When the Federal Communications Commission (FCC) instituted the subscriber line charge (SLC), telephone household penetration rates actually increased, even though local rates rose when the SLC was rolled in. That experience now finds confirmation from regulatory reform in Illinois, where a case study demonstrates that efficient pricing of local telephone service need not undermine the goal of universal access.

From 1986 to 1993, the Illinois Commerce Commission restructured residential telephone rates, phasing in mandatory local measured service (LMS) throughout the state. During that period, the commission allowed the access-line price component of the LMS rate to climb from roughly 10 to 30 percent for subscribers in the various Illinois calling regions. Nevertheless, the actual penetration levels (reported for Illinois by the FCC) fell only a small amount (em from an annual average of 94.3 percent in 1990 to 93.6 percent in 1993. The measured decline in household penetration is significantly less than would be expected given the accepted range of demand elasticities for telephone access. This decline might arise from many factors: increasing income levels, improvements in service, or the introduction of alternative pricing plans such as LMS.

Table 1 shows monthly residential telephone rates for three Illinois calling regions: Access Area B (portions of Chicago outside downtown [Area A], plus certain suburbs), Access Area C (mostly suburban), and the region Outside MSA1, which includes the remainder of the state served locally by Illinois Bell.1 The rates include the monthly cost of unlimited flat-rate service as well as the local line charge under LMS for individual residential customers.2 Rate changes in the three regions in Illinois from 1986 to 1993 were as follows:3

Outlying Chicago. In 1987, mandatory LMS was initiated in Access Area B (outlying Chicago and some suburbs). Those callers who were required to switch from flat rates to LMS saw their minimum price of access fall, but had to pay usage charges. In 1990, the local line charge under LMS increased by $1.03, from $4.53 to $5.56 (20.5 percent). With a supplemental line charge of $3.484 included in the base price of access, the minimum monthly price of access rose to $9.04, or 12.9 percent above its 1989 level.

Suburbs. In 1987, mandatory LMS was initiated in Access Area C (most Chicago suburbs). Callers in this region who were required to switch from flat rates to LMS also saw their minimum price of access fall, but had to pay usage charges. In 1990, the local line charge under LMS increased by $1.03, from $8.00 to $9.03 (12.1 percent). Including the supplemental line charge of $3.48 in the base price of access gives a minimum price of access of $12.51, or 9.0 percent above the 1989 level.

Downstate. In 1990, LMS became mandatory in non-MSA1 regions (em making LMS mandatory statewide. Callers in this region who were required to switch from flat rates to LMS in that year also saw their minimum price of access fall, but had to pay usage charges. However, residents in this region saw their monthly local line charge increase by $3.00 (em from $6.03 in 1989 to $9.03 in 1992 (em a cumulative increase of 49.8 percent over the three-year period. Including the SLC of $3.48 in the base price of access gives a minimum price of access of $12.51 (em a 31.5-percent cumulative increase above the 1989 level.

On November 9, 1989, in response to proposals filed by Illinois Bell in December 1988, the Illinois Commerce Commission (ICC) entered an order on a modified regulatory structure and rate restructuring.5 Effective January 1, 1990, rates were reduced by $45.8 million (em above-rate changes that replaced a $85-million temporary credit implemented in July 1988. This rate restructuring represents a total permanent rate reduction of $95 million (em far more than the $35-million reduction proposed by Illinois Bell. Although residential local line charges were raised under the rate restructuring and prepaid flat-rate service was eliminated, usage rates were reduced by $128 million through improved discount schedules as well as reduced charges for calls beyond eight miles. The rate restructuring included reduced rates of up to 50 percent on intra-MSA toll calls as well as volume discounts of up to 33 percent for residential customers.6

Predicting the impact of these price changes on telephone penetration requires knowledge of the price elasticity of demand for telephone access. In 1983 Lewis Perl came up with an estimate of -0.0414 for the elasticity of demand for measured rate access, by analyzing elasticity as a function of the cost of telephone service, income, and several socio-demographic factors.7

Elsewhere, Kenneth Gordon and John Haring8 cite additional studies of price elasticity of demand for telephone access. These studies include empirical estimates at various levels of consumer demand (e.g., city, state, household). Of these studies, the highest and lowest elasticity estimates (in absolute terms) are -0.17 and -0.05 for U.S. cities and states, respectively.9 These elasticity estimates allow us to predict the expected change in the demand for telephone access as a result of yearly price changes. Table 2 shows the predicted changes in residential telephone subscribership for our three regions. The statewide impact of the price increases in the access component of LMS was calculated using a weighted average of the predicted changes for the three separate regions.

Data on the number of subscribers were taken from the FCC's time series on telephone subscribership (at the state and national levels) by selected demographic characteristics. The FCC data reflect a staggered panel survey of approximately 58,000 households conducted by the Bureau of the Census.10 Since no seasonal variation appears in the "telephone available" statistics, the data in the FCC report are not seasonally adjusted.11

Data reporting the actual percentage of Illinois households owning a telephone allowed us to evaluate the impact of the rate restructuring on universal access. For 1985 through 1993, Illinois telephone subscribership based on "units available" fell by 0.1 percent (em from 93.7 to 93.6 percent (em and is not statistically significant.12

To analyze the effect of rate restructuring in Illinois, we begin with the year 1989 (em the year before LMS first became mandatory throughout the state.13 All three regions experienced higher rates for the cost of access in 1990 (when the telephone subscription rate actually rose). All in all, the cumulative percentage change in telephone subscribership in Illinois declined by -0.274 percent for 1990 to 1993.

