For more than two decades, a near-sacred principle has governed federal regulation of American Telephone & Telegraph Co.'s long-distance service: Profits must never be more than a certain percentage of its investment in facilities.

The Federal Communications Commission has had the job of determining that figure, which now stands at 12.2 percent. The commission then leaves it to AT&T to bring in for approval its projections of phone call traffic, corporate taxes and expenses, and the rates that consumers would have to pay to make the bottom line work out correctly.

With AT&T continuing to dominate the nation's long-distance business -- it handles about 75 percent of interstate traffic -- the rate-setting system has had indirect but palpable effects on what AT&T competitors like MCI Telecommunications Corp. and US Sprint Communications Co. charge their customers. They have tended to follow AT&T rates downward in recent years.

Now the FCC is saying that it's time to change, and in a radical way. In August, it gave tentative approval to a plan to drop the so-called rate-of-return regulation and to substitute a "price cap" system in which the FCC would set ceiling prices that could be charged to phone users and AT&T would be free to make whatever profit it could within those revenue limits.

Many industry analysts say it could be the most important regulatory change affecting the telephone industry in the foreseeable future. The idea is to start with AT&T, then expand the new system to the federally regulated businesses of the seven regional Bell companies and the 1,400 local phone companies.

It could play a major role, analysts say, in determining the rates that long-distance users pay and the long-term financial stability of the companies offering the service.

AT&T and many parts of the phone industry have welcomed the idea. So has FCC Chairman Dennis Patrick, who has made implementation of the new system a personal project.

"Rate-of-return regulation, by its very nature, tends to place upward pressure on rates and frustrate technological innovation," he said in testimony last week to the House telecommunications subcommittee. "...Price caps would increase carriers' incentives to cut costs, innovate and realize efficiencies."

But many consumer groups and telephone user associations are not convinced that the new system will be better, and are gearing up to fight -- in court if necessary.

Some see the system as opening the door to monopoly-style abuse. Others suggest it is unwise to start changing a system that has brought steadily declining consumer rates, improved quality and progress toward universal service. "A solution in search of a problem" is how Maryland People's Counsel John M. Glynn described the price cap idea.

Many industry analysts say the opponents are fighting an uphill battle. The plan probably will go into effect, they say, perhaps as early as next year.

"Rate-of-return regulation will go," predicted Daniel Zinsser, a vice president at Goldman Sachs & Co. who watches AT&T. "The FCC's committed to it."

The FCC argues that the current arrangement was well-suited to the monopoly days but not to the mid-1980s, when more than 500 companies nationwide are engaged, to some degree, in the long-distance telephone business.

Today, the commission says, the old system gives companies "perverse incentives" to get fat. They cannot raise profits by becoming more efficient, but they can do so automatically by enlarging their investment base, which in the case of AT&T's interstate business was valued at $9.3 billion at the end of July. This is said to encourage a process known as "gold-plating," in which facilities are built when they are not really needed and existing ones are made better than they need to be.

Price cap proponents say the present system also encourages the regulatory transgression of cross-subsidization. Companies can now shift costs from businesses over which there is no governmental regulation -- office equipment leasing, for instance -- to areas that are protected under the rate-of-return umbrella.

Such a shift increases the investment and thereby the profit to which the company is entitled, but wouldn't make any difference under a price cap.

The price cap already is being tried by a number of states, and a variation being used with British Telecom, Britain's newly privatized national phone company, also has piqued FCC interest.

The process would begin with regulators setting certain rates as the maximum permissible price, probably lowering them a bit from those now in effect. AT&T would then be allowed any profit it could manage, no matter how high -- or low.

A race to cut costs would begin, proponents promise, bringing in the most efficient technology and the best possible service because higher profits would be the reward for them. AT&T's competitors would have to follow suit or lose customers.

Rate administration also would become easier and cheaper, the FCC says. "The commission is not in a very good position to micromanage the well over 1,400 local exchange carriers {phone companies} and AT&T" and make them efficient, said FCC official Michael Wack. "The beauty of price caps is that you switch that incentive around and the carrier has an incentive to be efficient and cut its costs."

The allowable rates would not be carved in stone, however. There might be a consumer price index component to the plan, allowing rate increases as the phone companies' costs went up, and a productivity index, requiring declines in the rates as the companies became more efficient at their jobs (though still allowing them to keep part of the earnings so created). Hard-luck stories from the companies asking for a special rise would be accepted only in extreme circumstances, the FCC says.

"You may see higher profits for the companies but lower prices for the consumer at the same time because you've cut down the cost -- that's what we're aiming for," said Gerald Brock, chief of the FCC's common carrier bureau. The FCC will not proceed with the plan, he said, unless it is convinced that consumers will get a better deal than under the current system.

Critics, however, challenge the whole basis of the idea.

"The FCC has not provided empirical evidence detailing the shortcomings of the rate-of-return model," Rep. Edward J. Markey (D-Mass.), chairman of the House telecommunications subcommittee, said at the hearings last week. He displayed a chart showing that the consumer price index has gone up 188.5 percent since 1975, but telephone costs by only 77.8 percent.

The telephone industry is a declining-cost area, critics note. Lower rates for consumers have been brought about not by competition, they maintain, but by strong-arming from federal regulators. Price ceilings could only slow the decline of rates, they contend.

Critics ask whether companies would take a short-cut to higher profits by cutting back on service quality. They also question whether "gold-plating" is really a problem. Asked at the hearings to give specific examples of that practice, FCC Chairman Patrick offered none.

Many opponents of the plan perceive the long-distance business as not too far removed from the old monopoly of AT&T. The company retains a dominant market share, though it has lost a good chunk to MCI and Sprint, and opponents are suspicious of allowing it unlimited profits. "We see a market that is far from competitive," said Gene Kimmelman, legislative director of the Consumer Federation of America, in testimony on the price cap. "To us, this is a great risk, a great danger."

MCI and Sprint operate essentially free of FCC price regulation, though the commission does retain the right to veto their rates. Both companies have come out in favor of the plan, though with some reservations.

They are said to be gambling that the price cap system would slow the roller-coaster pace of rate declines that has placed heavy pressure on them and would introduce a measure of stability to the market. "If you go to the new system, you'll get price cutting but it will be more moderate," predicted Frank Governali, who watches AT&T for Kidder Peabody & Co.

Other industry analysts see AT&T as the biggest winner. It has been losing market share and in recent years coming in somewhat below its authorized 12.2 percent return on investment.

Zinsser of Goldman Sachs & Co. said AT&T believes price caps will enable it to pick up again. "In the longer run, they see that this would lead to a more efficient long-distance marketplace and probably better profits."