Computer Games

The crime of Internet subsidies


The Internet is a wonderful tool. Say you want to write an article on the role of criminal sanctions in the plan to subsidize Internet connections for schools and libraries. Without leaving an air-conditioned study you can download the Telecommunications Act of 1996, the 824-page Federal Communications Commission Report and Order implementing it, and a deluge of backup material.

Because the Internet is so useful, the idea of subsidizing educational connections to it seems like a Great Idea to Make the World a Better Place. As with most such ideas embraced by the government, debate over the policy was superficial, and schools and libraries now gleefully anticipate $2.25 billion a year in subsidies. But their thirst for loot has led them into a danger zone. Government subsidy programs come with tangled strings of conditions and regulations. These are enforced by sanctions, including not only criminal fines and jail terms, but also civil monetary penalties, punitive damages, hefty remedial payments, and asset forfeitures. Many of these are not formally "criminal," but a "civil" penalty of $10,000 stings just as much as a "criminal" fine.

The schools and libraries aren't worried, remaining confident of their own probity. But they should be worried. A growing number of middle-class managers, professionals, entrepreneurs, and land owners are finding themselves in trouble as a result of their participation in government largess. Medicare is a prime example, as the political pressure to hold down "fraud and abuse" makes the government downright grumpy. Doctors at 125 teaching hospitals are in jeopardy from audits for Medicare fraud. Two hospitals already audited have been nicked for $42 million in repayments and fines. Some hospices are also in trouble for collecting Medicare payments for patients who then stayed alive longer than the six months the government allows for terminal illness.

Other programs follow the same trajectory. Savings and loan executives profited for years from government restrictions on competition and other benefits, then got bitten by the hand that fed them. Over 6,000 executives and owners were charged with crimes in the fallout from the S&L mess, including 3,700 who went to jail, despite estimates by Bert Ely, the recognized guru of finance in Washington, D.C., that only about 3 percent of the losses were due to fraud.

The basic idea of the Internet subsidy program seems simple. The part of the law creating it is short, about a page. It says that telecommunications carriers, "upon receiving a bona fide request," must provide services to schools and libraries for educational purposes at a discount specified by the government. The carrier then treats the discount as an offset to other obligations created by the act. The law gives the FCC rule-making authority, specifies that the services provided may not be resold, and excludes for-profit schools and those with endowments of more than $50 million.

Passing a general statute is easy, but the real work of implementation is up to the FCC. The initial FCC Report and Order on this program runs 86 densely written pages–and that's only the beginning. Soon these initial texts will become thickly crusted with interpretations, caveats to the interpretations, amendments, reversals, exceptions, court cases, and informal guidance. Hot lines for advice will be set up, staffed by summer interns and 22-year-old English B.A.'s willing to work cheap.

People who have not dealt with regulatory programs don't fully comprehend how complicated and difficult the process becomes. It helps to look at the statute with an implementer's eye, dreaming up questions that must be answered: What is a bona fide request? What is a school? What is a library? What do you do with a library that is a sub-unit of a non-eligible school, such as a college? What if a college spins off its library into a free-standing corporation–does that render it eligible? What about a consortium of libraries, some of which are eligible and some not? Or a consortium of schools? Or of both? What is an endowment of $50 million–does this include the value of a school's land and buildings, and, if so, must the real estate be priced to market? What are "educational services"? If a student uses the Internet connection to look at pornography or to run a business on the side, is his school liable for refunding the discount? Does his action taint the school's entire discount, or only that part of the service fairly allocable to the violation? If it is allocable, do you allocate by full cost or variable cost?

Does a library violate the provision against resale of the service if a student works part time for a private company and uses a library Internet connection at night to do paid research? What if the library doesn't know what the student is doing–does that matter? Can the carrier insist that a school police its students to be sure they do not look at Penthouse (except to read articles on free speech, of course) and do not resell the service? Can other schools and libraries insist on policing, on the ground that the total subsidy is capped at $2.25 billion, so if one school diverts services to noneducational uses other schools may be deprived?

These are not abstract issues. Every one of them must be addressed, and this list is a bare start. The FCC has reached some initial conclusions. For example, a college can indeed spin off its library into an eligible entity, and carriers must grant a discount on the cost of wiring individual classrooms within a school, not just on the cost of connecting to the wall of the building. (After all, says the commission, the president said that we should wire 2 million classrooms, not just schools. This closes the inquiry into whether this policy makes sense.) The FCC has also established a schedule setting six different levels of discounts depending on the economic need of the locality, and decided that the applicable level should be self-certified by the school or library. Other questions are answered as well, but there is still a long way to go, and every answer will raise new questions.

The commission rules resolving these issues–or leaving them maddeningly uncertain–are criminal statutes. It says so right there in Title V of the act. Anyone can be fined and jailed for one year for "willful and knowing" violations of the act or of FCC rules. Anyone who "willfully or repeatedly" violates rules is also subject to civil penalties, which can be imposed by the commission itself under procedures and standards of proof looser than those applicable in courtrooms. For schools and libraries, the penalties can go up to $10,000 per day for a continuing violation. Carriers and others who are in the business face considerably higher civil penalties.

