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The Pollution Haven Paradox: Can an Effluent Tax Improve both Profits and Welfare?

Robert Driskill and Horowitz Andrew W. ()
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Horowitz Andrew W.: Sam M. Walton College of Business, University of Arkansas

The B.E. Journal of Economic Analysis & Policy, 2007, vol. 7, issue 1, 1-18

Abstract: Stringent environmental taxes in high-income countries are assumed to drive dirty industries to low-income countries, but the empirical evidence for ``pollution havens" is surprisingly weak. We demonstrate that a government trying to prevent flight by a ``dirty" durable good monopolist can impose an effluent tax that is offset by a lump-sum subsidy so that both firm profits and host-country welfare are increased. The scheme exploits the Coase Conjecture insight: a durable goods monopolist has a time-consistency dilemma that limits its ability to restrict future output. In this environment the effluent tax provides a credible commitment that restricts future supply. We assert that the use of lump-sum subsidies in strategic location competition is consistent with this mechanism, and this paradigm may be an important piece of the ``pollution haven paradox."

Date: 2007
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