Optimal law enforcement and regulation models generally assume a single punishment scheme. However, when there is unobservable heterogeneity in violation propensities, welfare can be improved by offering punishment menus to potential offenders ex ante. When this is done, individuals with low violation propensities will choose low audit probabilities and high penalties, while individuals with high violation propensities will choose high audit probabilities and low penalties. We present a formal model showing that allowing individuals to choose from a punishment menu improves social welfare relative to a single punishment scheme by simultaneously reducing auditing costs and enhancing deterrence. This model provides a rationale for some recently proposed citizen trust policies in which people can enter their identities in a public registry and be subject to less-demanding inspections.
Alfago et al. (Thu,) studied this question.