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Optimal Fines and Auditing When Wealth is Costly to Observe

  • A. Mitchell Polinsky

    (Stanford University and National Bureau of Economic Research)

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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File URL: http://www-siepr.stanford.edu/repec/sip/03-038.pdf
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Paper provided by Stanford Institute for Economic Policy Research in its series Discussion Papers with number 03-038.

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Date of creation: Aug 2004
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Handle: RePEc:sip:dpaper:03-038
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  1. Andreoni, J. & Erard, B. & Feinstein, J., 1996. "Tax Compliance," Working papers 9610, Wisconsin Madison - Social Systems.
  2. Louis Kaplow & Steven Shavell, 1991. "Optimal Law Enforcement with Self-Reporting of Behavior," NBER Working Papers 3822, National Bureau of Economic Research, Inc.
  3. 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.
  4. 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.
  5. A. Mitchell Polinsky & Steven Shavell, 1990. "A Note on Optimal Fines When Wealth Varies Among Individuals," NBER Working Papers 3232, National Bureau of Economic Research, Inc.
  6. 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.
  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. 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.
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