Incentive compatibility constraints as an explanation for the use of prison sentences instead of fines

Abstract

In standard models of optimal deterrence, which assume perfect information on the part of the social planner, fines dominate jail sentences as an instrument for punishing crime. In the real world, however, punishment using prisons is quite common. This paper provides an explanation for that empirical observation. If criminals either have private information about their own wealth, or have a substantial portion of their wealth in the form of human capital, the social planner cannot simply impose a fine on a criminal, who can always claim to have insufficient wealth to pay the fine. Rather, because of the need for incentive compatibility, it is as if the social planner offers the criminal a choice: either pay the fine or go to jail. That additional constraint on the social planner dramatically reduces the effectiveness of fines vis-a-vis a perfect information world. Mandatory sentencing guidelines exacerbate the problems associated with incentive compatibility by restricting a judge's ability to tailor penalties to individual criminals.