CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

CBO

PAPER

MARCH 2005

Financing

Universal

Telephone

Service

S. Alden/Photolink/Photodisc/Getty Images

The Congress of the United States O Congressional Budget Office

CBO

Financing Universal Telephone Service

March 2005

A

PAPER
Notes

Numbers in the text and tables of this paper may not sum to totals because of rounding.

Unless otherwise indicated, all years referred to in this paper are calendar years.
Preface

Under the Telecommunications Act of 1996, the Universal Service Fund (USF) 

supports both traditional telephone service and advanced telecommunications services, particularly in rural and other remote regions that otherwise might not be served by telecommunications companies. Since the enactment of the 1996 law, universal access has been financed by 

a federal tax on interstate and international long-distance calls. However, a recent decline in 

revenues generated by long-distance service has raised concern about the desirability of that 

financing mechanism. 

This Congressional Budget Office (CBO) paper—prepared at the request of the Senate Budget Committee—examines recent trends in the financing sources that underlie universal service and analyzes options for change. In keeping with CBO’s mandate to provide objective, 

impartial analysis, this report makes no recommendations.

Philip Webre of CBO’s Microeconomic and Financial Studies Division prepared the paper 

under the supervision of Roger Hitchner and David Moore. The paper benefited from comments by Coleman Bazelon, Billy Jack Gregg, Jim Lande, and Paul Vasington. (The assistance 

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

with CBO.) Within CBO, Kim Cawley, Bob Dennis, Pete Fontaine, Arlene Holen, Bob Murphy, Sarah Puro, Tom Woodward, Dennis Zimmerman, and Melissa Zimmerman offered 

helpful suggestions. 

Loretta Lettner edited the manuscript, and Christian Spoor proofread it. Angela Z. McCollough prepared drafts of the paper. Maureen Costantino designed the cover and prepared the 

paper for publication. Lenny Skutnik produced the printed copies, and Annette Kalicki prepared the electronic version for CBO’s Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

March 2005

Summary vii

1 Introduction 1

Budgetary and Administrative Background 2

Telecommunications Revenues, the USF Revenue Base, 

and the Contribution Factor 4

2 Options for Financing Universal Service 13

Expand the Contribution Base of the Current System 13

Establish Fees Based on Telephone Numbers 14

Establish Fees Based on the Capacity of Telephone Lines 15

Distributional Issues 15

3 The Economic Cost of Alternatives for Financing 

Universal Service 19

Economic Distortions from the Current Mechanism 

and Alternatives 19

USF Fees and Competing Advanced Telecommunications 

Services 20

Funding the USF Through General Revenues 20

CONTENTS
vi FINANCING UNIVERSAL TELEPHONE SERVICE

Tables

S-1. Receipts and Outlays of the Universal Service Fund, 1999 to 2004 viii

S-2. The Contribution Base for the Universal Service Fund in Relation 

to Telecommunications Revenues, 1997 to 2004 ix

S-3. Distribution of Telecommunications Companies’ Contributions to 

the USF Under Different Financing Mechanisms, 2003 and 2007 x

S-4. Distribution of Business and Residential Consumers’ Share of USF 

Contributions Under Different Financing Mechanisms, 2003 

and 2007 xi

1-1. Receipts and Outlays of the Universal Service Fund, 1999 to 2004 4

1-2. Telecommunications Industry Revenues, 2003 5

1-3. The Contribution Base for the Universal Service Fund in Relation 

to Telecommunications Revenues, 1997 to 2004 7

2-1. Distribution of Telecommunications Companies’ Contributions to 

the USF Under Different Financing Mechanisms, 2003 and 2007 17

2-2. Distribution of Business and Residential Consumers’ Share of USF 

Contributions Under Different Financing Mechanisms, 2003 

and 2007 18

Figures

1-1. Annual Changes in Consumer Long-Distance Prices 8

1-2. Share of Contributions to the Universal Service Fund, 

by Type of Company 9

1-3. Universal Service Fund Contribution Factors, by Quarter 10

Boxes

1-1. How USF Contributions Are Collected 3

1-2. Fees for Telecommunications Spending 6

1-3. The Universal Service Fund and the Antideficiency Act 11
Summary

The Telecommunications Act of 1996 reaffirmed 

and expanded federal policy regarding the concept of universal telephone service. The goal of universal service is to 

ensure that the largest number of U.S. residents possible 

have access to high-quality telephone service regardless 

of their household income or geographic location. The 

1996 law further authorized the Federal Communications Commission (FCC) to make advanced telecommunications services available to qualifying schools, libraries, 

and rural nonprofit health care providers at subsidized 

rates. 

To achieve the law’s stated objectives, the FCC requires 

that telecommunications carriers contribute a percentage 

of the revenues they derive from long-distance telephone 

and other interstate and international services to the Universal Service Fund (USF). The USF, in turn, disburses 

payments to eligible carriers that provide the services that 

federal policy seeks to make widely available. Overall responsibility for the process lies with the FCC, which, in 

conjunction with state utility regulators, determines the 

level of spending necessary to meet the requirements of 

the law and ensures that telecommunications companies 

make adequate contributions. The Universal Service Administrative Company (USAC), a not-for-profit corporation regulated by the FCC, administers the specific programs that promote universal service. The USAC collects 

the funds to pay for the programs and dispenses payments to eligible telecommunications providers. Because 

payments into and disbursements from the USF are 

required by law, they are counted as revenues and outlays 

in the federal budget.

Since the enactment of the Telecommunications Act, 

spending for USF programs has steadily increased. Meanwhile, the revenue base that is taxed to fund those programs has eroded. Some observers argue that rapid 

changes in the telecommunications marketplace have 

rendered the current financing system increasingly impracticable and unfair. As a consequence, FCC officials 

and other policymakers have begun to explore new ways 

of funding universal service. In this report, the Congressional Budget Office (CBO) focuses on the current system of USF financing and discusses proposals to change 

that system.

The Universal Service Fund’s

Structure, Spending, and Revenues

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 and its territories. Those mechanisms for providing widespread telecommunications services include the High Cost support 

program, the Low Income support program, the Schools 

and Libraries support program, and the Rural Health 

Care support program. The High Cost mechanism assists 

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 local telephone companies with funds 

that enable them to offer discounts on the installation of 

standard residential telephone service or assistance with 

monthly service charges. The Schools and Libraries support program provides financial assistance to schools and 

libraries for the purchase and installation of advanced 

telecommunications services (such as high-speed Internet 

access). Finally, the Rural Health Care support mechanism assists eligible medical facilities by ensuring that 

they pay no more than urban health care providers do for 

comparable advanced telecommunications services.

The USF operates by collecting mandatory contributions 

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

and providers. Those contributions are based on a percentage of the revenues derived from providing interstate 

and international services, subject to certain adjustments. 

Telecommunications companies may recover all or part of 
viii FINANCING UNIVERSAL TELEPHONE SERVICE

Summary Table 1.

Receipts and Outlays of the Universal Service Fund, 1999 to 2004

(By fiscal year, in billions of dollars)

Source: Congressional Budget Office.

Note: * = less than $50 million.

their payments to the USF by passing the cost along to 

their customers. 

In the High Cost and Low Income support programs, 

telecommunications companies that provide local telephone service to high-cost areas or low-income individuals receive disbursements from the USF, which in turn 

allow them to offer services to targeted markets and individuals at a lower price than would otherwise prevail. In 

fiscal year 2004, those disbursements accounted for about 

three-quarters of USF outlays (see Summary Table 1). In 

the Schools and Libraries program—which constituted 

about one-quarter of 2004 outlays—the USF provides 

grants to schools and libraries for the purchase of advanced telecommunications equipment and service. 

(Spending on rural health care providers is minimal.)

Since the enactment of the 1996 law, the Universal Service Fund has collected more than it has spent. In an 

effort to keep the fund in balance, the FCC adjusts the 

assessment rates charged to providers quarterly. But because a lag exists between when the USF commits to 

projects in the Schools and Libraries program and when 

it actually pays for those projects, the USF carried a cash 

balance of $3.4 billion at the end of fiscal year 2004. 

Outlays from the USF grew from $3.3 billion in fiscal 

year 1999 to $5.7 billion in fiscal year 2004.1 Growth in 

the High Cost support program accounted for most of 

that expansion—not only because more resources were 

being devoted to providing telecommunications services 

to areas under its jurisdiction, but also because previously 

uncounted intercarrier payments were included in tallies 

of USF spending for the first time under the 1996 law. In 

addition, a portion of the increase in USF spending 

stemmed from the growth of the newly created programs 

to provide schools, libraries, and rural nonprofit health 

care providers with advanced telecommunications. 

The contribution base that funds the USF has been 

declining in absolute terms since 2000 (see Summary 

Table 2). Before that time, that revenue base had been on 

the upswing, but a decline in long-distance revenues

—due in large part to a decrease in long-distance prices—

reversed that trend. The revenue base fell by 5 percent 

between 2000 and 2003, but USF outlays (converted to a 

calendar year basis) rose by 32 percent during that period. 

Thus, the fact that the percentage of eligible telecommunications revenues that providers must pay into the fund 

—the contribution rate—has grown in recent years can 

be attributed more to increased spending than to the decline in the revenue base. 

The FCC imposes USF fees on the following types of residential and business service: landline voice service, cellular telephone service, and digital subscriber line (DSL) 

service. USF fees on landline telephone service have two 

principal components. First, interstate and international 

long-distance revenues are subject to fees that increase in

1999 2000 2001 2002 2003 2004

Receipts 3.7 4.5 5.2 5.4 5.7 6.4

Outlays

High Cost 1.7 1.9 2.6 2.8 3.3 3.4

Low Income 0.5 0.5 0.6 0.7 0.7 0.8

Schools and Libraries 1.0 1.6 1.7 1.6 1.6 1.5

Rural Health Care 0.1 * * * * *

Total 3.3 4.0 4.9 5.1 5.6 5.7

1. Some states have their own universal service programs, which supplement funding provided by the federal USF. Those programs are 

beyond the scope of this report, and their spending is not included 

in the estimates presented here.
SUMMARY ix

Summary Table 2.

