ESTIMATING THE EFFECT OF PENALTIES ON REGULATORY COMPLIANCE Introduction Since the seminal work of Becker (1968) on the economics of crime, economists

Introduction Since the seminal work of Becker (1968) on the economics of crime, economists have explored various dimensions of regulatory enforcement. Becker’s framework has been applied and extended to myriad types of regulations, including tax and environmental regulations. The environmental regulation literature has focused on the relationship between inspections and compliance decisions. For example, see Magat and Viscusi (1990), Deily and Grey (1991), Grey and Deily (1996), Laplante and Rilstone (1996), Nadeau (1997) and Helland (1998a). Empirical analyses that jointly consider the effect of inspection and penalties on compliance are much less common. Two studies (Earnhart 2004, Shimshack and Ward 2005) include both inspection and penalties in modeling compliance decision, but fail to account for undetected violations. As Feinstein (1989) noted, when violations can go undetected, parameter estimates of enforcement actions can be biased downwards. A more recent study (Scholz and Wang 2006) considers the potential for undetected violations, but uses a discrete, rather than continuous, penalty measure. Using a discrete measure prevents one from discerning responses of minor violators from those of