Working Paper

Fiscal Federalism, Interjurisdictional Externalities, and Overlapping Policies

Oct 9, 2018 | Jessica Coria, Magnus Hennlock, Thomas Sterner

Summary

We study the combined effects of policies to reduce an externality that causes local and national damages.

Key Findings

  • We study the effects of a mixed policy with a tax at the national level and emission standards at the local level.
  • The stringency of local standards increases when combined with a national tax.
  • Local regulators set more stringent local standards to reduce the tax payment to the national government.
  • The increased stringency is not aggressive enough to induce any reductions in emissions beyond those induced by the tax.
  • Firms’ emissions reduction will be thus determined by the national uniform tax.

Abstract

In this paper, we analyze the effects of the interaction between national and local policies designed to reduce an environmental externality that causes environmental damages both nationally and locally. We formulate a theoretical model to develop hypotheses regarding the combined effects of such policies on the stringency of the local policies and on firms' emissions reductions. To test our hypotheses, we use actual data for Sweden, where emissions of nitrogen oxides from combustion plants are subject to a heavy national tax and to individual emissions standards set by county authorities. Our analytical findings suggest that it is unlikely that local regulators will impose emissions standards stringent enough to achieve further reductions than those induced by the national tax. This is confirmed in our data, where most emissions reductions can be attributed to the national tax and the effects of the emissions standards are not significant.