The Contribution Base for the Universal Service Fund in Relation to

Telecommunications Revenues, 1997 to 2004

(Billions of dollars)

Source: Congressional Budget Office based on Federal Communications Commission, Trends in Telephone Service (May 2004), Table 15.1, 

and Telecommunications Industry Revenues (various years), Tables 1, 6, and 8.

Notes: To avoid double taxation, the contribution base includes only revenues from services to end users. 

To be consistent with previous years, 2003 and 2004 data include revenues declared uncollectible.

a. Preliminary estimate.

direct proportion to the amount spent on the service. 

Second, the FCC imposes USF fees on the portion of 

local telephone companies’ revenues that, by convention, 

is associated with the cost of providing interstate and 

international long-distance calls. Because of the difficulty 

of separating interstate revenues from total revenues, cellular carriers are subject to a modified fee system. Cell 

phone operators pay USF fees on 28.5 percent of their 

total revenues, unless they can provide evidence that their 

interstate share is less than that “safe harbor” percentage. 

Because DSL has been classified as an interstate service, 

providers pay USF assessments on the telecommunications portion of the service. (The portion of DSL revenues that pays for Internet access is exempt from USF 

contributions.) Large-capacity leased telephone lines that 

large institutions use for Internet access and other data 

services also incur USF fees.

Financing Alternatives

If policymakers determined that the current financing 

mechanism was no longer appropriate, universal service 

could be financed in other ways. Three alternatives to the 

current system have received attention:

B Expanding the present revenue-based system to include revenues that are currently excluded from telecommunications services (for instance, revenues from 

intrastate service or from high-speed Internet service 

delivered through cable modems);

B Establishing a financing system based on connections—such as telephone numbers or communications capacity—rather than on interstate revenues; or,

B Using a combination of all of those various funding

mechanisms.

Some proposals would use charges on telephone numbers 

or telecommunications capacity as the primary financing 

mechanism and supplement it with complementary fees 

that address special situations. For example, large enterprises often lease high-capacity lines for their data or internal telephone networks. The capacity of such lines is 

greater than that of the average telephone line by significant degrees. To avoid shifting a disproportionate share of 

the financing of universal service to such lines, proposals 

for a capacity-based system include tiers of fees that 

would increase with capacity but would levy lower perunit capacity charges on those lines.

For this analysis, CBO estimated the distribution of payments to the USF by types of telecommunications providers and by the share (if distributed proportionately) 

shown on the bills of residential and business consumers 

under current policy and under several financing alternatives. CBO’s analysis relied on a modified version of an 

accounting model developed by the FCC. Those estimated distributions indicate sources of payments—not 

the ultimate burden of USF fees on consumers and 

providers.

1997 1998 1999 2000 2001 2002 2003 2004a

Total Telecommunications Revenues 

from Service to End Users 188.4 200.4 215.8 229.1 235.5 232.4 230.7 228.3

Contribution Base for the USF 69.3 74.9 79.9 80.6 79.2 77.0 76.6 76.3

Contribution Base as a Percentage 

of Total Revenues 36.8 37.4 37.0 35.2 33.6 33.1 33.2 33.4
x FINANCING UNIVERSAL TELEPHONE SERVICE

Summary Table 3.

Distribution of Telecommunications Companies’ Contributions to the USF

Under Different Financing Mechanisms, 2003 and 2007

(Percent)

Source: Congressional Budget Office. 

Note: USF = Universal Service Fund; n.a. = not applicable.

a. Cable modem revenues only.

Distribution of the Initial Burden of USF

Contributions Among Different Types of

Telecommunications Providers

The distribution of USF fees among providers has 

shifted, largely because of the increasing number of cellular providers and the entry of local telephone companies 

into the long-distance market. Under current policy, cellular carriers’ share of payments to the USF is forecast to 

rise from 22 percent in 2003 to 31 percent in 2007 (see 

Summary Table 3). That increase mirrors the decline in 

long-distance carriers’ share (from 51 percent to 37 percent)—with local telephone companies making up the 

difference.

The distribution of those fees under the policy options 

that CBO examined would vary greatly. Including revenues based on services provided by cable modems in the 

USF contribution base would slightly reduce cellular carriers’, long-distance carriers’, and local telephone companies’ shares of the payments. A plan based on telephone 

numbers would shift responsibility for funding the USF 

away from long-distance providers and toward local telephone companies, doubling their share of payments compared with the 2003 level. A plan based on communications capacity would cause similar, but smaller, changes in 

shares.

Distribution of USF Fees Between Business and

Residential Consumers 

Under current policy, the relative burden on households 

is not projected to change substantially between 2003 

and 2007. Assuming that carriers recovered all of their 

USF contributions from their customers, residential 

consumers’ share of USF payments would rise from 43 

percent in 2003 to 44 percent in 2007 (see Summary 

Table 4). Correspondingly, business consumers would see 

their share fall from 57 percent to 56 percent. The policy 

alternatives that CBO analyzed would not significantly 

affect the distribution of USF fees between residential 

and business consumers compared with that under current policy. 

If policy did not change, households would see their 

monthly charges rise from about $2.09 in 2003 to $2.26 

in 2007, an increase of 8.1 percent (or 0.1 percent with 

the effects of inflation removed). Under some alternative 

financing options, total USF contributions would more 

than double. However, long-distance rates and houseShare of Total Contributions, by Type of Company

Financing Option

Local Telephone

Companies

Long-Distance

Companies

Cellular Telephone 

Companies Cable Companiesa

In 2003

Current Policy 28 51 22 n.a.

In 2007

Current Policy 31 37 31 n.a.

Including Cable Modem 

Revenues 28 34 28 9

Telephone-Number-Based Plan 55 13 32 n.a.

Capacity-Based Plan 43 22 33 n.a.
SUMMARY xi

Summary Table 4.

Distribution of Business and Residential Consumers’ Share of USF Contributions 

Under Different Financing Mechanisms, 2003 and 2007

Source: Congressional Budget Office.

Note: USF = Universal Service Fund.

holds’ monthly interstate charges (including their subscriber line charges, long-distance charges, and USF fees) 

would fall compared with 2003 levels. By contrast, the 

cost of the intrastate portion of local phone service, 

which is largely exempt from USF fees, would rise.

Financing Universal Service Efficiently

A central question to be asked about any mechanism used 

to finance federal spending is whether there is a way to 

collect the funds at a lower cost to the economy. The 

overall economic cost hinges on the degree to which a 

financing mechanism affects choices made by both producers and consumers. Consumers who pay a fee will 

have forgone not only the value of the fee itself but also 

the benefits they would have derived from the goods they 

did not buy because of the fee. 

Some analysts argue that the current system for funding 

the USF imposes a greater cost on the economy than 

would alternative financing mechanisms. The present fee 

structure is intended to fall disproportionately on longdistance and cellular telephone calls. Studies have shown 

that consumers alter their consumption patterns more in 

response to increases in the prices they pay for those services than they do in response to price increases on basic 

telephone access. Considered in that light, USF fees that 

taxed telecommunications capacity or telephone numbers 

would be less likely to distort consumers’ choices than the 

current system does.

However, the pricing structure of the telecommunications industry seems to be moving on its own in a direction that lessens the distortions caused by USF fees. Increasingly, long-distance and cellular service carriers are 

able to offer bundles of long-distance minutes for a flat 

rate. Carriers can provide diverse plans that vary in size, 

time-of-day restrictions, and monthly fees. For consumers who subscribe to such plans, the USF becomes less a 

usage fee on their individual long-distance calls and more 

an access fee on long-distance service in general. The 

price of an additional phone call for those consumers—if 

they stay within their plans—is unaffected by the USF 

fees. Consequently, the negative effects of the fees are 

reduced. Such bundled or flat-rate plans now account for 

about a quarter of consumer subscriptions.

Consideration of mechanisms to finance universal service 

also raises the question of potentially uneven effects on 

communications technology. In selecting types of services, consumers also choose among different technologies. If USF fees fall unequally on similar services that use 

different technologies, then consumers’ choices will be affected by the fees as well as by the costs of providing specific services. As far as high-speed access to the Internet is 

Average Monthly Charge 

per Household Percentage of the Contributions Met by

Financing Option (Dollars) Residential Consumers Business Consumers

In 2003

Current Policy 2.09 43 57

In 2007

Current Policy 2.26 44 56

Including Cable Modem Revenues 2.47 48 52

Telephone-Number-Based Plan 2.47 46 54

Capacity-Based Plan 2.28 45 55
xii FINANCING UNIVERSAL TELEPHONE SERVICE

concerned, the current system—which imposes a fee on 

the telecommunications portion of DSL service but not 

on its nearest competitor, high-speed Internet access delivered through a cable modem—favors cable technology. 

That different treatment arose in part because DSL service evolved within the context of landline telephone service, which is subject to USF fees, whereas cable modem 

service evolved in the context of cable video service, 

which is not.

Most federal spending is funded with general revenues, 

and some analysts have suggested that lawmakers consider financing universal service in that way. The current 

system of financing the USF is a legacy of the days when 

the Bell telephone system relied on profits from business 

and long-distance customers to help defray the expense of 

providing service in high-cost areas. With the dissolution 

of the Bell system, what had been a system of implicit 

intracorporate transfers became a set of increasingly 

explicit intercarrier transfers, which were most recently 

modified in the Telecommunications Act of 1996. Funding universal service with general revenues would sever 

the current relationship between telecommunications 

industry revenues and universal service funding.

