Tax Competition in Vertically Differentiated Markets with Environmentally Conscious Consumers
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This paper analyses the effects of tax competition on environmental product quality, pollution and welfare in a two-country, vertically differentiated, international duopoly, in which consumers are environmentally conscious. The firm in each country chooses first the environmental quality of its product (which reflects the emissions generated in the production process) and then the price. In equilibrium one country will be more polluted than the other because firms choose different levels of environmental quality of their products. We find that a country’s optimal commodity tax is higher if the domestic firm is the more polluting supplier. Furthermore, non-cooperative commodity tax rates are inefficiently high in equilibrium. This is because, in this framework with environmentally aware consumers, commodity taxes affect the choice of firms regarding their emissions. Therefore, a domestic tax reduction not only raises the profits of the foreign firm but also lowers its emission levels, resulting in higher welfare for the other country. We also analyse the optimal cooperative and non-cooperative commodity and emission taxes with border tax adjustments. With these two policy instruments available, commodity taxes are higher.
KeywordsCommodity tax Emission tax with border tax adjustments Environmental product quality Vertically differentiated market
The research project is implemented within the framework of the Action “Supporting Postdoctoral Researchers” of the Operational Program “Education and Lifelong Learning” (Action.s Bene.ciary: General Secretariat for Research and Technology) and is co-financed by the European Social Fund (ESF) and the Greek State.
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