Netizens, prepare to pay more

If you own a cable modem, expect a substantial increase in your monthly rates if a proposal currently before the Federal Communications Commission goes forward.

The FCC is considering levying an additional tax of up to 9.1 percent on the revenue of cable modem providers. In theory, a cable provider is not required to pass the tax increase along to customers, but in practice, companies tend to do just that. EarthLink said last week that it would raise prices because of digital subscriber line (DSL) taxes imposed by state governments. It's safe to assume that EarthLink will do the same thing if a cable modem tax comes along from the federal government.

So far, few people have paid attention to the FCC's proposal, which began in typical bureaucratic fashion with a reference on paragraph 78 of a 58-page filing in February 2002. Even the FCC has mostly ignored it, spending the past 16 months focusing on broadband deregulation and media ownership rules.

But now that those hotly contested votes are over, the FCC is planning to return to its February 2002 proposal, with D.C. buzz predicting formal regulations by the end of the summer. FCC representative Mike Balmoris told me on Friday: "It is one of the priorities of the chairman. A few of the other priorities--media ownership, triennial review--have been completed. The commission could be tackling that in the coming months."

The origin of this proposal lies in the 1996 Telecommunications Act, in which Congress bowed to rural politicians and special interest groups--including librarians, educators and physicians--and created a Universal Service Fund that's paid for by additional taxes on telecommunications companies.

About 85 percent of the fund's revenues are split between two causes: the "E-rate" program (40 percent), which subsidizes school and library Internet connections, and rural telephone companies (45 percent), which might otherwise end up paying more for telephone service than city dwellers. The remaining 15 percent goes toward discounts to low-income subscribers and funds rural health care.

Like typical government entitlement programs, the Universal Service Fund has grown steadily since its birth. It started out at about $3 billion and is now hovering around a fat $6 billion. The Congressional Budget Office has estimated that the fund will balloon to more than $13 billion, which is probably a conservative figure.

Why is this relevant today? Well, according to current FCC regulations, DSL providers such as Verizon Communications, SBC and BellSouth are required to pay a portion of their revenues to the Universal Service Fund. But cable modem providers, which are classified differently as "information services"--a category dating back to the FCC's Nixon-era regulations--are exempt from that tax.

Now the FCC is wondering whether it's high time to tax both DSL and cable modems at the same rate. Its February 2002 request for comment questioned "whether other facilities-based providers of broadband Internet access services (should) be required to contribute" to the fund. The notice also mentioned levying identical taxes on wireless, satellite and Net telephony services such as Vonage and Net2Phone.

Not everyone has missed what the FCC's proposal might mean. AOL Time Warner, which owns cable companies, submitted a response to the FCC, saying that the agency "should not reverse decades of sound legal and policy conclusions" and warning that taking such action would also reduce regulations on the regional Bell companies that are necessary to spur competition.

Verizon, on the other hand, says in its response to the FCC that its competitors should not be exempt from a tax it has to pay.

Now the FCC is wondering whether it's high time to tax both DSL and cable modems at the same rate.

"If telephone companies face universal service obligations for broadband that are not imposed on cable, satellite and terrestrial wireless providers, then telephone companies will bear an additional expense that will be passed on to their customers," Verizon's law firm wrote. "That will make their services relatively less attractive than cable, satellite and terrestrial wireless broadband and will result in market distortions."

One important point to note: If the FCC goes ahead with its proposal and cable users end up paying more in taxes, DSL users will end up paying less. Because more people will be contributing to the same $6 billion fund, under FCC procedures, each person's contribution gets reduced. So, while DSL taxes currently are 9.1 percent, that rate could fall substantially.

Colleen Boothby, a former FCC official who is now a partner at Levine, Blaszak, Block, and Boothby, warns that, if the FCC goes forward and taxes cable modem providers--which are, you remember, an information service--it could open up a particularly squiggly can of worms.

"If they want cable modem services to pay, they have to decide how to avoid sweeping in all other information services as well," Boothby says. "That's really the point. How do you say an information service like a cable modem has to pay, without saying that all other information services have to pay? And (how do you) do that in a way that survives court review?"

Boothby says that the information services category that would be taxed includes credit card validation networks, airline reservation systems, Web hosting providers and e-mail service providers.

When asked for comment, one FCC official who asked to remain anonymous said it might be possible to concoct rules that cover only cable modem information services--but acknowledged that it's "not a foregone conclusion." (If you want to peruse more FCC arcana, one good explanation of the information services category starts on page 21 of the agency's 1998 report to Congress.)

If the FCC goes ahead with its proposal and cable users end up paying more in taxes, DSL users will end up paying less.

If you're confused by all this, don't blame the FCC. Blame Congress, which invented these definitions and created the Universal Service Fund.

Blame politicians from rural states--like Republican Sen. Ted Stevens of Alaska, who heads the appropriations committee, along with Republican Sen. Conrad Burns of Montana, who heads the communications subcommittee. Stevens, Burns and other rural-state politicians vie to find new excuses to increase Universal Service Fund-related taxes.

The idea of universal service is certainly a worthy one. But when cellular phones are so popular, do we really need to spend billions of dollars a year on subsidizing rural America's landlines?

In addition, blame the companies and special interest groups that benefit from the Universal Service Fund and have every incentive to lobby to keep the current system in place. Instead of handing out corporate welfare to fund recipient Walt Disney, why not give "telephone stamps" to the needy, modeled after food stamps?

And blame the rest of Capitol Hill, which has agreed to higher and higher taxes while ignoring all but the worst abuses that accompanied the Universal Service Fund from the start.

An October 2002 report from the FCC's inspector general noted "weakness" in oversight of the E-rate program, which is handled by the FCC but overseen by the government-created Universal Service Administrative Company. The inspector general said audits were still under way, "but preliminary results indicate potential irregularities at many locations."

The sad thing, of course, is that the FCC's regulations would amount to nothing more than thousands of pages of confusing and contradictory verbosity if it weren't that billions of dollars and the future of our monthly Internet bills are at stake.