Raising general revenues tends to distort consumers’ 

choices less than raising sector-specific taxes does. Analyses of economic losses indicate that USF fees cost the 

economy an additional $0.64 to $1.47 for each dollar in 

revenue they produced.2 (Those estimates probably overstate the current economic cost of the USF fee system 

because long-distance access fees have declined recently.) 

By comparison, the economic losses arising from general 

federal taxes are estimated to be substantially lower, ranging between $0.25 and $0.40 for each additional dollar 

collected.

2. Michael H. Riordan, “Universal Residential Telephone Service,” 

in Martin Cave and others, eds., Handbook of Telecommunications 

Economics, vol. 1, Structure, Regulation and Competition (Amsterdam: Elsevier, 2002), p. 438, available at www.columbia.edu/

~mhr21/US-aug-29.pdf; and Jerry Hausman, Taxation by Telecommunications Regulation: The Economics of the E-Rate (Washington, D.C.: AEI Press, 1998), p. 15, available at www.aei.org/

docLib/20040218_book245.pdf.
1

Introduction

Efforts to foster the goal of universal telephone 

service in the United States and its territories were reaffirmed and amplified by the Telecommunications Act of 

1996. As codified in that law, the overriding goal of universal service is to ensure that the largest number of U.S. 

residents possible have access to high-quality telephone 

service regardless of their household income or geographic location. The 1996 law further authorized the 

Federal Communications Commission (FCC)—the 

administering agency—to provide funds to make advanced telecommunications service available to qualifying 

schools, libraries, and rural nonprofit health care providers at subsidized rates. 

To achieve the law’s stated objectives, telecommunications companies are required to contribute a percentage 

of the revenues they derive from long-distance and other 

interstate and international services to the Universal Service Fund (USF). In turn, the USF reimburses eligible 

telecommunications carriers that provide the services that 

the law seeks to make widely available. Overall responsibility for the process lies with the FCC, which, in conjunction with state utility regulators, determines the level 

of spending necessary to meet the law’s requirements and 

ensures that telecommunications companies comply by 

making adequate compensation. The Universal Service 

Administrative Company (USAC), a not-for-profit corporation regulated by the FCC, manages the specific programs that promote and support universal service. The 

USAC also collects the funds necessary to finance those 

programs and dispenses the payments to eligible telecommunications providers. Because those transfers between 

providers are required by law, payments into and disbursements from the Universal Service Fund are counted 

as revenues and outlays in the federal budget.1

The USF supports four primary programs designed to 

help achieve the federal goal of universal service.2

 Those 

mechanisms are the High Cost support program, the 

Low Income support program, the Schools and Libraries 

support program, and the Rural Health Care support 

program. The largest of the four, the High Cost mechanism assists 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 local telephone companies with funds that enable them to offer discounts to 

qualified low-income people (rural or urban) on installation charges for residential telephone service and on 

monthly service fees. The Schools and Libraries program 

offers assistance to schools and libraries for the purchase 

of certain network hardware, the payment of monthly 

charges for high-speed Internet access, and other expenses 

related to installation of advanced telecommunications 

services.3 (That program largely focuses on schools and 

libraries that serve low-income communities.) Finally, the 

CHAPTER

1. Rate-making policies under the jurisdictions of the states 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—with 

the net result that residential customers benefit at the expense of 

business customers. Those implicit subsidies do not appear in federal or state budgets.

2. Assistance offered by the Telecommunications Relay Services 

(TRS), which is funded with federal dollars and administered by 

the National Exchange Carrier Association, is also considered to 

promote universal service because the TRS makes telephone service available to the speech- and hearing-impaired. Although the 

TRS shares the goal of making telephone service more widely 

available, those services are administered separately from the other 

universal service programs. The fees are also separate. For those 

reasons, this report generally excludes them. In addition, some 

states have universal service programs, which are outside the scope 

of this analysis.

3. The Schools and Libraries program is the one mechanism in 

which a substantial amount of USF funding goes to entities other 

than telecommunications carriers.
2 FINANCING UNIVERSAL TELEPHONE SERVICE

Rural Health Care support program assists eligible medical facilities by ensuring that they pay no more than urban health care providers do for comparable telecommunications services.

For a variety of reasons, spending on the programs that 

support universal service is rising. The costs associated 

with delivering telephone services to high-cost areas and 

low-income people have steadily grown. In addition, 

some of the cost increases borne by the USF are an outgrowth of accounting changes mandated by the Telecommunications Act of 1996. Specifically, the law required 

universal support to be explicit, thus reducing many implicit cross-subsidies that had formerly been a mainstay 

of universal service.4 Consequently, some of the increase 

in USF spending can be attributed to changes in the 

method of funding—and its inclusion in the federal budget—rather than to new economic resources devoted to 

providing universal service. Lastly, the 1996 law authorized the creation of programs designed to subsidize 

advanced telecommunications services for qualifying 

schools, libraries, and rural nonprofit health care providers.5

At the same time that funding demands have increased, 

the revenue base of interstate and international services 

that pays for universal service has shrunk since 2000, and 

most likely will continue to erode, for various reasons. 

The escalation of costs, in combination with an eroding 

revenue base, has caused a corresponding rise in the USF 

“contribution factor”—the tax rate that the FCC levies 

on revenues from long-distance and other interstate and 

international telephone services. (The contribution factor 

is set on a quarterly basis to raise sufficient funds to cover 

the costs of universal service.) As a consequence, the FCC 

and other policymakers have begun to consider new ways 

of financing universal service. This Congressional Budget 

Office (CBO) report examines the system currently used 

to fund universal service and compares proposals for 

changing that system.

Budgetary and Administrative

Background

The current financing system for the Universal Service 

Fund derives its authority from Section 254(d) of the 

Communications Act of 1934, as added by the Telecommunications Act of 1996.6 That section states that every 

provider of interstate telecommunications service must 

contribute to the USF. The law further directs the FCC 

to establish a funding mechanism that is “specific, predictable, and sufficient.” Subsequent FCC decisions and 

court cases have refined that general statement of principals into a functioning system. (For a description of the 

process used to calculate mandatory contributions from 

telecommunications carriers, see Box 1-1.)

In concept, the USF is budget neutral: contributions are 

intended to be just sufficient to cover spending. The contribution rates for telecommunications carriers are variable, changing quarterly in an effort to maintain the fund 

in balance. In the High Cost and Low Income programs, 

the administrators of the USF have generally been successful in matching fund inflows with outflows. But because a lag exists in the Schools and Libraries program 

between when the USF commits to funding projects and 

when it actually pays for those projects, the USF has consistently collected more than it has spent in recent years. 

At the end of fiscal year 2004, for instance, the fund carried a cash balance of $3.4 billion. 

Spending on Universal Service

Both USF outlays and receipts have grown since 1999. 

Outlays from the fund rose from $3.3 billion in fiscal 

year 1999 to $5.7 billion in fiscal year 2004, while 

receipts grew from $3.7 billion to $6.4 billion (see 

Table 1-1).7 Outlays may not be the best measure of the 

yearly claims of universal service programs on the telecommunications sector. Program receipts—the funds 

that telecommunications carriers (and ultimately their 

customers) are required to pay into the USF—better represent the programs’ anticipated claims on the economy. 

Since those commitments may take several years to 

spend, receipts are consistently greater than outlays.

4. 44 U.S.C. 254(e). 

5. See Congressional Budget Office, Federal Subsidies of Advanced 

Telecommunications for Schools, Libraries, and Health Care 

Providers (January 1998).

6. 44 U.S.C. 254(d).

7. The estimates presented in this report are USAC outlays and 

receipts. USF program commitments will differ from those estimates. The USAC’s fiscal year also differs from the federal fiscal 

year. 
CHAPTER ONE INTRODUCTION 3

Factors Underlying the Growth in Spending 

Increased spending from the USF can be attributed to 

many sources. The High Cost and Low Income programs 

experienced substantial growth in recent years. Outlays 

for the program to reduce the cost of providing telecommunications service in high-cost rural areas, for example, 

rose from $1.7 billion to $3.4 billion between fiscal year 

1999 and fiscal year 2004, while the cost of support for 

low-income households rose from $490 million to $760 

million. Part of the growth in USF spending also stems 

from the expansion of the new programs to provide 

schools, libraries, and nonprofit rural health care providers with advanced telecommunications services. 

One of the main reasons that the High Cost fund has 

grown is the requirement in the Telecommunications Act 

of 1996 that implicit subsidies—which were formerly 

embedded in access charges paid by long-distance providers to local telephone companies—be recognized as explicit USF payments. In response to that requirement, in 

2000 the FCC created the Interstate Access Support program within the High Cost program, which added $650 

million in outlays to the High Cost program in that fiscal 

year. In 2002, the FCC created the Interstate Common 

Line Support program for rural carriers, also within the 

High Cost program. Together, those two programs—

which provide an alternative source of revenues that preBox 1-1.

How USF Contributions Are Collected 

Contributions to the Universal Service Fund (USF) 

are collected in an interactive process that involves 

telecommunications carriers, the administrator of 

the various universal service programs—the Universal Service Administrative Company (USAC)—and 

the Federal Communications Commission (FCC). 

Each quarter, telecommunications providers report 

their eligible billings from the previous quarter (including USF charges) to the USAC, as well as how 

much they expect to bill in the subsequent quarter 

(including USF charges). Carriers also report how 

much of their eligible billings they actually expect to 

collect.

With that information, the USAC calculates the 

“projected collected” revenues for the current quarter. For example, assume that a carrier reports that it 

billed $100 million in the previous quarter and that 

it expects to bill $104 million in the coming quarter. 

