Regulatory compliance under enforcement gaps

Abstract

Analyses in the literature on regulatory enforcement usually assume that regulatory agencies know all of the entities subject to regulation. But constant entry and exit of firms create gaps in agencies’ knowledge of regulated entities. This paper conducts a theoretical and empirical analysis of firms’ compliance strategy when such enforcement gaps are present. Our theoretical analysis indicates that a firm with a sufficiently low probability of being subject to enforcement action will delay compliance. We analyze the effect of enforcement gaps on the compliance protocol development component of regulations empirically in the context of nutrient management regulations in Maryland. The Maryland Department of Agriculture (MDA), which enforces this regulation, relies on a registry of farms that includes less than half of the farm operations in the state. We conduct an econometric analysis using farm-level survey data combined with county-level enforcement data. Our econometric model indicates that the probability of being included in the MDA farm registry is associated with a statistically significant and economically meaningful increase in the probability of being in compliance with nutrient management regulations. This result suggests that enforcement gaps can have a significant effect on the performance of environmental regulations.

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Fig. 1

Notes

  1. 1.

    The OIG review covered regulations enforcing all major environmental legislation, including the Clean Air Act, the Clean Water Act, the Federal Insecticide, Fungicide, and Rodenticide Act, the Toxic Substances Control Act, the Safe Drinking Water Act, and the Resource Conservation and Recovery Act.

  2. 2.

    The regulator may interact with a firm along multiple dimensions. For example, a regulator may enforce different regulations on the same firm. In this case, each regulation would be a different dimension along which the regulator interacts with the firm.

  3. 3.

    This form of regulation is common in the health and safety context, among others. Food safety regulations based on the Hazard Analysis of Critical Control Points (HACCP) concept, of instance, require firms to develop detailed plans for (a) ensuring that food does not become contaminated during processing and (b) for handling any incidents of contamination that may occur. Periodic inspections are used to determine whether acceptable plans are in place and whether observed equipment and operating procedures are consistent with that plan. Regulations governing occupational safety, protection of patient medical data, and quality of care in skilled nursing facilities have the same general structure. Recipients of farm subsidies are required to have in place a conservation plan approved by local Natural Resource Conservation Service or soil conservation district technicians; failure to comply can result in loss of access to new subsidies and, in some cases, demands to repay subsidies already received. The equivalent two-stage process in some industries consists of (1) installing pollution control equipment (e.g., smokestack scrubbers) and (2) keeping that equipment in operation at all times it is needed.

  4. 4.

    We are ruling out the case where a firm does not file but complies with a protocol as that option is strictly dominated.

  5. 5.

    If a firm is able to reduce the penalty (plus the cost of effort expended on reducing the penalty) below the cost of compliance, it will be optimal for the firm to remain out of compliance indefinitely.

  6. 6.

    Animal units are defined as follows: 1 beef cow = 1 animal unit, 1 bird = 0.008 animal units, 1 dairy cow = 1.25 animal units, 1 pig = 0.4 animal units, 1 sheep/goat/lamb = 0.1 animal units, and 1 horse = 2 animal units.

  7. 7.

    Our theoretical analysis assumes that (a) the fine for failure to file a protocol is less than the fine for failure to comply and (b) fines for noncompliance exceed compliance costs. The cumulative nature of the fine for noncompliance with a NMP means that it can easily exceed the fine for failure to file a NMP. The cost of a typical NMP in Maryland is about $1200 or roughly $400 a year since a plan is valid for 3 years. Following a plan’s recommendations for fertilizer and manure use rarely increases annual nutrient management expenditures and may well reduce them (see for example Lawley et al. 2009). The combination of formal and informal penalties can thus easily exceed the costs of filing and implementing a NMP.

  8. 8.

    There is no reason to believe that the response rate was affected by a desire to avoid revealing information to MDA. The survey is administered by NASS, which has no regulatory role in the implementation of the WQIA, conducts numerous surveys about farming activities every year, and does not share individual-specific data with MDA. Farmers would thus have no reason to believe that their responses would have any regulatory implications. The fact that 23.2% of respondents with characteristics indicating that they were required to adopt a nutrient management plan reported not having one provides additional evidence that respondents did not believe that their responses would be used for regulatory purposes.

  9. 9.

    This farm size distribution is typical of that in the US as a whole.

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Correspondence to Erik Lichtenberg.

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Andarge, T., Lichtenberg, E. Regulatory compliance under enforcement gaps. J Regul Econ 57, 181–202 (2020). https://doi.org/10.1007/s11149-020-09405-0

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Keywords

  • Enforcement
  • Environmental regulation
  • Nutrient management
  • Water quality

JEL Classification

  • L51
  • Q58