An FCC letter shows why new phone services like Google Voice must soon trigger a regulatory overhaul.

An innocuous-looking letter from the FCC to Google marks the beginning of the end of the telephone system we have known for the past 130 years.

The old phone system, the one started by A.G. Bell and still in use today, has a dedicated connection between each pair of people talking to each other. Whether plugged in by a switchboard operator, in the early days, or dialed by the user, later on, whether carried by copper wire, microwave radio, satellite signal, or fiber-optic cable, every individual phone conversation has its own separate circuit which is (a) set up for just that one call and (b) taken down when the parties hang up. This is called a “circuit-switched” system.

The FCC has regulated this set-up since 1935. The details evolved over the decades. But the FCC rules, then and now, have always been geared specifically to a circuit-switched system.

One element of these rules recently became controversial. When you place a long-distance call to your Aunt Mildred in Boston, say, you pay the long-distance carrier, and it in turn pays the Boston phone company to accept the call and ring Aunt Mildred’s phone. In telephone-speak, the money changing hands is called an access charge for terminating the call. It is an important source of revenue for local phone companies. If Mildred lives in rural South Succotash, the access charges are higher, because it costs more to run a phone system where the customers are farther apart.

The differences in access charges present an opportunity for abuse. Some companies that generate a lot of inbound long-distance traffic, like conference-call bridges and sex-call services, deliberately locate in rural areas. The incoming calls then generate high access-charge revenues for the local phone company, which may split the take with the conference-call or sex-call provider. The practice is called traffic pumping. For now, at least, it is legal.

The Digital Revolution

Flash forward to the future.  All phone calls are digital. The telephone handset converts the voice signal to a series of 0s and 1s, compresses the bit stream, separates it into “packets,” and gives each packet an address corresponding to the phone at the other end of the call. Traveling through the Internet, re-routed on the fly, the phone-call packets share the wires with packets carrying other people’s phone calls, video, web pages, baby photos, and everything else we send to each other. Among the different “protocols” for setting up and addressing packets, the ones used on the Internet are collectively called “Internet protocol” or IP. The term VoIP refers to the combined technologies for carrying voice over IP – that is, over the Internet.

Most home and office phones are still tied to circuit-switched local telephone systems. But companies like Skype and Vonage offer VoIP service to end users. People who receive their telephone service through a cable company or FIOS also use VoIP, although that fact is often buried deep in the service agreement.

VoIP has important advantages over the circuit-switched phone system. Because voice packets make up only a tiny fraction of the data carried on the Internet, transport is cheap. Calls within the U.S. are usually free; calls to other countries cost just a few cents per minute. Phone numbers need not be tied to location, so a subscriber in Sydney, Australia can have a local New York City phone number, which further lowers costs for calling friends in New York (although a careless pizza order can be expensive).

In contrast to its historically tight regulation of the circuit-switched phone system, the FCC takes a mostly hands-off approach to data services. Its Computer II decision of 1976, well before the public Internet emerged, kept full common carrier regulation over phone lines, even if they also carry data, but forbore from regulating the data. The Internet is squarely in the data category; and true to its word, the FCC left the Internet alone. As broadband emerged, the FCC largely deregulated the facilities that carry it, which left only voice lines under traditional regulation.

The voice vs. data distinction worked well for thirty years. But then came VoIP, which straddles both categories. Early VoIP drew little attention from regulators, being just another novel Internet application that needed special equipment and skills. But the technology soon moved beyond the hobbyists and into the mainstream. A subscriber could place and receive calls using what looked like an ordinary phone, yet bypass most of the phone system. Passing the ultimate test for ease of use, VoIP became popular with many elderly people as an inexpensive way of keeping in touch with far-flung family members.

The FCC, which dislikes ontological questions, had to make a decision: Is VoIP a voice service or non-regulated data service? It depends, was the answer. VoIP that meets the “quacks-like-a-duck” test – that functions as a full substitute for traditional voice service, phone number and all – became subject to many of the same rules as traditional voice: 911 call location, access by disabled users, law enforcement wiretaps, privacy rules, and universal service payments. Yet even quacks-like-a-duck VoIP remains exempt from most common carrier regulation.

The result is two phone systems operating side by side. The old one is ubiquitous and regulated. The new one is used only by some people, though more every day, and is mostly outside FCC regulation. The two interconnect to the extent that VoIP users can place and receive calls to and from ordinary phones. But not to and from everywhere – a point that has now caught the attention of the FCC, and could portend major changes in phone service.

Google Voice Muddies the Waters

VoIP can do a lot more than just emulate a circuit-switched phone. A service called Google Voice shows some of the possibilities. We described GV in an earlier post: A subscriber receives a new phone number, local in a region of the subscriber’s choosing.  Calling that number rings all the customer’s phones, wherever they are:  office, home, cell, etc.  Different callers can be automatically routed to different phones, or forwarded selectively to still other phones, or fed different voice mail greetings, or given different rings, or blocked altogether.  All the voice mails from all the phones end up in one place, where they can be read in printed form, like emails, or listened to online from anywhere. There are provisions for setting up conference calls, and for recording phone conversations for online storage. And all of this is free.

