View article

In this paper, we consider the design of optimal environmental policies composed of pollution standards and probabilities of inspection, where fines for exceeding the standards depend on the degree of noncompliance and the environmental technology that the firm uses in its production process. We show that the selection of a progressive or a proportional penalty with respect to the degree of noncompliance is crucial: while the optimal standard is zero in the progressive case, we obtain a positive standard in the linear case, with important welfare implications. While firms prefer proportional fines due to the relaxed regulations induced, regulators may prefer the progressive case for sufficiently large monitoring costs.