Environmentalists fear that international competition among jurisdictions in the field of environmental regulation will lead to low emission taxes and lax environmental standards. This issue is the basis of Discussion Paper No. 1032, by Research Fellow Michael Rauscher. The examination is set in a non-competitive partial equilibrium framework where there is one firm that wishes to establish a plant in one of n countries. Countries undercut each other until the tax revenue equals the environmental damage.

The analysis shows that it is the shape of the environmental damage function that determines an emission tax, which may be either too low or too high. It will be too low if damages are small compared with the potential tax revenue, because governments then compete for the tax revenue. Indeed, taxes may be driven to zero if there are substantial transfrontier pollution effects. It will be high if damages are large, however. In this case, the neglect of the consumer surplus leads to tight environmental standards and a low level of output. If environmental damages are very high, the plant may not be built at all. The reason is the neglect of the consumer surplus that accrues to other countries. This is the `not-in-my-backyard' case.

Environmental Regulation and the Location of Polluting Industries
Michael Rauscher

Discussion Paper No. 1032, November 1994 (IT)