Except for the final connection to a dialed or forwarded number, the whole thing runs over the Internet.

But although the Internet goes everywhere, Google Voice does not. Complaints from many quarters allege that GV refuses to place or forward calls to certain rural areas. Google has said why: it wants to avoid paying high access charges. Of course, a GV subscriber whose Aunt Mildred lives in South Succotash still has the option of reaching her with an ordinary call over the old system. But GV’s form of discrimination, if true, raises one of those awkward definitional problems that so trouble the FCC. A common carrier is not allowed to pick and choose among call destinations. It must connect wherever the customer dials. A non-common-carrier is not subject to that obligation.

In response to the complaints, the FCC sent a letter to Google that asks two kinds of questions. First is whether and how Google Voice restricts calls to certain phone numbers or groups of numbers. Translation: do you discriminate? Second and third are whether GV charges end users for its services (no), and whether use of GV is by invitation only, as Google claims (yes, although anyone can request an invitation.)

Why do those last two questions matter? The law defines a common carrier service as one that is (1) offered for a fee (2) directly to the public, or to enough people that they effectively constitute the public. If the FCC finds the GV service is “for a fee” and offered to the public (or most of it), then GV is a common carrier service and must connect to anywhere. But that is not a likely outcome. Google no doubt will make a case that the service is truly free of charge, and truly limited in availability. The FCC would then have to agree it is not a common carrier service. The non-discrimination rules would not apply, and GV could decline those South Succotash calls with impunity.

Rewriting the Rules

The problem is, if we care about the future of the phone system, then none of Google’s possible answers yields a good result. The incongruity of shoehorning an IP service into circuit-switched regulation suggests that technology may have outpaced the rules.

Suppose the FCC, against all odds, decides that GV is a common carrier service. It must then require GV to provide rural connections and pay rural access charges. Google’s business model collapses and, with it, any incentive to continue offering the service. The public loses out.

On the other hand, if GV is held not to be common carriage, then companies like Google can skim off the cheap, easy-to-provide services, and leave the more expensive ones, like rural voice calls, to the traditional regulated phone companies. As urban and suburban customers abandon their old phone service for cheap VoIP, the regulated companies’ revenues will fall. Some of their costs, like system maintenance and universal service fees, will become an increasing percentage of revenues. Local phone rates will climb, driving more users to VoIP alternatives, in a self-reinforcing spiral. That is also a poor outcome.

Unfortunately, the only lasting solution entails an overhaul of the Communications Act. When we last did that, in 1996, it was not fun for anyone, and we’re sure not looking forward to it now. But with the engineers having gotten out ahead of the lawyers, the lawyers have little choice but to catch up.

The rough outlines of a reform are easy to foresee. In the past, Congress and the FCC have eased regulation of services that became subject to competition. In the long-distance market, for example, the AT&T divesture of 1984 and a pro-competitive FCC created dozens of players. (We know exactly how many, because they all used to phone us at dinnertime.) Cell phone service has always been at least minimally competitive, and has never been subject to traditional telephone regulation.

Sooner or later, Congress will have to find that IP-based services like cable-provided VoIP, Skype, and Google Voice are giving local phone companies enough competition to justify some easing of traditional regulation. Rates, including access charges, will become more responsive to market forces. That will make traffic pumping less profitable, but will also give companies like Google Voice less expensive access to more areas of the country. Traditional phone companies will also benefit, in some respects, as they will find it easier to offer innovative services of their own.

But across-the-board deregulation will not do the trick. We still need a “carrier of last resort” to serve the always-expensive rural customers. We still need ways to subsidize service to high-cost areas and low-income subscribers, and to assist hearing- and speech-impaired users. The states, too, have a large role in regulating local telephone service, and may rank various outcomes differently. A largely rural state with a widely-dispersed population may have priorities at odds with those of a more urban state having dense concentrations of sophisticated users.

In short, VoIP and its spin-offs promise better, more flexible, and less expensive phone service. For the time being, though, these benefits will not reach everyone. Circuit-switching, although technologically obsolete, is everywhere, and will remain part of the telephone system for decades to come. The goal is a regulatory system that lets each deliver what it does best, keeping the enormous efficiencies and flexibilities of VoIP without sacrificing the ubiquity of the circuit-switched system.

Getting all the moving parts to mesh correctly will be an enormous undertaking. But we think the tone of the FCC’s letter to Google signals an awareness that the present regulatory scheme will not hold up. Inequities and discrepancies of the kind now presented by Google Voice will only get worse. Occasional patches might keep the current regime working a little longer, but an overhaul is coming due.

The FCC’s letter may be the first important regulatory step in that process.