Multielement optimization of environmental tax on FDI of heterogeneous manufacturers based on Melitz model derivation

Abstract

The present study concerned about the issue of optimal environmental tax under the assumption of heterogeneous productivity of firms when foreign direct investment (FDI) is allowed. A Melitz model was developed to calculate the effect of environmental tax on FDI when two governments adopt either a cooperative or a competitive strategy. The results showed that the impacts of environmental policy on FDI is different when different strategies are adopted by the governments. These differences in both strategies heavily depend on price effects and profit effects. In conclusion, in order to decide the optimal environmental tax, it is important to consider marginal benefits and costs on environmental investments.