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Honesty in a Regulatory Context Good Thing or Bad?

It is often taken for granted that if more firms were innately honest or ethical in the way they behaved, this would be a good thing. In this paper we use the example of environmental regulation to show that such a claim cannot, in general, be sustained. If regulation is by pollution tax we show that - once optimal agency response is taken into account - social welfare is non-monotonic in the proportion of firms that report emissions honestly. The choice of policy instrument may itself be characterised by 'reversals' with command-and-control methods being preferred for intermediate values of population honesty, a tax system being preferred at the extremes. This means that if - because of the spread of "ethical shareholding" or for whatever reason - the honesty of the corporate population increases through time, we should not be surprised to see at first a switch away from market-based instruments, and then a switch back. The model is argued to be consistent with a number of the stylised features of American regulatory history. It may also provide a defence of the USEPA's willingness to tolerate a 'distasteful culture of dishonesty' amongst those it is supposed to police (Yaeger [1991]). Though environmental regulation is used as an example for the purposes of exposition, the results are of more general interest.

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Paper provided by Department of Economics, Royal Holloway University of London in its series Royal Holloway, University of London: Discussion Papers in Economics with number 98/6.

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Length: 19 pages
Date of creation: Dec 1997
Date of revision: Dec 1997
Handle: RePEc:hol:holodi:9806
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  1. John Haltiwanger, 1987. "Responders Versus Nonresponders: A New Perspective on Heterogeneity," UCLA Economics Working Papers 436, UCLA Department of Economics.
  2. Clifford Nowell & Jason F. Shogren, 1991. "Challenging the Enforcement of Environmental Regulation," Center for Agricultural and Rural Development (CARD) Publications 91-wp80, Center for Agricultural and Rural Development (CARD) at Iowa State University.
  3. Haltiwanger, John & Waldman, Michael, 1993. "The role of altruism in economic interaction," Journal of Economic Behavior & Organization, Elsevier, vol. 21(1), pages 1-15, May.
  4. Xepapadeas, A. P., 1995. "Observability and choice of instrument mix in the control of externalities," Journal of Public Economics, Elsevier, vol. 56(3), pages 485-498, March.
  5. Brian Erard & Jonathan S. Feinstein, 1994. "Honesty and Evasion in the Tax Compliance Game," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 1-19, Spring.
  6. Harrington, Winston, 1988. "Enforcement leverage when penalties are restricted," Journal of Public Economics, Elsevier, vol. 37(1), pages 29-53, October.
  7. Magat, Wesley A & Viscusi, W Kip, 1990. "Effectiveness of the EPA's Regulatory Enforcement: The Case of Industrial Effluent Standards," Journal of Law and Economics, University of Chicago Press, vol. 33(2), pages 331-60, October.
  8. Bruno Frey, 1992. "Pricing and regulating affect environmental ethics," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 2(4), pages 399-414, July.
  9. Heyes, Anthony G., 1996. "Cutting environmental penalties to protect the environment," Journal of Public Economics, Elsevier, vol. 60(2), pages 251-265, May.
  10. Gray, Wayne B. & Deily, Mary E., 1996. "Compliance and Enforcement: Air Pollution Regulation in the U.S. Steel Industry," Journal of Environmental Economics and Management, Elsevier, vol. 31(1), pages 96-111, July.
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