The Economics of Regulatory Tiering

Abstract

Many regulations impose lighter requirements on smaller firms than on largerfirms. Such differential treatment is known as tiering. This article presents a framework for analyzing tiering. It assumes that regulators use taxes to reduce negative externalities, that the collection of taxes imposes administrative costs on the taxedfirm and the regulatory agency, and that firm heterogeneity arises because firms have differential access to a scarce factor. The scarce factor is taken as managerial ability, although this identity is not essential for any of the results obtained. The article shows that when there are scale economies in regulatory compliance, tiered regulations may be Pareto-superior to untiered regulations under certain circumstances. It then compares existing tiering schemes with Pareto-efficient tiering schemes and suggests possible improvements in existing tiering schemes.