Transboundary Pollution, Tax Competition, and the Efficiency of Uncoordinated Environmental Regulation

Abstract

Under capital tax competition, surprisingly, Ogawa and Wildasin (2009, American Economic Review, 99(4), 1206-1217) find that uncoordinated policymaking leads to a first-best outcome even in the presence of transboundary pollution. However, I show that if the level of environmental regulation is endogenized, the regulation level becomes too loose compared with the optimum (race to the bottom). Thus, despite the efficiency result of Ogawa and Wildasin (2009), efforts to achieve an international environmental policy coordination are needed. I then examine the dependence of this result on the level of decisive voter's capital endowment. If the decisive voter's capital endowment is below the average, uncoordinated regulation is always looser than the optimum. On the contrary, uncoordinated regulation may become inefficiently strict if it is above the average (race to the top).