Interjurisdictional Tax Competition, Voting and Environmental Policy

Oates, Wallace and Robert M. Schwab. 1988. “

Economic competition among jurisdictions: efficiency enhancing or distortion inducing

? Journal of Public Economics 35: 333-354

Assumptions

• capital is mobile• capital augments labor• production generates emissions• pollution is local• firms perfectly competitive and have CRS

production functions• n jurisdictions (provinces) sell their numeraire

output Q in a single national market

Regulation:

• government caps total local emissions by putting a limit on emissions • per worker cap on aggregate local

emissions, emission permits bundled with labor• capital tax = t

Equilibrium

• treat r as exogenous (determined in ROW)• equilibrium condition: fk-t=r (2) where fk = marginal product of

capital

Homogeneous Population

• If everyone is the same, want to set t=0, and choose pollution policy so that marginal rate of substitution between consumption and environmental quality equals marginal product from higher emissions.

• I.e. set efficient policy.• Somewhat reassuring: interjurisdictional

competition alone won’t necessarily breed inefficient environmental policy.

Heterogeneous Populatios

• two types of voters: –workers–folks with outside income

• Any revenue generated by capital taxation is rebated lump-sum to all local citizens equally.

Worker majority

• If workers are in the majority, they will elect to subsidize capital, setting tk<0. • This subsidy attracts capital, which

augments the wage. • The jurisdiction would have to finance

the subsidy by levying lump-sum taxes on the entire local population.

Intuition

• “Workers reap all the gains from the increased wage income associated with a larger capital stock, but they do not bear the full cost of the subsidy to capital---some of the cost of the subsidy falls on non-wage earners.” (p.347)

• Moreover, since tl<0, have a fiscal incentive to repel capital– choose implicit pollution tax that’s less than MD.

Non-wage earner majority

• Will elect to tax capital---pure “fiscal” effect.• Ambiguous as to whether implicit pollution

tax is > or < MD–May want high pollution tax so as to secure

clean environment at expense of local workers–or may want to expand tax base by weakening

environmental policy.

Conclusions

• Inter-jurisdictional competition for capital doesn’t necessarily induce inefficient policy

• whether voting leads to inefficiently weak environmental policy depends on who is in majority– needn’t be capital owners in charge in order to

see capital get subsidized

Lumpy Investment

Markusen, James, Edward Morey and Nancy Olewiler. 1995. "

Competition in Regional Environmental Policies When Plant Locations are Endogenous

," Journal of Public Economics 56: 55-77.

• build a two-region model• single firm • investment is lumpy– there are fixed costs associated with opening a

new plant• transporting finished products is costly

competing concerns

• countries want to host investment for two reasons:– avoid transport costs– pollution tax revenue

• downside– production pollutes local environment

Game

• Governments set binding tax rates• Firm decides how many plants to build and

where

Policies

• Each government extracts rents from the firm, setting pollution tax higher than MD– Makes it profitable to host the firm

• Also charge export taxes– gives governments incentives to bid down own tax

rates so as to get the firm to shut down its overseas plant and capture export tax revenue

One possible outcome

• Not In My BackYard: – both countries set pollution taxes too high– firm doesn’t set up anywhere– both countries could be better off if one would

agree to host the firm and receive side payments from the other

Conclusion

• Quest for lumpy investment can induce governments to bid down their pollution taxes, eroding benefits from hosting dirty industry– too much pollution

• Possible outcome: no one wants to host– too little pollution

Reconciling MMO w/ O&S

Levinson, Arik. 1997. “A Note on Environmental Federalism: Interpreting some Contradictory Results

” JEEM 33: 359-366

• MMO suggest interjurisdictional competition drives down pollution taxes

• O&S suggest τ>MD

What’s the difference?

• there are monopoly profits in MMO, which are ignored by the policy makers

• In O&S the capital rate is exogenous, so there are no costs/benefits to capital owners from weak/strict environmental regulation

• Levinson redoes MMO, taking into account the firm’s profits.

• compares “non-strategic, strategic, and pareto-optimal tax rates, pollution levels, welfare and profits” (p.361)

Finds...

• “when profits are included in the welfare calculations, the ...[competitive] tax rates lead to higher welfare than the non-strategic...tax rates and are closer in spirit to the Pareto optimum” (p.361)