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Government regulations, whether they appear in statutes or administrative rules, often contain exemptions: certain persons or transactions are fully or partially excused from complying with the regulatory scheme. Even regulations without explicit exemptions may be worded in such a way as to implicitly exempt certain persons. A rule that applies to "all green objects" implicitly exempts objects of every other color?
Economists and legal scholars have written dozens of analyses of the efficiency of various government regulations but, with a few exceptions, they have not paid much attention to exemptions from those regulatory requirements. The limited economic and legal literature on exemptions focuses on one particular type of exemption - the small business exemptions which appear in many U.S. statutes and regulations.
The traditional assumption that an exemption is justified if the cost of regulating the exempted group exceeds the benefit is incorrect. The case for regulatory exemptions is more complicated. The traditional view provides only a necessary, not a sufficient, condition for exemptions. The transaction costs of exemptions, such as specification costs, strategic behavior, enforcement costs, and any third-part information costs, must also be considered. A regulatory exemption is economically efficient only if the cost to regulate the exempted firms exceeds the sum of the benefit of regulating the exempted firms and the transaction costs of the exemption.