Assume further that the carrier reports that, from its 

accounting studies, it has discovered that 5 percent 

of its accounts are uncollectible. The USAC will assume that the current quarter of collectible billing 

for that carrier will be $102 million (the average of 

the previous and subsequent quarters) minus 5 percent uncollectible, or $96.9 million. 

To calculate the USF contribution rate, the USAC 

totals all of the estimates of eligible billings from the 

individual carriers to obtain an aggregate estimate of 

the projected collected revenues for the current quarter, adjusted for expected USF contributions. (Without an adjustment for USF contributions, there 

would be double taxation.) The administrators then 

divide the estimate of projected collected revenues 

into the estimate of the current quarter’s USF 

needs.1 From that calculation, the FCC derives a 

“contribution factor.” Each carrier’s contribution 

equals the contribution factor multiplied by the carrier’s eligible billings. Carriers make contributions 

monthly.

To continue the example above, assume that the 

USAC announces that it needs $1.5 billion to cover 

program and administrative costs for a quarter. If the 

industry revenues eligible for contribution total 

$18.75 billion, the FCC calculates a contribution 

factor of 8 percent ($1.5 billion divided by $18.75 

billion). That percentage multiplied by the carrier’s 

$96.9 million in eligible billings equals $7.75 million, which is the carrier’s quarterly obligation (paid 

in monthly installments).

1. The USAC also includes periodic revisions to bring projected revenues in line with actual revenues.
4 FINANCING UNIVERSAL TELEPHONE SERVICE

Table 1-1.

Receipts and Outlays of the Universal Service Fund, 1999 to 2004

(By fiscal year, in billions of dollars)

Source: Congressional Budget Office.

Note: * = less than $50 million.

viously flowed between long-distance companies and 

local telephone companies in the form of interstate access 

charges—have added more than $1.1 billion in spending 

to the High Cost program.

In addition, a number of new networks, primarily cellular 

telephone networks, have become eligible for USF payments. That development has led to higher spending in 

all of the programs contained in the High Cost fund. 

Between 2002 and 2003, the funds going to rural local 

telephone companies grew by $190 million. Support for 

new cellular telephone networks accounted for $80 million of that growth.

Spending levels are determined differently for each of the 

four main programs. Spending for the Schools and Libraries mechanism is capped by the FCC at $2.25 billion 

per year.8

 Meanwhile, the Rural Health Care mechanism 

is not fully utilized by potential recipients, and spending 

for that program does not approach its cap. In the case 

of the Low Income support mechanism, individual states 

determine eligibility criteria for recipients. In many 

states, enrollment in the program has risen since 1997, 

with a corresponding increase in program costs. 

Spending in the High Cost support mechanism is determined by a complex combination of historical costs and 

economic models. Each fall, the National Exchange Carriers Association (NECA) submits a filing to the FCC 

that details the costs to rural telephone service providers 

of providing local telephone lines. The NECA filing is 

used to determine per-line costs. A portion of those perline costs that is above the national average for each carrier is multiplied by the number of lines each carrier 

serves: the portion is determined by the size of the carrier 

and the extent to which costs in a given area exceed the 

national average for local line costs. That figure becomes 

the carrier’s subsidy for the first quarter of the next calendar year.9

 Payments for the subsequent quarter are adjusted according to the line count for each provider. For 

larger, nonrural providers’ local line support, the FCC 

uses a cost model to determine per-line costs. In addition 

to the local line support portion of the High Cost mechanism, there are other, smaller elements of the High Cost 

mechanism that are determined by different combinations of formulas and embedded costs, all of which are 

occasionally subject to caps.

Telecommunications Revenues,

the USF Revenue Base, and the

Contribution Factor

Receipts collected for the Universal Service Fund originate as revenues from telecommunications services. As 

indicated, however, only those revenues over which the 

federal government has regulatory jurisdiction enter the 

USF revenue base. Because the USF administrators are

1999 2000 2001 2002 2003 2004

Receipts 3.7 4.5 5.2 5.4 5.7 6.4

Outlays

High Cost 1.7 1.9 2.6 2.8 3.3 3.4

Low Income 0.5 0.5 0.6 0.7 0.7 0.8

Schools and Libraries 1.0 1.6 1.7 1.6 1.6 1.5

Rural Health Care 0.1 * * * * *

Total 3.3 4.0 4.9 5.1 5.6 5.7

8. Although more schools and libraries apply for grants than can be 

funded, the delays in getting matching local funding and otherwise solidifying their plans mean that the $2.25 billion cap generates only $1.5 billion in outlays.

9. The annual growth of subsidies to those providers is capped by 

formula as well.
CHAPTER ONE INTRODUCTION 5

Table 1-2.

Telecommunications Industry Revenues, 2003

(Billions of dollars)

Source: Federal Communications Commission, Telecommunications Industry Revenues, 2003 (March 2005), Tables 6 and 8.

mandated to collect sufficient revenues to match spending, they set the contribution factor to match collections 

with anticipated spending. (See Box 1-2 for a description 

of fees on consumer services.)

From Telecommunications Revenues

to the USF Contribution Base

Although only interstate and international revenues are 

subject to USF contributions, interstate revenues are 

defined to include a portion of revenues that local telephone companies assess for originating and completing 

interstate and international long-distance calls.10

Various limitations apply to the inclusion of international 

revenues in the contribution base. Such revenues are excluded if the total amount of interstate revenues recorded 

by the filing firm and its affiliates is less than 12 percent 

of the total of interstate and international revenues of the 

consolidated firm and its affiliates. Small firms with minimal contributions are also excluded. Revenues derived 

from the provision of service for resale (commonly called 

the carrier’s carrier) are not subject to USF contributions, 

in order to avoid double taxation. (It would be as if there 

were a tax on tires and then a tax on the car that included 

the tires.)

After adjustment for the exclusions and deductions outlined above, only $76.6 billion (or one-third) of the 

$230.7 billion in end-user telecommunications revenues 

in 2003 entered the contribution base (see Table 1-2). 

Toll carriers—providers of interstate and international 

services—saw 64 percent of their end-user revenues enter 

the base, whereas 23 percent of the end-user revenues of 

cellular and local telephone companies were included in 

the base.

Both total telecommunications revenues derived from 

service to end users and the USF contribution base have 

declined in recent years, although each peaked in different years (see Table 1-3). Total end-user telecommunications revenues have fallen by 3 percent from their 2001 

peak, and the revenues used to finance the USF have declined by 5 percent from their 2000 peak.11 However, the 

deterioration of the contribution base as a percentage of 

total end-user revenues seems to have stopped.

The Shrinking Contribution Base

The contribution base has gotten smaller for several reasons. First, an increase in the supply of long-haul capacity 

in the competitive market for long-distance services reduced the prices that companies charged their consumers 

by so much that revenues actually declined from 2000 to 

2002.12 Decreases in long-distance telephone prices, 

although common since the 1982 consent decree that 

broke up the Bell telephone system, became larger after 

2000. According to federal price data, the decline in

USF Contribution

Telecommunications Revenues

from Service to End Users

Industry Segment Base Intrastate Interstate International Total 

Local Wireline Carriers 20.4 67.7 20.4 0.3 88.5

Wireless Service Carriers 19.0 65.0 19.2 0.2 84.4

Toll-Service Carriers 37.2 18.1 30.1 9.6 57.8

Total 76.6 150.9 69.7 10.1 230.7

10. Those subscriber line charges represent the portion of the local 

network assigned to the interstate jurisdiction and are regulated by 

the FCC. Subscriber line charges appear on customers’ local bills 

for local services, and revenues produced by those charges are 

retained by the local telephone carriers.

11. Starting in 2003, the FCC began netting out revenues deemed by 

the telecommunications carriers as uncollectible. To be consistent 

with previous years, CBO used the gross numbers in its calculations. After removing uncollectible revenues, end-user revenues 

totaled $223.9 billion in 2003. 

12. In 2000, total international and interstate revenues were $119.7 

billion, but by 2002 that figure had fallen to $111.8 billion. Federal Communications Commission, Trends in Telephone Service

(May 2004), Table 15.1. 
6 FINANCING UNIVERSAL TELEPHONE SERVICE

Box 1-2.

Fees for Telecommunications Spending

The Federal Communications Commission (FCC) 

imposes Universal Service Fund (USF) fees on consumers’ wireline, wireless, and digital subscriber line 

(DSL) service. (The actual fees are paid by the relevant telecommunications service providers, but the 

carriers generally attempt to recover those costs from 

their customers.)

The current structure of residential USF fees is as 

follows:

B Wireline Voice. Two components of revenues from 

wireline voice telephone service enter into the 

USF contribution base: payments for interstate 

and international long-distance calls and charges 

paid to a local telephone company by its customers for access to interstate service. (The latter is 

called the subscriber line charge.)

B Wireless. Cell phone companies pay on a modified 

fee system. USF fees on cell phone service increase with cellular charges but only on 28.5 percent of the revenues. Alternatively, if a cell phone 

company can show that less than 28.5 percent of 

its calls are long distance, it can use a lower percentage based on its own study.

B Broadband. Typically, the charge for DSL service 

is a combination of a telecommunications portion and an Internet service portion. The FCC 

has decided that Internet access delivered through 

DSL is an interstate service. The portion of DSL 

charges devoted to Internet access is considered 

an information service and is not subject to USF 

assessment. Consequently, only the telecommunications portion of DSL is subject to USF contributions.

For the most part, businesses pay the same USF fees 

that residential consumers do. Businesses that lease 

private telephone lines for their data and internal 

telephone systems also pay a fee on those services. In 

addition, there are fees to handle special situations, 

such as those applying to pay-phone companies.

All of the fees discussed above are assessed directly on 

service providers, not on households or businesses. 