This blend of command-and-control, subsidies, and enforcement through serious penalties guarantees future trouble for the schools and libraries. By now we have enough experience with this blend that the result has a certain inevitability. Judging by the history of other regulatory programs, details will soon proliferate to the point where no one can fully understand the rules. Even the most honest beneficiary will find it difficult to judge what he must do. For many, the transaction costs of figuring out the program's requirements will outpace its benefits. As a result, they will try to use common sense–a treacherous guide in any regulatory program. Even seeking official help is often little real help. If the English B.A. at the other end of the hot line tells you a bureau letter interpreting a commission rule defining a statutory term means X, are you bound? Is this The Law? Probably, but there is no clear legal answer.

Initially, the FCC is likely to spend little to enforce the provisions of this program, given all the other demands on its resources, and given that the commission does not really care about the details now that the public relations harvest has been reaped. That might seem good for schools and libraries. But if you cannot get an answer to a question, and it seems unlikely that you will be caught if you err, the obvious course is to make doubtful calls in your own favor.

Eventually, someone will go back and re-examine these decisions, especially if
the total resources for the program get squeezed. Then you can be in deep trouble. Because of limited resources for enforcement, the government will likely move to a system of enforcement through terror. If problems become rife enough to cause political embarrassment, and if the agency can move against only a small percentage of violators, it will make a horrible example of those few. For example, the Environmental Protection Agency explicitly sets penalties at levels designed to represent the expected gain adjusted for the probability of getting caught. If you save $10,000 by ignoring a rule, and the chance of your getting caught is only 1 percent, then the fine becomes $1 million.

These eventual enforcement efforts will not lack for targets, because everyone will have irresistible reasons to game the system. Students with access to cheap Internet service will respond like rational economic beings and use more of it. They will also take a broad definition of education, which will expand to include language arts (chat rooms), motor skills enhancement (computer games), and biology studies (on-line porn). The more enterprising will discover the glories of arbitrage. If you have free access to something that people in the real world pay for, you have something valuable to sell. This student gaming of the system will create tough enforcement problems for schools and libraries, and much debate about who is responsible for preventing it.

Schools and libraries will also have incentives to play games. They want to bring as many services as possible within the discount by interpreting the rules liberally. This impulse will be strengthened by the silliness of a basic premise of the program. The president's goal–"wire every one of 2 million classrooms"–has the same brainless quality as the targets of a Soviet five-year plan. Why should every classroom be wired? Might not some be used for reading, or writing, or even teaching? And is the issue not better decided at the local level? The temptation to rechannel resources into what the people at the working level really need will be constant.

Carriers will develop games of their own. Deep down, they may not really care what the schools and libraries do. But they don't want to be charged with granting illegal discounts, and they don't want the government to deny them their credits, so they have to cover themselves somehow. This will put them into conflict with the schools and libraries over basic issues.

All this complexity and gamesmanship will provide endless opportunities for mistakes and overreaching. And remember, mistakes and overreaching are now crimes. We've already seen this happen with the mother of all subsidy programs, Medicare. The government is involved in endless disputes with care providers over the nature of "fraud." Many of these cases involve real fraud, of course, but many are ambiguous. For example, one dispute is with teaching hospitals over staff doctors who supervise a resident who performs the actual hands-on patient care. Hospitals have been billing the doctor as a care provider; the government calls this criminal fraud. Other disputes concern the allocation of indirect overhead to health care services. Arcane and fundamentally insoluble issues of cost accounting now have criminal implications.

These types of conflicts will always arise in any program of subsidies for services. And talk about legal uncertainty and complexity: The government in 1997 says the hospitals should have known they were wrong because they got a letter about it in 1970. Some of the current Medicare disputes go back to interpretations made in the late 1960s, which modern practitioners are unlikely to be aware of.

In some ways, schools and libraries are fortunate: The word willful got inserted into the statute, so the government may well have to prove criminal intent before nailing someone. This is not true in many other regulatory areas, where knowledge and intent have been rendered irrelevant.

Lobbyists for the schools and libraries also got a provision shielding their clients from civil penalties for violating a rule unless the FCC tells them they are sinning and they continue to commit similar violations. This puts them miles ahead of the battered veterans of many other regulatory programs, where you might get a letter saying you've been trespassing on some obscure regulation for years and should please remit a check for $10,000 per day for the entire period. Many ways remain to nail the schools and libraries nonetheless, if the government puts its mind to it.

The path ahead for schools and libraries is grimly predictable. In the flush of euphoria, they will interpret things in their own favor. As good, law-abiding members of the middle class, it will barely occur to them that these interpretations are treading near the edge of criminality. Some will be cautious, but they will look foolish as others reap benefits and nothing happens to them, so they will join the parade.

After a time, scandals will hit, followed by exposés and recriminations. The FCC will move against a few institutions with the heavy guns of criminal and civil sanctions. Others will panic and decide they must have a zero-error policy. They will bring things under tighter control, asking "Mother, may I?" of the FCC for every tiny change. But the whole program will have become too complicated and contentious for its requirements to be predictable, and things will settle into the standard regulatory equilibrium of high transaction costs, quarrels over subsidies, sharp dealing, scandal, and occasional human sacrifice.

James V. DeLong is the author of Property Matters: How Property Rights Are Under Assault and Why You Should Care (The Free Press) and The New "Criminal" Classes: Legal Sanctions and Business Managers, a 1997 monograph published by the National Legal Center for the Public Interest in Washington, D.C. His Web site is