Environmental Federalism:
Interpreting Some Contradictory Results

Abstract

This paper reconciles some conflicting interpretations of recent literature on interjurisdictional environmental regulatory competition. Oates and Schwab (1988) present a model in which competition to attract investment by lowering environmental standards leads to a Pareto-optimal equilibrium. Markusen, Morey, and Olewiler (1993, 1995) model two jurisdictions competing to attract a polluting manufacturer, and find that such competition can result in a suboptimal Nash equilibrium. While it would be possible to draw opposite policy implications from the two models regarding the optimal degree of environmental federalism, such a conclusion would be incorrect. This paper shows that the different results depend in large part upon monopoly profits and tax exporting, not the nature of the pollution externality or environmental federalism.

Key words: Environmental policy; Tax competition; Plant location; Federalism

JEL classification: H7; Q2; R3

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