applicants have not been approved, for 

a variety of reasons; the bulk of the loans that have been 

approved have gone to existing telephone companies.12

The RUS is redesigning its application procedures to 

expedite the loan-making process.

Although the broadband program has been operating for 

only a few years, the Rural Utilities Service has been providing credit to rural telephone companies for decades. 

Like other financed investments, the plant and equipment funded by RUS loans and loan guarantees enters 

the rate base for the purposes of calculating a carrier’s historical costs—and thus its payments from the Universal 

Service Fund’s High-Cost Program. Similarly, an expansion of the RUS broadband program, to the extent that 

added funding went to carriers who were eligible for USF 

support, would tend to increase USF spending (subject to 

the cap on high-cost loop support for incumbents).

Such an increase would be limited to investments that a 

carrier could justify as helping to provide USF-supported 

services. At the same time, the carrier would have to justify the investments to the RUS as extending broadband 

access to the rural community in question. In the past, 

the Universal Service Administrative Company and the 

FCC have been fairly liberal about approving investments 

that carriers claim will further the cause of universal service.13 The RUS has been much more stringent in 

approving applications for its broadband loans. But as 

noted above, the RUS has been signaling that it intends 

to streamline its loan process. 

A second, much smaller RUS broadband program—

Community Connect—is designed to offer grants to 

rural and economically challenged communities to provide broadband for their public institutions (and for businesses and residences, if possible).

Broadband Proposals and the

USF Budget

Several policies have been proposed to accelerate the 

deployment of broadband in rural areas. Some proposals 

would explicitly include broadband as a service supported 

by the High-Cost Program. Although not all policies are 

directly tied to the Universal Service Fund, if they encourage investment by carriers that are eligible for USF 

funding, they may increase the USF’s costs. Other policies propose no new federal spending but rather offer to 

make more spectrum available to encourage rural broadband through wireless technologies.

Members of Congress have introduced many proposals to 

increase the availability of broadband in rural areas. Most 

recently, S. 2686 proposes adding an account to the USF 

to provide financial assistance for the deployment of 

broadband service in unserved areas. That account would 

be capped at $500 million annually. S. 2686 does not 

limit the assistance to eligible telecommunications carriers but rather requires the FCC to set up a competitive 

selection process. The approach of providing a limited 

amount of funding and selecting areas to receive it 

through a competitive process is similar to that used in 

the Schools and Libraries Program.

12. Vikas Bajaj, “Money Is There to Aid Rural Internet, but Loans 

Are Hard to Get,” New York Times, November 29, 2005.

Four Percent Loans 64

Treasury Rate Loans 1,085

Loan Guarantees 0 a

Fiscal Year 2006

13. John Nakahata, “Comments before the Digital Age Communications Act Universal Service Working Group: Discussion of a 

Working Group Draft Document” (Progress and Freedom Foundation, Washington, D.C., December 7, 2005).
28 FACTORS THAT MAY INCREASE FUTURE SPENDING FROM THE UNIVERSAL SERVICE FUND

Alternatively, if the Congress wanted to increase support 

for broadband service in rural areas, it might consider 

placing such support outside the Universal Service Fund 

and making the amounts spent subject to the same budgetary trade-offs that other discretionary programs

experience.

Even if lawmakers did not explicitly authorize the expansion of rural broadband service, the USF would continue 

to provide financing for some investments that facilitate 

the development of rural broadband. For example, such 

funding goes to pay for infrastructure investments by carriers that let them provide both conventional telephone 

service and advanced services, including broadband.



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