Generally, providers attempt to recover their contributions through charges outlined on the bills they 

send to their customers. They can do so either by 

raising their rates or by including one or more separate “line items” for universal service charges.

Starting in 2003, the FCC restricted the ability of 

carriers to recover their costs through line items.1

The FCC had found that many of the line items designated by carriers as universal service charges were 

significantly higher than the contributions actually 

paid by the carriers. Some of the overcharging was 

intended to account for uncollectibles and other factors related to the USF. But in its concern, the FCC 

prohibited carriers from marking up the USF line 

item above the relevant contribution. Furthermore, 

carriers were not allowed to average contribution 

costs across all end users when establishing end-user 

amounts. (The FCC imposed no such limitation if 

the carrier tried to include the recovery of USF contributions in its service rates.) The FCC also exempted customers of Lifeline—one of the USF support mechanisms aimed at low-income consumers—

from charges designed to recover USF contributions.

1. Federal Communications Commission, In the Matter of Federal-State Joint Board on Universal Service and Other Matters: 

Report and Order and Second Further Notice of Proposed Rulemaking (December 12, 2002), pp. 25-32, available at http://

hraunfoss. fcc.gov/edocs_public/attachmatch/

FCC-02-329A1.pdf.
CHAPTER ONE INTRODUCTION 7

Table 1-3.

The Contribution Base for the Universal Service Fund in Relation to

Telecommunications Revenues, 1997 to 2004

(Billions of dollars)

Source: Congressional Budget Office based on Federal Communications Commission, Trends in Telephone Service (May 2004), Table 15.1, 

and Telecommunications Industry Revenues (various years), Tables 1, 6, and 8.

Notes: To avoid double taxation, the contribution base includes only revenues from services to end users.

To be consistent with previous years, 2003 and 2004 data includes revenues declared uncollectible.

a. Preliminary estimate.

consumer long-distance charges averaged 2.7 percent annually between 1986 and 2004. But since 2000, the average annual drop has been 6.1 percent (see Figure 1-1).13

Second, the spread of advanced telecommunications 

technologies has contributed to the decline in the revenue 

base. Cell phone companies often include (or bundle) 

long-distance calls in their service plans at low effective 

rates; consequently, a smaller percentage of cell phone 

revenues enters the contribution base than is the case for 

revenues derived from landline services. Similarly, customers are most likely substituting e-mail or Internet 

browsing for long-distance telephone calls.14 As to the future, Internet telephony or Voice over Internet Protocol 

will almost certainly diminish the demand for traditional 

wireline long distance, although the FCC has not yet decided whether Internet telephony will be subject to USF 

fees.

Contributions by Type of Provider

Under the Telecommunications Act of 1996, current 

USF spending is funded by fees on interstate telecommunications revenues, but that limitation does not mean 

that only long-distance companies pay. Local telephone 

companies increasingly provide interstate services, as do 

cellular phone companies. In addition, the whole panoply 

of telecommunications providers, such as paging companies and pay-phone operators, also make payments into 

the USF. (See Box 1-1 on page 3 for a description of the 

collection method.)

Because the industry is in flux, USF revenue sources have 

changed in the recent past. Shortly after the Telecommunications Act was enacted, toll-service providers—mainly 

long-distance companies—accounted for 82 percent of 

the revenues going into the fund (see Figure 1-2). However, as local telephone companies were allowed to offer 

long distance under the provisions of the 1996 law, their 

share of USF financing rose along with their share of 

long-distance revenues. But it was wireless companies 

that increased their share most dramatically, from 3 percent in 1997 to 17 percent in 2002. As other participants’ 

shares rose, the relative contribution of long-distance 

companies fell. One implication of Figure 1-2 is that the

current division of the revenue base is neither stable nor 

of long standing. 

1997 1998 1999 2000 2001 2002 2003 2004a

Total Telecommunications Revenues 

from Service to End Users 188.4 200.4 215.8 229.1 235.5 232.4 230.7 228.3

Contribution Base for the USF 69.3 74.9 79.9 80.6 79.2 77.0 76.6 76.3

Contribution Base as a Percentage of 

Total Revenues 36.8 37.4 37.0 35.2 33.6 33.1 33.2 33.4

13. Department of Commerce, Bureau of Economic Analysis, Underlying Detail Tables of the National Income and Product Accounts, 

Table 2.4.4U, “Chain-Type Price Indexes for Personal Consumption Expenditures, Long-Distance Telephone.” The Bureau of 

Economic Analysis data series is based on an unpublished consumer price index series from the Bureau of Labor Statistics.

14. Consumers made 22 percent fewer interstate calls (measured in 

minutes) in 2003 than in 2000. Federal Communications Commission, Trends in Telephone Service, Table 10.1.
8 FINANCING UNIVERSAL TELEPHONE SERVICE

Figure 1-1.

Annual Changes in Consumer Long-Distance Prices

(Percent)

Source: Congressional Budget Office based on data from the Bureau of Economic Analysis.

Contribution Factors 

Contribution rates have been increasing since 1999 (see 

Figure 1-3 on page 10), more because of increases in 

spending than because of the decline in the revenue base. 

Between 2000 and 2003, that base fell from $80.6 billion 

to $76.6 billion, a drop of 4.9 percent.15 By comparison, 

USF outlays (converted from fiscal year to calendar year) 

rose from $4.2 billion to $5.6 billion over the same 

period, an increase of 32 percent. 

Those contribution rates would have been higher at several points were it not for various factors. For example, 

during much of 2002 and 2003, the FCC pursued the 

stopgap measure of using funds that had been committed 

but not yet spent from the Schools and Libraries support 

program to stabilize collection requirements. But taking 

advantage of lags and leads between receipts and outlays 

provided only a temporary solution. Commitments made 

under the Schools and Libraries program will eventually 

be manifest in spending, and the USF will have to replace 

the funds it used earlier. In part, the FCC raised the contribution rate for the first quarter of 2005 to make up for 

that deficiency. 

Another factor holding down contribution rates was a 

change in the contribution methodology applied to the 

revenues of cellular telephone companies. Initially, the 

FCC allowed cell phone companies to include only 15 

percent of their revenues in the USF base, believing that 

most cell phone calls were local. As long-distance cell 

phone calling plans became more common, the FCC 

increased that “safe harbor” portion to 28.5 percent. That 

policy change increased the size of the revenue base and 

reduced the rate of growth of the contribution factors.

The USAC’s shift to accounting practices that more 

closely resemble those used by the federal government 

may also affect the contribution rate. (For a discussion of 

the differences between USAC accounting practices and 

those of federal agencies, see Box 1-3 on page 11.) As the 

FCC makes the USAC conform to government accounting standards, USF administrators may need to raise contribution rates to ensure that funds are in hand before 

they are committed. However, that change would be a 

onetime shift and might not permanently affect contribution rates.

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

-15

-10

-5

0

5

10

15. FCC, Telecommunications Industry Revenues, various years, 

Table 8. 
CHAPTER ONE INTRODUCTION 9

Figure 1-2.

Share of Contributions to the Universal Service Fund, by Type of Company

(Percent)

Source: Congressional Budget Office based on Federal Communications Commission, Trends in Telephone Service (May 2004), p. 19-19.

Note: 2003 data run through the second quarter of the year.

1997 1998 1999 2000 2001 2002 2003

0

20

40

60

80

100

Long-Distance Providers Fixed Local Providers Wireless Providers
10 FINANCING UNIVERSAL TELEPHONE SERVICE

Figure 1-3.

Universal Service Fund Contribution Factors, by Quarter

(Percent)

Source: Congressional Budget Office.

1998 1999 2000 2001 2002 2003 2004 2005

0

2

4

6

8

10

12
CHAPTER ONE INTRODUCTION 11

Box 1-3.

The Universal Service Fund and the Antideficiency Act

The Administration concluded several years ago that 

the Universal Service Fund (USF) constitutes a permanent indefinite appropriation (that is, funding appropriated or authorized by law to be collected and 

available for specified purposes without further Congressional action). Although the USF constitutes 

“appropriated funds,” the fiscal and accountability 

controls applicable to the USF have not been clear. 

In September 2004, the Federal Communications 

Commission (FCC) decided that the Antideficiency 

Act was applicable to the USF.1

 That law requires an 

agency to limit obligations of federal funds to the 

amount of financial resources available to the agency. 

The FCC also decided that funding commitment 

letters issued under the Schools and Libraries program (also known as the E-Rate Program) are recordable obligations, so the total amount of funds committed may not exceed the amount available to the 

USF. 

To comply with the Antideficiency Act, the Universal Service Administrative Company (USAC) 

abruptly suspended issuing commitment letters and 

liquidated about $3 billion of investments in securities and commercial paper. That action was required 

for two reasons. First, the USAC was obligating 

funds for the Schools and Libraries program in excess of the total amount available. The USAC’s experience with the Schools and Libraries Fund indicated 

that between 10 percent and 20 percent of its funding commitments were not executed because recipients or their vendors failed to satisfy requirements of 

the program. As a consequence, the USAC regularly 

issued commitment letters totaling the amount it expected to actually provide rather than the amount it 

had collected. Obligations in violation of the Antideficiency Act also resulted from the fact that although 

the USF receives funds each quarter on a regular 

schedule, commitment letters are issued in batches 

that could exceed available funds.

Second, the USF had invested in nonfederal securities and commercial paper. Such funds held outside 

the Treasury are not available for obligation. In order 

to obtain sufficient funds to cover existing commitments, the USAC was forced to liquidate its investments. The results of USAC’s sale of its nonfederal 

financial investments were recorded in the federal 

budget as receipts in 2004.2

 According to the FCC 

and the Office of Management and Budget, none of 

the USF is currently invested outside the Treasury. In 

view of the applicability of the Antideficiency Act to 

the USF, the Government Accountability Office has 

asked the FCC to consider whether the Miscellaneous Receipts Statute is also applicable. That statute 

requires that money received for the use of the 

United States be deposited in the Treasury unless 

otherwise authorized by law. Application of the statute would mean that the USAC could not resume 

holding any funds in nonfederal securities.

