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March 17, 2006

Testimony Before the Senate Commerce, Science and Transportation Committee Regarding Video Franchise Reform and VoIP


Witness: Bartlett Cleland, Tom Giovanetti, George A. Pieler, Barry M. Aarons
Testimony Date 03/17/2006
Body of Congress: Senate
Committee: Commerce, Science and Transportation
At the Request of: The Commerce, Science and Transportation Committee

Testimony Subject:
Video Franchise Reform and VoIP Testimony Before US Senate



Chairman Ted Stevens
Senate Commerce, Science and Transportation Committee
508 Dirksen Office Building
Washington, DC 20510

Dear Chairman Stevens,

We appreciate the Committee’s invitation to comment on both video franchise reform and Voice over Internet Protocol as it deliberates on these issues.

About the Institute for Policy Innovation (IPI):
The Institute for Policy Innovation (IPI) is a nineteen year old free-market public policy research organization. IPI researches and promotes sound policy solutions that feature lower taxes, fewer regulations, and a smaller, less-intrusive government. IPI specializes in issues of economic and technology policy.

IPI does not lobby. We do not represent companies, or industries, and we do not advocate the passage of any particular piece of legislation. We do, however, advocate policies that stimulate economic growth, and we are firmly convinced that telecom reform, and correct communications policy will spur increased economic growth and competitiveness in the United States, and provide consumers with increased availability of valuable products and services.

Video Franchise reform:

What are the Main Goals of Deregulation?
There are three basic goals of any effort to deregulate any industry:

Lower barriers to entry and exit. It should be as easy as possible for new competitors to enter a market. It is equally important for competitors to be able to exit a market. Normally all anyone wants to talk about is lowering barriers to entry, but it’s just as important for a company to be able to leave a market when economics so dictates.

Allow markets to set prices. Normally, when a market is deregulated prices are artificially set, capped, or otherwise controlled by governments, rather than free contracts between customers and vendors. Just as a sign of a healthy organism is movement, the sign of a healthy market is prices that move as the information changes. Prices are information about a market. When the market changes, the information changes, and the change in price communicates that change in information to the consumer. In a healthy market, prices move.
End anticipatory regulation. Much regulation is anticipatory in nature, assuming that companies will behave badly unless they are hyper-regulated. This anticipatory regulation, where government anticipates problems that may never exist, places all kinds of burdens on companies even absent a track record of misbehavior. Remember that when industry is deregulated, government doesn’t go away. Antitrust law doesn’t go away. When you deregulate an industry, you do not give them immunity from prosecution. You simply make it easier for them to reach their customers. Government steps out of the way, and stops functioning as a gatekeeper, and a rent-extractor.

These should be the goals of telecom deregulation -- reducing barriers to entry and exit, allowing prices to move, and ending anticipatory regulation. Notice what is not said. The goal of deregulation should not be to “get the cable industry.” The goal should not be to lower cable rates. Congress could lower cable rates by regulatory mandate, and some consumer groups would think that was just ducky, but that would be price controls plain and simple and something antithetical to the free market.

What Principles Should Guide You?
Above all, there should be no discrimination between different ways of doing the same thing. If there are two or three or four different modes of delivering video to consumers, they ought to be taxed and regulated exactly the same way. Public policy should be neutral and non-discriminatory, and should not pick winners and losers.

Government should not serve as a gatekeeper. It’s offensive that a company must obtain the permission of a government before entering a perfectly legal business.

One of the most despicable things government does is insert itself as a middleman between consumers and producers in order to extract revenue. For this reason the entire system of video franchises should be tossed out the window. Franchise fees are pass-through taxes on consumers, and have little to do with accessing the municipal rights-of-way. Companies that provide video content are already taxed. The companies pay corporate income taxes, their shareholders pay dividend and capital gains taxes, and their employees pay income and sales taxes. There is no justification for additional taxes in the form of franchise fees. The reason all the players in this debate have so easily agreed on the new franchise fee formula in the reform is that none of them are actually paying it. They’re just passing it through to consumers. There is no justification for this continued regime.

Price Should Move. It is absurd that, for so long, prices in the telecom industries have been largely determined by appointed or elected regulators. In every other industry, prices are free to move. That includes trucking and airlines and railroads, industries that we deregulated years ago. Now it’s time to bring the same pricing freedom to telecom.

Property rights should be respected. Remember, it’s their network. It does not belong to the government, or to the “people.” These are private networks, built with private capital, and the owners of the networks should be free to direct their deployment and use with a minimum of interference.

These aren’t your father’s cable companies or telecom companies. Forget everything you think you know about communications companies. Today, these companies are aggressive, competitive risk-takers. They are making enormous investments and offering new products and services. They should be free to try new things, to test a new service in a particular test market without being required to deploy it everywhere. Let them experiment. Let them expand where opportunity presents itself and contract where opportunity no longer exists.

