This study relaxes the assumption of perfect and costless policy enforcement found in traditional agricultural policy analysis and introduces enforcement costs and cheating into the economic analysis of output subsidies. Policy design and implementation is modeled in this paper as a sequential game between the regulator who decides on the level of intervention, an enforcement agency that determines the level of policy enforcement, and the farmer who makes the production and cheating decisions. Analytical results show that farmer compliance is not the natural outcome of self-interest and complete deterrence of cheating is not economically efficient. The analysis also shows that enforcement costs and cheating change the welfare effects of output subsidies, the efficiency of the policy instrument in redistributing income, the level of government intervention that transfers a given surplus to agricultural producers, the socially optimal income redistribution, and the social welfare from intervention. ©2000 Elsevier Science B.V. All rights reserved.