A new study issues a stern warning to the Federal Communications Commission as it embarks upon transitioning its Universal Service Fund from phone service to broadband. First, the government must address the fact that a big percentage of USF cash currently goes to "inflated overhead expenses," rather than to making a call more affordable.

Here's the bottom line, according to the Technology Policy Institute's report. Of each dollar distributed to the USF's High Cost Fund, which subsidizes phone carriers in mostly rural areas, 59 cents goes to "general and administrative expenses"—personnel, government relations, planning—rather than to the actual business of making telephone service cheaper. The study is based on a review of 1,400 receivers of these subsidies from 1998 to 2008.

"These results, consistent with a large body of economics literature, suggest that the Universal Service Fund's method for subsidizing service in high-cost areas should be radically overhauled as a key component of the current desire to shift USF support from voice to broadband," concludes the report, authored by the TPI's vice president for research Scott Wallsten.

This finding can't be a complete surprise to the FCC, which is in the process of managing that shift. The USF was designed "for a world that no longer exists," FCC Chair Julius Genachowski told the Information Technology and Innovation Foundation last month. It was created "for a world with separate local and long-distance telephone companies; a world of traditional, landline telephones before cell phones or Skype; a world without the Internet."

But the TPI says that even beyond its antiquated assumptions, the USF needs to be reconfigured to put less of its money into administrative costs, and more into service.

"The current universal service system is broken," Wallsten says. "The widespread belief among policymakers that it should evolve from subsidizing voice to subsidizing broadband presents an unprecedented opportunity for reform. We should not let this opportunity pass us by."

Four fixes

The USF presently tithes your long distance bill—"long distance" being a concept that is rapidly disappearing in the age of IP telephony—and transfers that money to programs to subsidize the telephone service of low-income consumers and carriers that operate in high-cost regions (most of them rural). The High Cost fund takes the lion share of USF money. The program also provides funding for computers and networking to libraries, schools, and rural health care providers.

About $7.5 billion in USF money a year goes to carriers, the TPI estimates. The FCC wants to move it to a Connect America Fund to support broadband providers for poor and rural regions. The CAF will only subsidize providers in zones "where there is no private sector business case to provide broadband and high-quality voice-grade service," and will aim to support only one provider per area. Its recipients will be adequately audited. And, of course, they will have to provide broadband.

But the TPI says more housecleaning has to happen before the broadband shift is completed. The Institute makes four suggestions.

First, dump the High Cost Fund's current cost-based "rate of return" compensation system, "which eliminates the incentive for firms to operate efficiently and creates incentives to inflate reported costs."

Second, if it does fund multiple providers in any area (the idea is not to), it should set its subsidies to the needs of the lowest cost provider. At present, the system rather bizarrely calculates costs based on the incumbent to which USF recipients connect.

Third, use auctions to determine the rate of subsidies. These would presumably be "reverse" auctions, in which the lowest bidders got the contract to provide service in any given area.

And: "The program should explicitly consider the use and cost-effectiveness of satellite broadband, especially considering that the soon-to-be-available next generation of satellites will offer download speeds of between 5 and 25 Mbps."

Seems like the FCC and the USF's critics are on at least some of the same pages on this subject. The agency's new proposals for the new USF include these two recommendations:

Transition funding for duplicative phone service by multiple phone companies operating in the same area to provide support where it's most needed

Impose reasonable limits and guidelines for reimbursement to providers that have little incentive under our current subsidy system to operate efficiently

We contacted the Universal Service Fund for a reaction to the report. No comment, we were told.