Strategic Competition in Environmental and Fiscal Policies: Theory and Evidence from the United States

Abstract

A large literature explores strategic interaction in single instruments such as environmental or tax policy, with recent empirical studies documenting the existence of horizontal strategic interaction amongst governments. These studies rely on estimating reaction functions in a uni-dimensional policy framework, where a nonzero slope estimate suggests strategic interactions exist. This framework, however, may be potentially unduly restrictive; for example, in models of resource competition, local government may use more than one instrument to lure firms, leading to strategic interaction across policy instruments. In this study, we first develop a simple theoretical model of capital competition in two policy instruments. We empirically examine the implications of the model by examining US state-level panel data over the period 1977–1994. Empirical results provide support in favor of the existence of strategic interactions across the environmental and tax policy dimensions.