A Reason for Quantity Regulation

Abstract

In a variety of situations, governments regulate undesirable activities by controlling quantities rather than charging taxes. Blue laws prohibit all liquor sales on Sundays rather than impose higher taxes on that day. Zoning restrictions limit commercial construction in residential areas rather than charge for nuisance to neighbors. Anti-smoking and anti-trust laws restrict rather than tax particular conduct. Fishing and hunting rules allow hunting during particular time periods rather than tax the catch. Pollution controls impose limits rather than tax emissions. Quantity regulations are common in the financial sphere as well. In the United States, banking regulations for many years prohibited interstate banking, as well as ownership of investment banks by commercial banks. In many countries, commercial banks are limited in the amount of various activities they can pursue, such as real-estate investments or borrowing in foreign currency. In some countries, banking laws prohibit all lending to the parties related to the owners of the bank, the so-called related lending, rather than impose liability rules on loans to related parties that are found to be fraudulent or unsafe (Rafael La Porta et al., 2000). Despite this common practice, economists generally prefer taxes (and liability rules) to quantity controls (and property-rights rules) (Robert Ellickson, 1973; Louis Kaplow and Steven Shavell, 1996, 1997; Nathaniel Keohane et al., 1998) as the instrument for reducing undesirable conduct. When explaining why quantity regulations are so pervasive, they first make the political-economy argument that quantity restrictions are favored by incumbent firms that wish to deter entry (James Buchanan and Gordon Tullock, 1975). But this argument is not general: it does not explain such quantity restrictions as blue laws and hunting and fishing regulations, which affect all market participants equally. Some academics also argue that, because certain activities, such as smoking, are seen as morally wrong by the community, their level is regulated at zero. In other instances, however, such as pollution and hunting, positive but limited levels of activity are allowed, inconsistent with the moral argument that the reason for quantity regulation is the special attraction of zero. In this paper, we present an alternative reason for quantity regulations: one from the perspective of a benevolent government. We begin with the observation of Gary Becker and George Stigler (1974) that law enforcement is not free, but is fundamentally an economic problem. Throughout human history, and throughout the world today, there are chronic problems of under-enforcement (witness the low level of tax compliance in much of the developing world) and over-enforcement (by politically motivated prosecutors or regulators). An analysis of Pigouvian taxes versus quantity restrictions must recognize that, in reality, neither policy is free and automatic to enforce. In general, the choice of policies itself can facilitate or discourage enforcement, in two ways. First, policies can shape the incentives for enforcement. Second, policies can influence the costs of enforcement. In our earlier work (Glaeser and Sheifer, 2000; Glaeser et al., 2001), we have focused on incentives and shown that quantity regulations can be used as an optimal instrument to raise the rewards to law enforcers for identifying violations. Here we focus not on the incentives for the enforcers, but on the costs of finding violations: these costs are often lower in the case of quantity restrictions. We show that, even when quantity regulations, unlike taxes, restrict some socially efficient conduct, the reduced costs of identifying violations can enhance enforcement and overall efficiency. Such reliance of quantity regulation is especially important when private enforcement is crucial, as in the case of enforcing * Department of Economics, Harvard University, Cambridge, MA 02138. We thank the National Science Foundation for financial support and Louis Kaplow for extremely helpful comments.