Unexpected Effects of Expected Sanctions

The economic analysis of law enforcement holds that greater expected sanctions lead to greater compliance. The literature on positive and negative incentives holds that rewards and sanctions—or carrots and sticks—have identical first-order incentive effects. We extend the basic model of law enforcement in three ways. We allow agents to opt out of the regulatory regime, we allow for enforcement errors, and we model agents who vary in at least one trait in addition to their cost of compliance. We show that, following these three realistic modifications of the basic model, the two fundamental conclusions just described do not hold. Greater expected sanctions do not necessarily lead to greater compliance; carrots and sticks are not substitutes in their incentive effects. We also show that adding taxes and subsidies to the regulatory toolkit does not expand the set of achievable outcomes.