Differing environmental preferences, fiscal competition, and taxation of goods and pollution

Chiara Canta, Helmuth Cremer and Firouz Gahvari

No 21879, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop a two-country model of trade and global pollution in which country A values environmental quality whereas country B does not. Governments choose emissions and commodity taxes non-cooperatively under autarky and free trade. Under autarky, the principle of targeting holds: country A levies a Pigouvian emissions tax, whereas neither country uses a commodity tax. Opening borders fundamentally changes the design of corrective taxation. Country A subsidizes the polluting good to shift production toward its cleaner firms. The optimal subsidy depends on the marginal social damage of emissions despite the presence of an emissions tax, implying a violation of the principle of targeting. Contrary to the conventional pollution-haven prediction, the environmentally unconcerned country need not be the exporter of the polluting good. As country A's valuation of environmental quality increases, or country B's production-cost advantage narrows, production shifts toward $A$, which eventually becomes the exporter. Beyond a critical threshold, trade reduces global emissions relative to autarky. Welfare effects are asymmetric: trade always benefits country B but may either increase or decrease welfare in country A.

Keywords: global; externality (search for similar items in EconPapers)
JEL-codes: F15 H21 H23 H73 H87 (search for similar items in EconPapers)
Date: 2026-08
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Working Paper: Differing Environmental Preferences, Fiscal Competition, and Taxation of Goods and Pollution (2026)
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