This decline can be compared to the predicted changes in telephone subscribership shown in Table 2. Using the elasticities estimated by Lewis Perl,14 Table 2 gives the predicted changes on telephone subscribership for 1990 to 1993 (em the period during which LMS was mandatory statewide in Illinois. Table 3 compares predicted to actual yearly (and cumulative) changes in telephone subscribership.

For 1990, the expected change in telephone subscription would range from -0.612 to -1.836 percent. By 1993, when additional rate increases had taken hold in the downstate non-MSA1 region, one would have expected a higher overall change in subscribership rates for the combined regions (em somewhere between -0.837 and -2.514 percent. Nevertheless, the actual cumulative percentage change in actual telephone subscribership for 1990 to 1993 in all three regions was only -0.274. This figure is three to nine times smaller than the predicted decline.

Moreover, the disparity between actual and predicted declines in penetration rates may actually be understated. When LMS and flat-rate service were both available, high-volume callers could be expected to opt for flat-rate service, with low-volume callers choosing LMS. Thus, with the mandatory switch to LMS, the move away from flat rates would affect a high proportion of high-volume callers, and thus create an apparent price increase larger than expected and imply a greater drop in household penetration. But on the other hand, high-volume callers are not likely to leave the network.

The experience with mandated LMS in Illinois indicates that the impact of rate restructuring is

considerably less than might be expected. In part this conclusion is due to the fact that LMS keeps telephone access prices low in absolute terms. Nevertheless, no statistically significant changes occurred in Illinois' household telephone penetration rates.

Several other factors may also explain this disparity: reduced long-distance rates,15 an increase in the demand for complementary services available through the telephone network, and a general trend of rising incomes. Whatever the reasons, the Illinois experience demonstrates that telephone rates for residential customers can be restructured to reduce subsidies with minimal impact on universal service. t

Peter K. Pitsch is a communications attorney and an adjunct fellow at both The Hudson Institute and The Progress and Freedom Foundation. David P. Teolis is a PhD candidate in economics at Indiana University.

1. Market Service Area 1 (the MSA1 region) includes Access B and C, but not Access Area A, which represents downtown Chicago. Area A is excluded from MSA1 because Area A already had mandatory LMS and thus did not incur any rate increases when Illinois imposed mandatory LMS throughut the state.

2. Flat rates were obtained from various issues of Bell Operating Companies' Exchange Service Telephone Rates, published by the National Association of Regulatory Utility Commissioners. Local-line charges under LMS were obtained from A Modified Regualtory Structure and General Rate Restructuring, published by Illinois Bell (Nov. 1989). Table 1 assumes that the 1989 LMS local-line charge was in effect prior to that year and that no rate increases occurred after 1992.

3. All the MSAs not served by Ameritech as primary toll carrier are still under flat-rate service.

4. The supplemental line charge has since risen to $3.50.

5. Re Illinois Bell Tel. Co., No. 89-0033, Nov. 9, 1989, 108 PUR4th 89 (Ill.C.C.).

6. This analysis of the commission's order is based on the Illinois Bell publication, supra, note 2.

7. Perl, Lewis, Residential Demand for Telephone Service 1983, prepared for Central Service Organization of the Bell Oprating Companies, Inc., National Economic Research Associates, Inc., White Plains, NY (Dec. 1983), as reported in Taylor, Lester, TELECOMMUNICATIONS DEMAND IN THEORY AND PRACTICE, pp. 86-88 (Kluwer Academic Publishers, Boston, 1994). This figure reflects Per's 1983 telephone access demand equation. Perl's model confirms that access demand is primarily a function of minimum access charges.

8. See, Gordon, Kenneth and Haring, John, "The Effects of Higher Telephone Prices on Universal Service," OPP Working Paper Series, Working Paper No. 10 (March 1984) p. 17.

9. Elasticity of demand at the city level is not expected to be greater than at the state leve. A statewide estimate reflects rural areas that might have more inelastic demand because the availability of substitutes such as convenient access to pay phones decreases in these areas. Thus, the predicted change in demand for telephone access should fall by a smaller amount as the price of access increases.

10. The staggered panel examines residents at particular addresses for four consecutive months in one year, and for the same four months in the following year. See, Belinfante, Alexander, Telephone Subscribership in the United States, FCC (March 1994), pp. 2-3.

11. However, there is a significant degree of seasonal variation in the "telephone in unit" statistics (see, Belinfante, supra, note 10, p. 3).

12. The critical value based on telephone units, 2.1, multiplied by 0.5774 yields 1.21254, which is greater than the 0.1 percentage change in telephone subscription for Illinois during the period 1985 through 1993 (see, Belifante, supra, note 10).

13. The picture in earlier years is muddied by the phased implementation. Downtown Chicago alwasy had mandatory LMS; Access Areas B and C experienced rate cuts and increases in basic access (including the subscriber line charge) in 1987, with the required switch to LMS from flat rate service.

14. The elasticity estimates are based on the Perl study assuming an initial penetration rate of 93 percent(emapproximately the level of penetration in Illinois in 1990. See Taylor (supra, note 7), p. 93.

15. See, Hausman, Jerry, Tardiff, Timothy, and Belinfante, Alexander, "The Effects of the Breakup of AT&T on Telephone Penetration in the United States,) American Economic Review, Vol. 83, No. 2 (May 1993), pp. 182-83. The authors claim the SLC accounts for approximately one-third the average price of measured-rate basic access. Accordingly, using own-price elasticity, increases in the SLC would lead to a predicted decline in penetration. They determined that lower long-distance rates worked a positive effect on penetration of approximately three times the magnitude of the increase in basic exchange access prices. For Illinois, the local line charge makes up a larger percentage of the basic access price. Thus, lower intra-MSA toll calls over the same period also had a positive effect on penetration by mitigating the negative impact of higher basic-exchange access prices due to increases in the local line charge.

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