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 paretooptimal 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)