RESEARCH ARTICLE Only the Carrot, Not the Stick: Incorporating Trust into the Enforcement of Regulation

New enforcement strategies allow agents to gain the regulator’s trust and consequently face a lower audit probability. Prior research suggests that, in order to prevent lower compli-ance, a reduction in the audit probability (the “carrot”) must be compensated with the intro-duction of a higher penalty for non-compliance (the “stick”). However, such carrot-and-stick strategies reflect neither the concept of trust nor the strategies observed in practice. In re-sponse to this, we define trust-based regulation as a strategy that incorporates rules that allow trust to develop, and using a generic (non-cooperative) game of tax compliance, we examine whether trust-based regulation is feasible (i.e., whether, in equilibrium, a reduction in the audit probability, without ever increasing the penalty for non-compliance, does not lead to reduced compliance). The model shows that trust-based regulation is feasible when the agent sufficiently values the future. In line with the concept of trust, this strategy is feasi-ble when the regulator is uncertain about the agent’s intentions. Moreover, the model shows that (i) introducing higher penalties makes trust-based regulation less feasible, and (ii) combining trust and forgiveness can lead to a lower audit probability for both trusted and distrusted agents. Policy recommendations often point toward increasing deterrence. This model shows that the opposite can be optimal