After suspending new commitments under the 

Schools and Libraries program late in fiscal year 

2004, the USAC resumed issuing commitment letters in November 2004. In December 2004, the 

Congress and the President enacted Public Law 108-

494, giving the USF a one-year exemption from application of the Antideficiency Act. In February 

2005, a bill (S. 241) was introduced to permanently 

exempt the USF from compliance with the Antideficiency Act.

1. 31 U.S.C. 1341(a). The Government Accountability Office 

recently concurred with that legal opinion. See GAO, Telecommunications: Greater Involvement Needed by FCC in the 

Management and Oversight of the E-Rate Program, GAO-05-

151 (February 2005).

2. At the end of fiscal year 2004, the USF had $3.4 billion in 

cash held outside the Treasury.

2

Options for Financing Universal Service

One choice regarding the financing of the Universal Service Fund is whether to keep a telecommunications-specific fee as the main source of financing or 

whether to fund universal service using general revenues, 

which pay for most federal programs. (The latter issue 

will be discussed in Chapter 3.)

If policymakers choose to keep financing universal service 

through fees on telecommunications services, several 

options are open to them. They could simply retain the 

current system despite its deteriorating revenue base. 

Alternatively, policymakers could expand the current 

approach of taxing revenues to include more telecommunications revenues in the contribution base. They could 

also move in new directions, most notably by assessing 

fees on telephone numbers or telephone capacity.

All of the alternatives discussed in this chapter would 

retain the current requirement that providers of telecommunications services contribute directly to the USF. The 

method of calculating the fees would change, however. 

Instead of basing carriers’ contributions on interstate telecommunications revenues, the USF would use alternative 

metrics as the basis for carriers’ contributions. As with the 

current system, those fees would enter the carriers’ cost 

structure, which in turn would be reflected in the prices 

that carriers charged their business and residential customers. Also, as with the current contribution rate, those 

alternative metrics would need quarterly adjustment to 

match the USF’s changing need for funds.

Expand the Contribution Base 

of the Current System

As noted in Chapter 1, only about $80 billion of the 

roughly $230 billion in telecommunications revenues 

that are generated each year qualify for inclusion in the 

USF contribution base. The gap between the USF contribution base and total telecommunications revenues could 

be narrowed by including more revenues in the base. 

Currently, revenues generated by intrastate telecommunications services constitute the largest category of excluded 

funds. Additionally, some categories of nontelecommunications spending are commonly discussed in that context, 

most notably revenues from high-speed Internet service 

delivered through cable modems.

Interstate Versus Intrastate Revenues

The courts have ruled against the use of intrastate revenues to fund the USF, finding that the Telecommunications Act of 1996 specified the use of interstate revenues 

to fund universal service.1 Nevertheless, the Federal 

Communications Commission has expanded the portion 

of telecommunications revenues that it defines as interstate. The FCC has also raised the share of cell phone 

revenues that it considers to be interstate for contribution 

purposes, and it may similarly raise the default interstate 

portion for both cellular service and bundled services in 

the future. The FCC was able to increase the share of 

costs it identified as interstate and remain within the 

bounds of the law because a large fraction of the total 

costs incurred to deliver either interstate or intrastate 

service is joint and fixed and because the FCC provides 

guidance on the allocation of such costs to one or another 

specific service.2 Including intrastate revenues in the USF 

contribution base would also reduce the administrative 

burden of the current system: the administrators would 

no longer have to decide which carrier revenues were 

interstate and which were intrastate. 

CHAPTER

1. Texas Office of Public Utility Counsel v. FCC, 183 F.3d 393 (5th 

Cir. 1999), cert. denied, 120 S. Ct. 2212 (2000).

2. Rules governing jurisdictional separation, established in FCC regulations, assign 25 percent of the cost of local service to interstate 

service and thus define an upper limit. Jean-Jacques Laffont and 

Jean Tirole, Competition in Telecommunications (Cambridge, 

Mass.: MIT Press, 2000), p. 232. 
14 FINANCING UNIVERSAL TELEPHONE SERVICE

Cable Modems

Revenues from Internet access services delivered through 

cable modems are not classified as telecommunications 

revenues, and the providers of such services are not considered telecommunications carriers. In a series of decisions on the regulatory problems caused by the interdependence of computer technologies and services and the 

communications industry, the FCC divided “services” 

into telecommunications services and information services. The former are limited to transmitting voice or 

data without transforming them in any way. Information 

services, by contrast, involve transforming the communications in some way. Thus, transmitting a voice conversation is a telecommunications service, but providing voice 

mail, which records the voice for future playback, is an 

information service. As noted in Box 1-2, the transmission portion of DSL is a telecommunications service subject to USF contributions. Accessing the Internet is an information service.

In response to court rulings, the FCC determined that 

cable modem service was an information service with an 

integrated telecommunications component. The implication of the FCC determination is that because cable modem service is not classified as an interstate telecommunications service, cable companies are not required to pay 

into the USF for cable modem service, even though their 

service now competes with DSL, which is considered an 

interstate telecommunications service.3 The FCC decision is being contested, and the issue of how to classify 

cable modem services is now before the Supreme Court. 

If the Court decides that cable modem service constitutes 

a telecommunications service, then providers of that service may become subject to USF contributions. 

Establish Fees Based on 

Telephone Numbers

One proposed alternative for financing the USF is to impose a fee on carriers for each telephone number assigned 

to a customer.4

 As of December 31, 2003, roughly 500 

million telephone numbers were assigned in the United 

States—a number that was growing by 2.1 percent per 

year.5 A charge of about $1 per month per telephone 

number would have raised about $6 billion in 2003, 

almost covering the costs of universal service that year. 

Because assigned telephone numbers currently cost nothing, carriers and institutions may be assigned more numbers than they actually use. If a system of financing universal service that relied solely on a per-number tax was 

put in place, the volume of numbers assigned might drop 

even without any change in behavior, resulting in a perline fee higher than $1 per month.

As a complement to a per-number fee, various numberbased approaches present additional revenue-collection 

options. Most notably, many large institutions lease highcapacity private communications lines on which they currently pay USF fees.6

 Those lines are often not used for 

telephones directly connected to public telephone networks but rather carry data and the institutions’ internal 

telephone system. The most prominent telephone-number-based proposals include such large-capacity lines in 

the revenue base. Advocates of telephone-number-based 

fees propose that such large-capacity lines pay a multiple 

of the per-number fee based on tiers of capacity. For example, private leased lines with communications capacity 

of between 1.5 million and 4.5 million bits per second 

might pay one multiple of the per-number fee, and private lines with capacity of between 4.5 million and 45 

million bits per second might pay a higher multiple. But 

the increase in the multiple would be less than the orderof-magnitude increase in the capacity of the line. Meanwhile, private leased lines with capacity above 45 million 

bits per second would pay yet another multiple of the 

per-phone-number fee.7

3. FCC Order 02-77, March 14, 2002. 

4. See Comments of AT&T Corporation Before the Federal Communications Commission in the Matter of Federal-State Joint Board on 

Universal Service, CC Docket No. 96-45 (February 28, 2003), 

available at http://gullfoss2.fcc.gov/prod/ecfs/retrieve.cgi?native_

or_pdf=pdf&id_document=6513583215. See also Comments of 

the Intercarrier Corporation Forum Before the Federal Communications Commission in the Matter of Developing a Unified Intercarrier 

Compensation Regime, CC Docket No. 01-92 (October 5, 2004), 

available at http://www2.sprint.com/mr/cmastaticfiles/nonlanding/documents/PPTopic/Complete%20Ex%20Parte.pdf.

5. Federal Communications Commission, Number Resource Utilization in the United States as of December 31, 2003 (May 2004), 

Table 1.

6. Typically, the capacity of a telecommunications connection, 

regardless of the medium (fiber-optic cable, copper wire, or radio 

spectrum) is measured by the number of bits (computer zeros or 

ones) that it can carry per second. A landline voice conversation is 

allocated 64,000 bits per second; cell phones can carry less than a 

typical landline, which in part accounts for their inferior quality. 

Private lines, rented by large institutions, often have a capacity of 

1.5 million bits per second but can range much higher.

7. Each proposal is different and includes a different set of tiers.
CHAPTER TWO OPTIONS FOR FINANCING UNIVERSAL SERVICE 15

Advocates of that type of system argue that it would stem 

the current erosion of the revenue base and would support that base in the future. A tax on telephone numbers 

would fall on both landline and cellular telephones. Bundling local service together with long-distance service 

would not present a problem because, regardless of the 

number of services put on a telephone, the associated customer would still pay a single USF fee on the telephone 

number. Advocates of financing the USF with a number-based system argue that it would cover Internet telephony because if Internet telephony customers wanted to 

connect to the telephone network, they would still need a 

telephone number. 

Although a telephone-number-based fee might be more 

resilient in the future than the current revenue-based system, some changes in behavior to avoid the tax would be 

likely to occur. For example, online fax services might reduce the number of telephone numbers they used. Some 

erosion, therefore, would probably be inevitable.

