Monday, January 12, 2009

Demand side dynamics of corruption

In this post, I will argue that corruption and rent seeking practices are inevitable given the incentives furthering it inherent in the regulatory apparatus. I will elucidate this in terms of examples from two departments with which urban residents have the most frequent interface - Town Planning and Propert Tax assessment. Let us examine the demand side incentives first.

The first example is from Town Planning. A citizen who applies for a building plan finds that a significant proportion of his valuable land will have to be left vacant if he were to comply fully with all the building regulations. His opportunity cost is the rental value or utility value in having to forego the extremely valuable additional built-up area. The same is the incentive for a shop owner running his shop without any parking area or a property owner encroaching the road margins, both commonplace occurances in any city. The maximum penalty for a deviation is removal of the deviated portions, whose probability is minimal given the time consuming procedural requirements. Given the context in which the procedural requirements are situated, it is simple for a reasonably clever violator to get away by entangling the issue in litigation.

The next example is from property tax assessment. Property tax is a recurring expenditure for the tax payer and it is therefore in his personal interest to minimize the assessment. The multiple categories and complex assessment rules opens up ample scope for tax evasion and rent seeking. The ease of evasion (complex tax categories and corrupt officials, both in ample supply) and the difficulty in its detection, coupled with its considerable benefits, presents ample incentives for citizens to indulge in this practice. The tax evaders face even less deterrent than the building plan deviators. The procedural requirements are so loaded in favor of the evader and against any meaningful effort at enforcement. The worst penalty they face is to pay the evaded tax!

It is widely acknowledged that the success of any regulation depends on the record of its enforcement, which in turn depends on the robustness of the enforcement machinery and the certainty of punishments or penalties. In case of both tax evasion and building deviations, the dice is so heavily loaded in favor of the evader or violator, when in it comes to charging and punishing them according to the provisions of the relevant rules. The complex legal process and the long delays associated with ensures that such offenders get away scot free with their offence. All Urban Local Bodies (ULBs) are awash with numerous cases of tax evasion and building violations, which have been locked in litigation for years together, thereby benefiting the offenders. The absence of any sunset clauses in the routine status quo orders of judicial courts, is a boon for such offenders, who find cover under these court orders.

A less acknowledged, but more critical dimension relates to the incentive structure embedded in the architecture of the regulatory process itself. Citizens indulge in violations when the marginal benefits associated with every deviation from the regulation is much higher than the potential marginal cost incurred by deviating. In practical terms, this means that whenever the benefits of deviation are huge, the severity and certainty of punishment should be unacceptably high. However, this raises many practical problems given the difficulty of levying heavy penalties in a democratic polity and the limitations involved in enforcing them. The commonplace nature of many such deviations or violations ensures that the force of indignation against them has lost steam.

As can be seen from the two aforementioned examples, the demand side incentives to deviate or evade are enormous, and for many citizens too tempting to avoid. The penalties are too weak or too difficult to enforce, that its value as a deterrent is minimal. Further, these deviations and evasions have become too commonplace to be addressed through simple regulatory solutions. At the risk of sounding cynical and status quoist, I feel that it is almost impossible to wage a successful regulatory battle against such deviations and evasions.

Simplified procedures and rules may be a part of the solution. But even a simplified regime will leave us with enough regulatory issues to make enforcement a challenge. Even in cities where procedures and regulations have been drastically pruned, the violations and evasions, though reduced, remain at substantial enough levels. Only when the simplification is so radical, as to render even the basic regulatory parameters irrelevant, can there be respite. This would entail focussing solely on the built-up area, by say, doing away with building set-backs and plot size restrictions in our town planning rules, and dispensing with building types and usage classification in property tax assessment. All these will come up against another series of objections and distortions, in some cases more harmful and perverse than the original problem itself.

Therefore the more sustainable and practical approach to enforcement is to generate a ground-swell of support and opinion against such violations and violators. Even with this, the enforcement can be robust only if the regulations are minimized and simplified. I am inclined to believe that this is the major contributor towards the better enforcement of regulations in developed economies. Unfortunately, this has to be bottom-up and demand driven, which in turn calls for mobilizing the civic responsibilities of citizens. And this is one hell of a challenge!

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