- This article ignores the role of "provider of last resort."
Provider of Last Resort
Specifically, most cities require that all ISPs provide the same deal to all customers in the city regardless of cost. So if a customer lives in an area where it is very expensive to put the cable, he is charged the same as someone who lives where it is cheap to put the cable. This might sound "fair", but there are two consequences. The most obvious (but actually less important) consequence is that cheap customers cross-subsidize expensive ones. Some expensive customers would never pay for the internet if they had to pay what it costs (for example, people who live in relative isolation in the outskirts of cities). Consequently, the average cost of internet goes up for everyone.
The more serious consequence is that "provider of last resort" prevents entry. Effectively, an entrant ISP must be able to provide internet to everyone in the city if he is to provide internet to anyone at all. This stifles competition and is one of the main reasons why consumers have few options and the options are terrible.
Google Fiber
One of the reasons Google Fiber has been successful is that it has demanded that municipalities waive provider of last resort regulations as a precondition for entry. Google is able to do this because of its high visibility. Citizens hear about Google Fiber and demand that their legislators do what it takes to get Google Fiber. Even so, most municipalities haven't given in to Fiber's demands -- this is why Fiber announces only a few seemingly random sites of expansion. These are the cities where Google was able to get around the anti-competitive regulations.
Monopolies As Tax Collectors
Given the destructiveness of provider of last resort regulations, why do municipalities keep them? Ironically, it is precisely because provider of last resort regulations create monopolies. With these regulations, the few ISPs that do enter will face little competition and can charge far higher prices for far worse service. In turn, the municipalities can tax the ISPs to get their cut of the monopoly profits; both the ISPs and the municipalities get more money. Since customers are largely oblivious to all of the subtleties I have elucidated, they blame ISPs and do not recognize the role played by their legislators. So the politicians get away with a hidden tax.
This resembles a method of tax collection common in the medieval era. Namely, a city would sell monopoly rights for producing some good or service (exe. the right to make bricks). The firm would would be willing to pay as much as it would expect to make in monopoly profits. Thus, all the surplus the monopolist extracts goes to the government. The monopolist itself makes zero profits, but simply extracts resources from the citizenry and delivers them to the government. The monopolist is little more than a tax collector.
Of course this is an incredibly inefficient way to collect taxes. Monopolists are notorious for causing deadweight loss. Moreover, optimal tax theory shows that it is best to distribute taxes evenly across many goods, such as with a sales tax or an income tax. Taxing some goods very heavily and other goods not at all produces distortions.
The Big Picture
This tale fits into a broader picture of regulatory capture and bureaucratic empire-building. On the one-hand, regulations and regulatory apparatus can be utilized by the firms that were meant to be regulated as a means to stifle competition. This happens routinely. One of the oldest examples comes from the railroad industry. Railroads faced strong competition in city centers, where many railroad companies had terminals, but faced little competition in cities along the way, where typically only one railroad would have a depot. Unsurprisingly, the railroads charged higher prices in the countryside than they did in the city -- traveling between two cities would cost as much as a third what it would to travel from one city to a town along the way! The citizenry were infuriated by this, and the federal government created a regulatory body to impose uniform prices. Well, the railroad companies were able to use their influence to get their people on this committee, and instead of lowering prices for the towns, prices were raised for the cities. Whelp, that worked out well didn't it? Similar examples exist today: Walmart pushes for increases in the minimum wage because they pay their workers a little bit more than the current minimum wage but their mom-and-pop competitors pay their workers exactly the minimum wage; unions used to push for minimum wage increases because this reduced the price advantage of non-union workers (and was also a means of discrimination - many unions initially did not accept black members, so union membership in combination with minimum wage hikes were a way to keep blacks out of jobs); pharmaceutical companies want the DEA to schedule and the FDA not to approve treatments that are not currently on-patent; teachers unions push for regulations requiring that new teachers have masters in education (so as to increase the cost of new hires, thereby increasing the amount schools are willing to pay to retain older teachers); etc.
The lessons one should take from this are that: is quite common for regulations intended to benefit citizens to in fact harm citizens; governmental bodies ostensibly designed to protect consumers may instead collude with firms to extract greater resources from customers; regulations that mandate prices or provision of services to particular groups are especially susceptible to these problems.