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Optimal Fines and Auditing When Wealth is Costly to Observe

  • A. Mitchell Polinsky

This article studies optimal fines when an offender's wealth is private information that can be obtained by the enforcement authority only after a costly audit. I derive the optimal fine for the underlying offense, the optimal fine for misrepresenting one's wealth level, and the optimal audit probability. I demonstrate that the optimal fine for misrepresenting wealth equals the fine for the offense divided by the audit probability, and therefore generally exceeds the fine for the offense. The optimal audit probability is positive, increases as the cost of an audit declines, and equals unity if the cost is sufficiently low. If the optimal audit probability is less than unity, there are some individuals who are capable of paying the fine for the offense who misrepresent their wealth levels. I also show that the optimal fine for the offense results in underdeterrence due to the cost of auditing wealth levels.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10760.

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Date of creation: Sep 2004
Date of revision:
Publication status: published as Polinsky, A. Mitchell. "Optimal Fines and Auditing When Wealth is Costly to Observe." International Review of Law and Economics 26(3): 323-335, September 2006
Handle: RePEc:nbr:nberwo:10760
Note: LE
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  1. A. Mitchell Polinsky, 2004. "The Optimal Use of Fines and Imprisonment when Wealth is Unobservable," Discussion Papers 03-037, Stanford Institute for Economic Policy Research.
  2. Garoupa, Nuno, 1998. "Optimal Law Enforcement and Imperfect Information When Wealth Varies among Individuals," Economica, London School of Economics and Political Science, vol. 65(260), pages 479-90, November.
  3. Polinsky, A Mitchell & Shavell, Steven, 1991. "A Note on Optimal Fines When Wealth Varies among Individuals," American Economic Review, American Economic Association, vol. 81(3), pages 618-21, June.
  4. Andreoni, J. & Erard, B. & Feinstein, J., 1996. "Tax Compliance," Working papers 9610, Wisconsin Madison - Social Systems.
  5. Louis Kaplow & Steven Shavell, 1991. "Optimal Law Enforcement with Self-Reporting of Behavior," NBER Working Papers 3822, National Bureau of Economic Research, Inc.
  6. Levitt, Steven D., 1997. "Incentive compatibility constraints as an explanation for the use of prison sentences instead of fines," International Review of Law and Economics, Elsevier, vol. 17(2), pages 179-192, June.
  7. Cyrus Chu, C. Y. & Qian, Yingyi, 1995. "Vicarious liability under a negligence rule," International Review of Law and Economics, Elsevier, vol. 15(3), pages 305-322, September.
  8. Chu, C. Y. Cyrus & Jiang, Neville, 1993. "Are fines more efficient than imprisonment?," Journal of Public Economics, Elsevier, vol. 51(3), pages 391-413, July.
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