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What Do Regulators Value?

Dennis L. Weisman

Abstract:

In a pioneering article entitled “Taxation by Regulation,” Judge Richard Posner challenged the prevailing orthodoxy that regulation emulates competition along the lines of the Public Interest Theory of regulation. He argued that regulation is best viewed as a branch of public finance in which the power of the state is leveraged to achieve non-competitive outcomes. We develop an indirect test of Posner’s theory by specifying the regulator’s welfare function as a convex combination of consumer surplus, profits shared with the regulator and profits retained by the regulated firm. The welfare weights cannot be observed directly, but can be inferred from the regulator’s behavior in equilibrium. To wit, when the regulator permits the regulated firm to earn positive profits and authorizes higher prices in response to a greater degree of profit sharing this establishes both an upper bound on the consumer surplus weight and a higher weight on shared profits than on profits retained by the regulated firm. Applying this test to the implementation of the 1996 Telecommunications Act lends support to Posner’s theory.

JEL Classification: L51; L96

Acknowledgements

I am grateful to two anonymous referees and the editor, Johann Brunner, for insightful comments and constructive suggestions for revision that improved the manuscript. I thank Soheil Nadimi for expert research assistance. The usual caveat applies.

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Published Online: 2016-10-26
Published in Print: 2016-10-1

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