Truth or Consequences? Enforcing Pollution Standards

Evidence suggests that a surprisingly large fraction of firms comply with pollution emission standards even though expected penalties for noncompliance are low. We offer an explanation of this puzzle by extending the standard model of enforcement to include a self-reporting requirement and enforcement power. These extensions are enough to overturn the conventional result that higher fines lead to higher compliance rates. Specifically, under plausible conditions, higher compliance rates are achieved with lower fines for noncompliance. In addition, the cost of enforcing a given level of aggregate pollution is then minimized by setting the fine for noncompliance equal to zero.