Lessons from Texas
IPI is a national organization but being based in Texas, we put weight on the law Texas enacted in 2005 to streamline, simplify, and deregulate its market for telecom services. The new Texas law is in significant degree an appropriate model for Congress to consider in its deliberations. That is not to say that Texas got everything right -- for example, we believe that governments should not design an uneven playing field for certain competitors, and as discussed, the franchise system should be eliminated altogether.

Texas adopted a statewide franchising system for telecom providers, while sorting out which provisions of traditional municipal franchising were vital, paying due regard to the revenue and control concerns of municipal governments.

Thanks to telecom franchise reform in Texas, real competition is becoming a reality. Already telecom companies are able to offer video over broadband, and this source of competition has the potential to revolutionize the video market for the benefit of consumers.

As the Committee knows, the only residual justification for the franchise system as we know it has been the power to award monopolies and retain franchise and licensing revenues. Congress knows that the concept of a ‘natural monopoly’ in telecommunications services, including video services, has long been obsolete. With new competition from telecom companies, the status quo franchise system a urgently needs drastic overhaul, with fierce competition and speedy rollout of broadband technology.

When Texas enacted franchise reform, it allowed any video provider, not just telecom companies, to obtain a statewide franchise, rather than having to negotiate franchises jurisdiction-by-jurisdiction.

The result was immediate. All over the greater Dallas area, there are signs up explaining that sidewalk is under construction because, e.g., Verizon is rolling out its fiber-to-the-home network. The broadband rollout is happening, right now, in Texas, and it is uncanny how quickly things accelerated once Texas deregulated the video franchise business. Clearly opening up the franchise works: the existing franchise system truly did impede vital new competition.

These new competitors bring with them a critical new investment. New capital is flowing into Texas, and it is creating jobs. This new investment will also bring new tax revenue into the state’s coffers. This is the right kind of revenue increase: not raising the tax burden on existing entities, or subjecting them to unfair competition, but generating new revenue through economic growth.

Franchise reform in Texas also made it is easier for people to qualify for lifeline rates, which is as it should be. There is no reason to regulate an entire industry to protect a small subset of the population which needs help. Protect the target population and free the rest of the market.

We urge the committee to review in detail the particular features of the Texas Franchise Reform, but its implications reach beyond Texas.

According to Bank of America Equity Research, incumbent service providers in Texas, Florida, and Virginia where new franchise authority has been given to the Verizon FIOS service, have begun to offer much more competitive rates to the local customers for both bundled and unbundled services. In addition, a study prepared early this year by Citigroup Equity Services indicates that in the short run, the trend is toward increased competition and lower pricing structures Citigroup notes that “With most consumers still purchasing services from providers that charge higher prices, we see potential for upheaval, and churn, across all communications and video services. In part, this reflects a more pervasive deployment of cable voice and telco video.”

We suggest that market competition is the key to benefiting consumers, first, last, and always. Companies do not do things without a good reason. Companies do not invest in rolling out broadband without a reason to do so, and there is no doubt that the existing panoply of municipal franchise regulations has put a great deal of friction in the market, raising costs, delaying rollouts, and impeding competition. Now, the opportunity to compete with cable for video customers gives the telecoms the reason to aggressively rollout and price broadband.

US policy must foster a national competitive market in advanced technology services, a policy that still defers to legitimate local concerns over the quality, cost, and public interest vested in telecommunications service. We believe Texas has adopted such a regime.

By exercising Congressional authority in decisive and thoughtful manner, congress will provide consumers with enhanced choices and options in the video business and foster the creation of new services and innovations we can only imagine today.

Voice over Internet Protocol:
One of the fastest-growing services provided over the Internet is telephone service provided using the Voice over Internet Protocol (VoIP). Like so many aspects of the Internet in this new Telecommunications Age, internet-based telephony poses new challenges and striking opportunities for federal, state, and local authorities should services like VoIP be regulated and taxed like traditional wired phone service? If so, should that regulation and taxation be a principal concern of the federal government, or of states and localities?

What Principles Should Guide You?
Do not “regulate up”. VoIP-type services should not be dragged into an increasingly obsolete matrix of local, state, and federal telecom taxes and fees. Inasmuch as such distinguished authorities as the General Accounting Office and the Joint Committee on Taxation have recommended expanding the old tax regime to cover these new services, the Committee and the Congress should be vigilant against premature legislative or administrative decisions aimed at grasping the last dime of revenue, rather than rationalizing telecom taxes to better fit the markets of the future.

