Umeå Economic Studies,
Umeå University, Department of Economics

Abstract: This paper analyzes environmental policy in a decentralized economic federation comprising two countries, where a federal government decides upon environmental targets (maximum allowable emissions) for each country, which are implemented by the national governments. Both national governments have commitment power vis-à-vis the federal government, whereas one of the national governments (the horizontal Stackelberg leader) also has commitment power vis-à-vis the other country (the horizontal follower). The results show how the horizontal and vertical commitment power affect the horizontal leader’s use of income and production taxes, which are the tax instruments available at the national level.

Keywords: Environmental policy; Optimal taxation; Economic federation; Horizontal commitment power

JEL-codes: D62; H21; H23; H70

26 pages, November 3, 2008

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