Establish Fees Based on the

Capacity of Telephone Lines

Some carriers and analysts have suggested imposing USF 

fees on carriers on the basis of the capacity of the telephone lines that the carriers provide to end users. As with 

a telephone-number-based revenue system, the idea 

behind replacing the current system with a fee on telephone-line capacity is to decouple USF financing from a 

declining revenue base. The capacity of the telecommunications system to transmit information is growing: more 

telephone conversations, e-mails, and other computer 

files can be carried than ever before. As with the numberbased system, advocates of a capacity-based financing system argue that such a policy change would provide protection from the largest threats to the USF’s contribution 

base. Since the new fees would be based on capacity, bundling long-distance and local services or providing flatrate long distance would not continue to undermine the 

base. Nor would growth in Internet telephony erode the 

contribution base. The reason is that no matter what protocol or physical medium—wired or wireless—is used to 

communicate, capacity is a requirement for connection. 

Some proposals for a capacity-based system contain a fee 

schedule under which capacity tiers would determine 

where the fees would rise in a series of steps. That feature 

is designed to account for the extremely high capacity of a 

relatively small number of end users, who, without the 

tiering adjustment, would pay a disproportionate amount 

of the cost of universal service.

Capacity-based fees would require the FCC to collect a 

substantial amount of new information about carriers’ 

physical infrastructure, specifically the capacity of their 

end-user connections. Rough estimates of such capacity 

are available, but they are not of sufficient quality or detail to serve as the basis for a financing system. Furthermore, like the information on current revenues, estimates 

of communications capacity would be subject to frequent 

change as technology improved.

Distributional Issues

Changing the USF financing system raises three issues 

about who would bear the costs of the system:8

B The distribution of the initial burden of USF fees 

among telecommunications companies; 

B The split of USF fees between business and residential 

consumers; and

B The division of USF fees between providers and consumers of telecommunications services.

Analyzing the Distributional Effects

of Policy Options

To evaluate the current and alternative financing mechanisms for the USF, the Congressional Budget Office used 

an FCC model that traces quantities of traffic and the 

capacity to carry that traffic among many different classes 

of telecommunication carriers, consumers, and services. 

The model allows analysts to estimate how policy changes 

would affect both carriers and consumers. CBO used the 

model to estimate how various policy changes would alter 

the fees paid by providers (local, long distance, and cellular) and consumers (both residential and business).9

The model employs assumptions about the quantities 

and prices of a variety of telecommunications services. 

Those assumptions are typically based on historical 

trends (for example, growth in subscribers to telephone 

service). The details of a proposed policy, such as which 

type of service or line is to contribute, are specified in the 

8. The distributional issues on the spending side of the USF are not 

addressed in this paper.

9. The model provides no usage or geographic information about the 

distribution of the fees within those categories.
16 FINANCING UNIVERSAL TELEPHONE SERVICE

model, which then calculates how the policy changes 

would affect the fees needed to fund USF program 

spending and how those fees would be distributed 

between residential and business consumers and among 

different types of telecommunications companies.

The model is based on data collected through 2001 and 

produces estimates through 2007.10 Some factors have 

changed little since 2001. For example, the rates of 

household formation and telephone installation among 

households change only slowly. The use of residential 

high-speed Internet and cellular telephony, however, has 

increased rapidly. 

A limitation of the model is that it cannot be used to 

show the distributional effects of including revenues 

derived from intrastate services in the contribution base. 

However, it can be used to analyze the effects of including 

cable modem revenues in the contribution base.

Distribution of the Initial Burden of USF

Contributions Among Different Types of 

Telecommunications Providers

Regardless of how the burden of paying for universal service is ultimately divided between the consumers of telecommunications services and the owners and employees 

of telecommunications companies, the obligation to pay 

falls first on providers. The model allows the initial distribution of payments to be divided among three types of 

carriers: long-distance companies, local telephone companies, and wireless carriers. The model does not distinguish within each group, although there are differences 

within each category.

Under current policy, the rise in cellular carriers’ share of 

the initial burden mirrors the decline in long-distance 

carriers’ share. In 2003, wireless carriers paid 22 percent 

of all contributions to the USF. By 2007, contributions 

from wireless carriers are projected to account for 31 percent of contributions. Long-distance carriers are expected 

to experience a substantial decline during the same 

period, from 51 percent to 37 percent of contributions. 

Local telephone carriers would experience a small increase 

in their share under current policy, from 28 percent to 31 

percent, over the same period (see Table 2-1).

Except for a fairly consistent rise in the share of cellular 

carriers, different financing systems would produce generally divergent distributions of the burden of fees. Depending on the system, local telephone companies’ share 

could range from 28 percent to 55 percent. Similarly, 

long-distance companies could see their share range from 

13 percent to 37 percent.

Compared with current policy, including cable modem 

service revenues would not alter the relative standings of 

different types of providers: the share of each provider 

type would fall by 3 percentage points compared with the 

estimated shares in 2007 under current policy. However, 

that result is not the whole story. Increasingly, cable companies provide local telephone service. Consequently, 

some carriers classified as local telephone companies 

would be disproportionately affected by that option. 

However, as noted above, the model does not make distinctions within categories of providers: that is, it cannot 

distinguish between the revenues derived from local telephone service provided by a cable company and the revenues derived from local telephone service provided by a 

traditional wireline company. 

Division of USF Fees Between Business and

Residential Consumers

The second distributional question is how a policy 

change would affect the share of USF contributions that 

appear on the bills of residential and business consumers, 

assuming that the carriers passed on their contributions 

to their customers without markup. That distribution of 

billings does not indicate who would ultimately bear the 

burden of universal service, however. Businesses typically 

attempt to pass along any cost increase, whether from 

USF fees or other sources, to their customers. The extent 

to which they can do so depends on the conditions of 

supply and demand in their market. Cost increases generally result, on the one hand, in higher prices for consum10. The FCC staff model and study relating to alternative methodologies for calculating contributions to federal universal service and 

its accompanying documentation can be found at www.fcc.gov/

wcb/universal_service/documents/USFSTUDY.WK4; www.

fcc.gov/wcb/universal_service/documents/USFprint.WK4; and 

http://hraunfoss.fcc.gov/edocs_public/attachmatch/FCC-03-

31A1.pdf.

CBO updated a few of the more rapidly changing variables to 

reflect current conditions in the market. The major changes in 

assumptions were that CBO assumed lower USF revenue requirements, lower long-distance and broadband prices, and lower residential Internet telephony subscriptions. CBO assumed higher 

rates of residential broadband subscriptions, cellular telephonyonly subscriptions and consequently a movement by consumers to 

larger buckets of cellular minutes. 
CHAPTER TWO OPTIONS FOR FINANCING UNIVERSAL SERVICE 17

Table 2-1.

Distribution of Telecommunications Companies’ Contributions to the USF

Under Different Financing Mechanisms, 2003 and 2007 

(Percent)

Source: Congressional Budget Office.

Note: USF = Universal Service Fund; n.a. = not applicable.

a. Cable modem revenues only.

ers and, on the other, in reduced profits for business owners and lower wages for employees. But the FCC model 

presents only the initial and second-round allocation of 

the USF contributions, not their ultimate incidence in 

the economy.

On average, contributions by households would not 

change substantially on an absolute or relative basis if 

current policy remained in effect between 2003 and 

2007. Households would see their monthly charges rise 

from roughly $2.09 in 2003 to $2.26 in 2007 if policy 

did not change, an 8.1 percent increase (or 0.1 percent 

after removing the effects of inflation). Their share of 

USF payments would rise from 43 percent in 2003 to 44 

percent in 2007 (see Table 2-2). Correspondingly, business consumers would see their share fall from 57 percent 

to 56 percent of payments. Most of the proposed policy 

alternatives would not affect the percentage distribution 

of USF fees between residential and business consumers 

compared with current policy.

In absolute terms, however, households would see their 

USF charges rise from $2.09 per month in 2003 to 

between $2.26 and $2.47 per month in 2007, depending 

on whether current policy or one of the alternatives considered here was used to finance universal service. That 

$0.17 to $0.38 monthly increase would most likely occur 

in the context of a decrease of about $1.98 in residential 

customers’ average monthly interstate bill (including the 

subscriber line charge, long-distances charges, and USF 

fees) over the 2003-2007 period and increases in the cost 

of the intrastate portion of local phone service, which is 

exempt from USF fees.11

Division of USF fees Between Providers

and Consumers

The initial distribution results produced by the model 

measured only USF payments made by telephone companies. Although the costs and benefits of the USF fall 

mostly on telecommunications companies (and, by extension, on their shareholders and employees) in the first 

instance, they pass on some of those costs and benefits to 

their customers. The extent to which they are successful 

in doing so depends on market conditions and regulatory 

constraints.

Share of Total Contributions, by Type of Company

Financing Option

Local Telephone

Companies

Long-Distance

Companies

Cellular Telephone

Companies Cable Companiesa

In 2003

Current Policy 28 51 22 n.a.

In 2007

Current Policy 31 37 31 n.a.

Including Cable Modem 

Revenues 28 34 28 9

Telephone-Number-Based Plan 55 13 32 n.a.

Capacity-Based Plan 43 22 33 n.a.

11. FCC, Trends in Telephone Service (May 2004), Table 13.1, indicates that over the past decade, the average increase in local 

monthly charges and other fees besides the subscriber line charge 

was $0.16 per year. 
18 FINANCING UNIVERSAL TELEPHONE SERVICE

Table 2-2.

Distribution of Business and Residential Consumers’ Share of USF Contributions 

Under Different Financing Mechanisms, 2003 and 2007

Source: Congressional Budget Office.

Note: USF = Universal Service Fund.

The empirical evidence is mixed about the extent to 

which providers pass along the expense of USF contributions to consumers. An FCC study of some long-distance 

companies’ markups of USF fees suggested that providers 

sometimes charged customers fees that were greater than 

the companies’ underlying USF contributions.12 In other 

instances, the size of consumer USF charges bore no clear 

relationship to the USF fees. However, the FCC noted 

that some of those charges could be accounted for by the 

need to recover the fees from uncollectible accounts and 

other factors. As a result of its study, the FCC limited the 

ability of providers to mark up their USF contributions 

in a 2002 ruling.

