Abstract
We model an economy of K heterogeneous regions where agents value consumption vs. nature differently. Consumption obtained through pollution-inducing production also generates a negative externality on neighbors. We show that even with a decentralized policy we can obtain first-best efficiency by choosing a combination of pollution taxes in both regions and lump-sum transfers. Moreover, we show that optimal pollution taxes are determined only by the externality parameters, independent of agents’ preferences for consumption and nature.
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