TURN’s wish to regulate VoIP as a utility makes no sense

California is set to join 24 other states in prohibiting its Public Utilities Commission from imposing new regulations on VoIP and other Internet services without explicit authority from the state legislature.

SB 1161, a bill endorsed by major Silicon Valley trade groups, passed the California Senate by a wide bi-partisan majority in May, and recently cleared the state Assembly 63-12.  It now awaits Gov. Jerry Brown’s signature.

Any law keeping would-be regulators from tinkering with the mechanics of the Internet ought to be greeted as a glorious victory for Internet freedom.  But SB 1161 and its kin have been condemned by a vocal minority of academics and self-proclaimed consumer advocates.

Unable to impose their policy agenda at the federal level, these activists are now trying to fashion a crazy quilt of state and even local rules on everything from privacy to cybersecurity.  SB 1161 would require them to make their case to state legislators rather than small groups of unelected state and local commissioners.

Even then, the prospect of fifty conflicting bodies of rules and rulemakers is frightening enough, as the sorry state of the E.U.’s Internet economy amply demonstrates.  But their rationale for turning Internet governance over to local regulators is even scarier.  Internet services have become so important, their argument goes, that local authorities ought to manage them like gas, water, or electric companies—that is, as public utilities..

Those calling for public utility treatment for VoIP and other Internet services clearly haven’t had much experience working with state PUCs, either as businesses or consumers.  More to the point, they don’t seem to have the slightest idea what a “public utility” is.

While the effectiveness of state utility regulation has been hotly debated for the last century, the definition of a public utility hasn’t changed in hundreds of years.  According to the classic 1964 book Public Utility Economics, they are that tiny subset of companies that “operate with government approval as monopolies and supply a service which is indispensable to modern life.”  These, everyone agrees, are the two “unique characteristics” that justify public control of privately-owned services.

For true public utilities, monopoly is hard to avoid.  If the cost of serving every resident requires enormous investment in infrastructure, effective competition is unlikely.  Public utilities are therefore said to be “natural” monopolies.  A public utility is thus a necessary evil—the single source for an indispensable service.

PUC regulation, in turn, is an extreme response to an extreme condition.  In practice, public utilities operate much more like government agencies than like businesses.  Regulated utilities are granted the power of eminent domain to build and maintain their infrastructure, but in return must offer service to all residents.  Without PUC permission, they cannot “enter new markets, supply a new service, or abandon an existing market.”

But the most severe penalty for operating a regulated monopoly is losing control of prices. Throughout the long history of public utility regulation, the principal job of local PUCs has been to determine, in excruciating detail, what consumers will pay for the indispensable service–and precisely how much profit the provider is allowed to make.

As the California PUC puts it, rate-setting cases are the agency’s “major form of regulatory proceeding,” ensuring that “customer rates ultimately are based on the CPUC’s determination of how much revenue the utility reasonably requires to operate.”  Rate-setting is a PUC’s hammer, whether the problem they’re trying to solve is a nail or not.

The case against public utility treatment for VoIP is strong.  While applications such as Skype, Google Voice and Apple’s FaceTime bear a superficial similarity to still-regulated switched network local telephone service, the two have nothing in common when seen through the lens of PUC regulation.

For one thing, the genius of the packet-switched network means new VoIP services can reach every user worldwide without any specific infrastructure investment. You don’t need eminent domain to build software.  No surprise, then, that even without regulation, competition is robust.  According to the FCC, California consumers can already choose from over 125 VoIP providers.

Now consider the limited toolkit of a PUC:  the power to set prices, levy taxes to subsidize residents who can’t afford basic service, require specific equipment, establish minimum service levels and pre-approve any change in offerings.

Force-fitting any of these remedies on VoIP providers would spell disaster.  By using the Internet to route voice calls, for example, the physical distance between parties has no impact on cost or service level.  “Local” and “long distance” mean nothing in the VoIP context.  Why should a Skype call to my next-door neighbor cost any more or less than to a friend in London?  (Both are free and untaxed.)

Speed also matters.  PUC regulation necessarily slows—or worse—the rate of innovation in the industries it regulates.  Digital entrepreneurs keep innovating faster, while the pace of regulators decelerates.  Internet services are enhanced and redesigned on an on-going basis, sometimes several times a year.  California’s PUC took seven years just to approve Caller ID.

And the cost of public utility “proceedings” is hardly trivial.  The California PUC’s budget soared from $1.1 billion in 2011 to $1.4 billion in 2012.  (The agency’s annual report doesn’t even bother to note that amount, or how it was spent.)  Consumers have ample reason to doubt whether even under the best of circumstances that cost was offset by benefits.  And there are other costs to public utility regulation, including long histories of scandal and corruption.

Finally, there is the endemic problem of “regulatory capture,” which, in its least insidious form, means that decades of intensive oversight traps both career regulators and company management in a deadly embrace.  Both sides see each other as their one true client; a kind of mutual Stockholm Syndrome.  After a hundred years of PUC operation, actual customers have been demoted in agency jargon to mere “rate-payers” or simply “meters.”

In objecting to SB 1161, notably, PUC Commissioner Mike Florio never once mentioned California consumers.  Instead, he argued that leaving VoIP regulation to the FCC would be even worse.  “I think that’s a far bigger risk to the future of some of these technologies,” he said in an interview with Bloomberg BNA, “than anything this commission would ever do.”

(Indeed, the FCC has already imposed much of its wireline telephone rulebook on VoIP.  Providers have been forced to re-architect their services to handle 911 service
s, and must follow data protection rules that have long applied to wired carriers. In April, the agency began looking to levy Universal Service fees, currently charged on every consumer’s phone bill, to VoIP providers and possibly other Internet companies.)

The mutual dependence of PUCs and the industries they regulate explains why the prospect of losing out on a growing VoIP market sent California regulators into a tailspin.  In a strange and unintentionally revealing report on SB 1161, for example, the agency’s legal division concluded that implementing a ban on future regulation would require 57 new hires and cost the state $1 billion or more.

Later, the PUC’s own General Counsel complained that the report had been issued without his approval, reflecting a “lapse in our system of internal controls.”

The agency’s Communications Division, meanwhile, determined that the bill would have no impact on currently regulatory activity.  (The bill was later amended to make even clearer that traditional PUC power over legacy telephone carriers was unaffected).

In the end, the PUC voted to take a neutral position on the legislation.  The decision not to decide, of course, took months.  Which perhaps is all the proof needed of the wisdom of SB 1161, and of keeping Internet services as far from the world of public utility regulators as possible.

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Ed’s Note: Downes is the author of the“Unleashing the Killer App: Digital Strategies for Market Dominance.” Portions of this op-ed recently appeared on forbes.com.