Do not “tax up”. The present Internet Tax Moratorium (IFTA) was devised as a check on discriminatory and distracting state and local taxes, yet it apparently has not discouraged states and localities from trying to draw new revenue off the Internet. The moratorium ‘grandfathered’ certain state tax initiatives preceding its enactment, and the 2004 extension of the moratorium left open the question whether it would be OK, for example, to tax VoIP services. The ostensible rationale was that VoIP is a competitor for traditionally-taxed telephone services and the fact that it is Internet-based should not be a safe harbor from taxation.

One problem with interpreting ITFA to leave open the door to taxing VoIP is that a VoIP tax cannot be distinguished from a tax on the ISP services which facilitate VoIP. Further, the VoIP tax rate could be set so high that it implicitly becomes an Internet service tax. Theoretically a ‘level playing field’ among all types of phone service demands any VoIP tax be limited to the tax rate on more traditional phone services. It would be better if competition from VoIP and other emerging services made us rethink telecom taxation from the ground up, perhaps reducing or eliminating such taxes altogether.

The City of Chicago has told VoIP customers they must pay the same telecom tax as applies to traditional (including wireless) phone services. Florida narrowly rejected a definition of its telecom tax covering VoIP, and clearly VoIP is still seen as a juicy target for future revenue growth. Just how juicy is unclear: the FCC in November 2004 ruled that VoIP was presumptively a federal issue (implying possible federal preemption of state taxing authority in this area), but the scope of the FCC’s ruling remains to be tested.

The enthusiasm for VoIP taxation is not confined to states and locals: in 2004 the Joint Committee on Taxation proposed raising federal revenue by redefining telecom services covered by the federal telephone tax. This definition would have included VoIP and essentially all types of landline, satellite, and broadband services over which communication occurs. Only a brief uproar in Congress put the kibosh on this proposal, but there it lies on the revenue options table, waiting to be picked up by any eager member of Congress. Three federal judicial circuits have ruled that the federal telephone tax cannot be imposed on call plans priced by call time rather than ‘distance’ the call travels. As USA Today reports, this would mean “cellular phones, Internet phone service, and about one-third of long-distance calls would be exempt from the tax.” In theory this could lead to VoIP exemption from the telephone tax, but the legal situation remains in flux. VoIP has also been targeted by the Federal Communications Commission (FCC) for contributions to the ‘Universal Service Fund’ (USF), although USF remains a continuing focus of controversy over the legitimacy of the FCC’s authority (is the Commission not raising taxes here?), and over the manner in with the USF monies have been managed and deployed to ‘improve access’ to advanced telecommunications services in underserved areas.

This so-called ‘dedicated fee’ from the FCC threatens to take on a life of its own without even the minimum scrutiny and oversight provided by the congressional budget and appropriations process. If anything this issue will grow in importance: Congressmen Lee Terry and Rick Boucher are working on legislation to ‘regularize’and codify the USF on a very broad base indeed, defined as “universal services as of the date of enactment plus high speed broadband services and an evolving level of telecommunications services to be identified by the FCC.” (Terry/Boucher Discussion Draft, Universal Service Reform Act of 2005, dated November 17, 2005).

Give critical attention to the legal-regulatory framework. The Committee should undertake a thorough review of both the legal and ‘real world’ context for modern telecom services before making any quick decisions about the proper regulatory framework for VoIP (much of that framework, of course, will be set by the Federal Communications Commission). Issues such as federal preemption of state and local regulation of VoIP are important, and arguably Internet-based services such as VoIP are more naturally a subject of federal interest than were old-style local phone service. This is an area where both courts and regulatory authorities are divided, and it may be that a case-by-case resolution will rationalize the regulatory regime as well as any Act of Congress might. That is an issue Congress should keep open, however, since uncertainty in the legal parameters for creating new markets and new services seldom advances the public interest.

With regard to both taxes and regulation, VoIP and other new services yet to be deployed raise important questions for policymakers at all levels of government. We have outlined some of the most urgent issues the Committee should address in shaping the federal role vis-à-vis the states as the telecom market continues to evolve. IPI hopes that this Committee, and Congress, will choose wherever possible to limit taxation, fees, and regulations that inhibit that market evolution: and to do so by striking a proper balance between national authority and local prerogative, consistent with the emergence of cyberspace as a vital, border-free channel of health, commerce, learning, entertainment, and communication.

Footnote: Three federal judicial circuits have ruled that the federal telephone tax cannot be imposed on call plans priced by call time rather than ‘distance’ the call travels. As USA Today reports, this would mean “cellular phones, Internet phone service, and about one-third of long-distance calls would be exempt from the tax.” In theory this could lead to VoIP exemption from the telephone tax, but the legal situation remains in flux


Tom Giovanetti, President
Bartlett D. Cleland, Director
Barry Aarons, Senior Research Fellow
George Pieler, Senior Fellow


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