Honesty in a regulatory context - good thing or bad?

It is often taken for granted that if more firms were innately honest or et hical this would be a good thing. We use the example of pollution policy to dispute such a claim. If regulation is by pollution tax social welfare is non-monotonic in population honesty. The choice of policy instrument may it self be characterised by 'reversals', with command-and-control methods bein g preferred for intermediate Values of population honesty, a tax system bei ng preferred at the extremes. This means that if - because of the spread of 'ethical shareholding' or for whatever reason - the honesty of the corpora te population increases through time, we should not be surprised to see at first a switch away from market-based instruments, and then a switch back. Though environmental regulation is chosen as a context, the implications ar e more general. (C) 2001 Elsevier Science B.V. All rights reserved.