Supply Side Effects of Pollution Tax Rate Asymmetries

Abstract

We investigate the effects of asymmetric per-unit pollution tax rates in two countries on a firm's choice of location for its manufacturing facilities, local and global environmental damage, and social welfare. The novelty of our approach is that we consider a manufacturer which offers products on multiple separated markets and that these products need the same inputs that have to be purchased from common suppliers. Accounting for the interaction between the supply side and the firm's location strategy, we show that establishing production facilities in an environmentally stringent region might be optimal for the manufacturer despite the higher pollution tax. Additionally, an increase in the pollution tax in one country does not necessarily decrease the total profit of a multinational manufacturer. We also demonstrate that a unilateral increase in the pollution tax rate to reduce emissions can actually lead to an increase in local and also global environmental damage. Since the multinational manufacturer's choice of organizational design accounts for the interactions with its vertical channel, our finding supports the conclusion that neglecting supply side interactions when determining emission tax rates might have unintended consequences.