The Congressional Budget Office (CBO) has scored S. 652, the Telecommunications Competition and Deregulation Act of 1995, as a new $7 billion tax on the telecommunications industry. The reason for this is that certain provisions of the legislation expand federally mandated subsidy transfers across industries, maintaining lower prices in one segment of the market (local, rural, and residential) at the expense of another (urban, business, and long-distance). Although the subsidies do not flow directly through the federal government, the CBO correctly concludes that they should be scored as taxes because "payments between companies are made as a result of the exercise of the sovereign power of the federal government, not as a normal business transaction between companies."

S. 652, as currently drafted, will increase the use of these subsidy flows to deliver more advanced telecommunications services to some Americans. Traditionally, these subsidies have been used only to spread the delivery of basic telephone service. The new legislation, however, requires an "evolving" definition of universal service, meaning more than basic phone service must be subsidized. In addition, the bill demands that all Americans be provided with advanced telecommunications services once "a substantial majority" have access. These provisions would be extremely costly to administer and, therefore, would require increased taxes.

While these problems must be addressed, Congress should not permit CBO's findings to threaten the success of broader legislative initiatives to deregulate the telecommunications industry. Fortunately, lawmakers have two options for addressing these findings and continuing to move forward with this legislation:

OPTION #1: Give states control of universal service.

The current federal telecommunications entitlement program, with its overlapping and inefficient cross- subsidies, should end. Congress could do this by giving states responsibility for designing, defining, financing, and delivering universal service. Roughly three-fourths of these subsidies already are administered at the state and local levels. Congress could establish a Federal-State Joint Board to transfer any remaining federal authority to the states. The Board also could provide guidance to the states on how to eliminate current cross-subsidies that flow to multi-billion dollar corporations. It could replace them with means-tested vouchers that give individual consumers deemed needy the means to choose among several providers, instead of forcing them to rely on a single monopolistic provider.

This is a sound policy option to address the tax problem created by an inefficient system of subsidies to large corporations. By contrast, any plan to maintain a federal role in the delivery of universal service would require tax increases to cover subsidy costs. Sending or "devolving" all responsibility to the states would eliminate this federal tax problem while ensuring that universal service is delivered more effectively.

OPTION #2: Table universal service for further study while moving forward with other deregulatory initiatives.

Congress could move forward with its broader efforts to remove barriers to entry, putting off reform of subsidization mechanisms for a few months and dealing with it in separate legislation at a later date. This would eliminate the federal tax problem as long as other legislative provisions do not create additional cross- subsidies. However, Congress must follow three steps to ensure that any bill that passes does not contain a telecom tax:

STEP 1: Eliminate all current universal service language from the bill.

STEP 2: Do nothing to alter the current system in the interim.

STEP 3: Include a provision requiring the Federal Communications Commission (FCC) or a presidentially appointed independent panel to complete a study within six months after enactment that requires the FCC or the panel to do the following:

Provide a detailed description of all implicit and explicit subsidies (both federal and state) utilized currently to provide universal service.

Quantify the cost of each of the described subsidies and the economic costs and benefits associated with each subsidy. This also would include a description of the providers and recipients of such subsidies.

Present its findings to Congress for immediate consideration. The study also should have to present Congress with alternative policy options for ensuring the delivery of universal service. This would need to include the feasibility of giving states complete responsibility for universal service as outlined in Option #1. If Congress requires the FCC or an independent panel to study the current universal service system and policy alternatives, it will have more and better information than currently exists on how to reform the system.

These two options provide Congress with a solution to CBO's findings while continuing to pursue broader telecommunications reform. Such reform is critical to dismantling a system that now destroys competitive incentives in the local telephone market while draining billions of dollars from American businesses and consumers.

Adam D. Thierer is a former Alex C. Walker Fellow in Economic Policy at The Heritage Foundation.