CBO has found no academic studies that specifically 

address the pass-through of USF contributions. But there 

is a parallel literature involving long-distance access 

charges.13 Access charges are fees that long-distance companies pay to local companies to complete long-distance 

calls. As access charges have decreased, various analysts 

have examined whether competition among longdistance companies has been sufficient to make them pass 

the decreases through to their consumers. The results of 

such studies are mixed, with more-recent ones suggesting 

that long-distance firms were under sufficient competitive pressure to make them pass through the decreases 

in access charges to their consumers. If long-distance 

companies behaved similarly with charge increases as 

with decreases, then they would pass along increases or 

decreases in their USF contributions to their customers. 

The USF contributions based on the subscriber line 

charge, however, are based on a service delivered in a market with little competition. The division of that portion 

of the contributions between providers and consumers 

would depend on the conditions of supply and demand 

in the particular market and on the regulatory regime in 

place. In its analysis, CBO assumed that all USF contributions would be passed forward without markup to 

both business and residential consumers.

Average Monthly Charge

per Household Percentage of Contributions Met by

Financing Option (Dollars) Residential Consumers Business Consumers

In 2003

Current Policy 2.09 43 57

In 2007

Current Policy 2.26 44 56

Including Cable Modem Revenues 2.47 48 52

Telephone-Number-Based Plan 2.47 46 54

Capacity-Based Plan 2.28 45 55

12. FCC, In the Matter of Federal-State Joint Board on Universal Service 

and Other Matters: Report and Order and Second Further Notice of 

Proposed Rulemaking (December 12, 2002), pp. 25-32, available at 

http://hraunfoss.fcc.gov/edocs_public/attachmatch/FCC-02- 

329A1.pdf. See especially paragraph 45 ff and footnotes 124 and 

125.

13. This discussion is based on David Kaserman and John Mayo, 

“Competition in the Long Distance Market,” in Martin Cave and 

others, eds., Handbook of Telecommunications Economics, vol. 1, 

Structure, Regulation and Competition (Amsterdam: Elsevier, 

2002), pp. 533-544. As noted in Chapter 1, the USF operates 

along with other policies that promote universal service. Access 

charges also help rural carriers provide inexpensive telephone service.
3

The Economic Cost of Alternatives

for Financing Universal Service 

A key consideration underlying any choice about 

federal financing is whether funds are collected at the 

lowest cost to the economy. Because fees or taxes imposed 

on the consumption of a service alter the prices that consumers face, they distort consumers’ choices: consumers 

will allocate their spending differently than they would 

have in the absence of a tax. Aside from taxes intended to 

discourage a particular activity, taxes or fees typically diminish the benefits that the economy delivers to consumers. Different taxes and fees distort consumers’ choices to 

different degrees and so impose different costs on the 

economy.

Economic Distortions from the

Current Mechanism and Alternatives

Estimates of the losses to the economy that are caused by 

distortions associated with the current system of funding 

universal service provide a basis on which to conclude 

that either a number-based or a capacity-based system 

would most likely have a lower economic cost than the 

current system does. This analysis does not extend to 

quantifying the size of that advantage, however.

The extent of the loss induced by a tax or fee depends for 

the most part on two factors: the size of the tax and the 

degree to which consumers reduce their purchases as a 

result of being forced to pay the higher prices associated 

with the tax. The higher the tax rate and the more consumers reduce their purchases when faced with higher 

tax-inclusive prices, the greater the loss caused by distortion.

The universal service system generally serves to reduce the 

cost of basic access for people in high-cost areas by increasing the cost of long distance for all users.1 The demand for basic access is extremely insensitive to price: in 

other words, consumers have almost no reaction to 

changes in the price of basic telephone access.2

 Consumers’ reaction to price changes for long-distance service is 

also small but not quite zero. (A similar argument could 

be made about cellular service, which is also more sensitive to price fluctuations than is basic access.) Fees on the 

use of long-distance and cellular telephone service, therefore, trigger a larger consumer response and thus a larger 

reduction of consumer benefit than does a fee of the same 

size on basic access. Because the USF fee varies with consumer spending on long distance, it affects a consumer’s 

decision every time a long-distance or cell phone call is 

made. Thus, a flat fee that is insensitive to use, such as the 

fee in both the number-based and capacity-based alternatives, would distort consumer choice less than the current 

variable fee does.

However, recent changes in telephone billing practices 

moderate one distortion caused by the USF fee. Increasingly, long-distance and cellular service carriers are providing bundles of long-distance minutes for a fixed fee. 

Carriers offer diverse plans that vary in size, time-of-day 

restrictions, and monthly fees.3 For consumers who subscribe to such plans, the USF becomes less a usage fee on 

CHAPTER

1. This discussion focuses on the High Cost component of universal 

service, which is the largest. The arguments would be different for 

the other support mechanisms.

2. In economic terms, the elasticity of demand for long-distance calls 

is generally agreed to be around -0.7, whereas the elasticity of 

demand for basic telephone access is thought to be closer to -0.02 

or -0.03. Lester Taylor, “Customer Demand Analysis,” in Martin 

Cave and others, eds., Handbook of Telecommunications Economics, 

vol. 1, Structure, Regulation and Competition (Amsterdam: Elsevier, 2002), pp. 126-127. See, in the same volume, Michael H. 

Riordan, “Universal Residential Telephone Service,” p. 447.

3. For a sample of the terms of such plans, see www.MyRate

Plan.com.
20 FINANCING UNIVERSAL TELEPHONE SERVICE

their long-distance calls and more an access fee on longdistance service. For those consumers, the price of any 

additional phone call—if they stay within their plans—is 

unaffected by the USF fees, and consequently the negative impact of the fees is reduced. Marketing statistics 

suggest that about a quarter of telephone subscribers currently have such plans and that more consumers will buy 

them in the future.

Cell phone subscriptions contribute to the trend toward 

flatter fees. Traditionally, long-distance and international 

service provided by wireline is priced by minutes of service. But cell phone plans more often offer unlimited 

long-distance calls (albeit, usually only during the evening and on weekends) and specified numbers of minutes 

(usually allocated in “buckets”) that can be used anytime 

without incurring extra charges beyond the flat monthly 

fee. Since about 170 million people have cellular telephones, the ability to substitute cellular long distance for 

conventional long distance is available for many households and can be expected to increase. New technology 

should make various combinations of services more 

readily available. The use of cell phones and other fixedminute-based pricing plans means that USF fees are less 

often an influence on a consumer’s decision to buy an 

additional minute of telephony service than they were in 

the past. 

USF Fees and Competing Advanced 

Telecommunications Services

As noted in Chapter 2, the FCC does not impose USF 

fees on cable modem service but does impose them on 

a portion of the revenues derived from digital subscriber 

line service. Those two forms of high-speed Internet 

access—cable modems and DSL—compete in the marketplace for residential customers and generally provide 

the same service. A tax applied to one technology that 

provides a certain service but not to another technology 

that provides the same service distorts prices and thus 

imposes an economic cost.

The uneven regulatory treatment of cable modems and 

DSL is largely a historical artifact, arising from the fact 

that DSL is a service provided over a telephone wire, 

which was already subject to USF fees.4 By contrast, cable 

modem service evolved in the context of cable video service, which was not subject to USF fees because it was 

never considered a telecommunications service. Thus, 

services delivered by telephone wires and video cables 

have now come to compete in the marketplace under different regulatory regimes and different taxation—creating 

economic distortions.

Funding the USF Through 

General Revenues

Most federal spending is funded through general revenues, and some analysts have suggested that lawmakers 

consider financing universal service through that mechanism.5

 The current financing system was put into place 

when the Bell telephone system relied on profits from 

business and long-distance customers to provide service 

in high-cost areas. With the breakup of the Bell system, 

what had been a set of intracorporate transfers became 

a set of intercarrier transfers, which was then modified, 

most recently, in the Telecommunications Act of 1996. 

Financing universal service with general revenues would 

dissolve the long-standing relationship between the funding of universal service and spending on telecommunications services.

The economic cost of raising a dollar in general revenues, 

which may influence the supply of labor and capital, is 

generally less than the economic cost of raising a dollar 

from sector-specific taxes, which tend to distort consumers’ choices by affecting the prices of goods and services. 

A 1998 assessment determined that USF fees cost the 

economy an additional $0.64 to $1.47 for each dollar in 

revenue they produced.6 Because long-distance access fees 

have declined since that analysis, those estimates probably 

overstate the current economic cost of the USF fee system. The economic losses arising from general taxes are 

estimated to range between $0.25 and $0.40 for each additional dollar collected. Thus, they are substantially 

lower than the cost of raising an additional dollar through 

fees or taxes on telecommunications services.

4. However, the FCC did affirmatively decide to subject DSL to 

USF fees. See GTE Corporation Asymmetric Digital Subscriber 

Line Order, 13 F.C.C. Rcd. 22466 (1998).

5. Thomas Hazlett and others, Sending the Right Signals: Promoting 

Competition Through Telecommunications Reform (report submitted by the Analysis Group to the U.S. Chamber of Commerce, 

September 22, 2004), p. xviii.

6. Michael H. Riordan, “Universal Residential Telephone Service,” 

in Cave and others, eds., Handbook of Telecommunications Economics, vol. 1, p. 438, available at www.columbia.edu/~mhr21/

US-aug-29.pdf; and Jerry Hausman, Taxation by Telecommunications Regulation: The Economics of the E-Rate (Washington, D.C.: 

AEI Press, 1998), p. 15, available at www.aei.org/docLib/

20040218_book245.pdf.