Globalization enhances competition between countries and regions to attract firms, secure jobs, and over time, sustain economic development. An important issue is the use of environmental standards as a source of firms¿ attraction and economic development. Policymakers in high-income countries and intermediate or low-income countries have a strategic incentive to cut their business taxes and relax environmental standards to attract footloose firms at the expense of their competitors. However, the benefits of economic development have increasingly been brought into question over the last decades, especially in developed countries, on the grounds that a concentration of industrial activities pollutes, not only in the same jurisdiction as the polluting activities, but also in neighboring ones and even in more distant countries, since pollutants can be transported over hundreds, even thousands of kilometers. These considerations have opened the door to the analysis of how competition among different countries to attract capital affects global pollution. The proposed research aims to analyze how tax competition and environmental agreements are interconnected, from a theoretical and empirical point of view. The approach of the analysis is twofold: first, we develop a theoretical model of competition between a set of rich (high-income) countries and a set of poor (intermediate or low-income) countries, that are assumed to compete over corporate tax rates and environmental standards in the context of increasing capital mobility and concerns over globalization and cross-border pollution; second, we present a novel empirical analysis that investigates via a quasi-experimental causal design how Green local governments influence environmental outcomes by regulation and local taxes, by constructing a new and original dataset using Italian municipal data.
There is a long-standing strand of the theoretical public finance literature in which fiscal competition is modeled as a non-cooperative game where public authorities tax mobile capital and provide public goods. One of the main results is that equilibrium tax rates are too low to finance public goods adequately. The standard model of tax competition has been extended in various directions, including through the combination of tax and environmental competition between identical countries. This small section of the literature dates back to the seminal paper by Oates (1988), which showed that governments set inefficiently low capital taxes at equilibrium and relax their environmental standards. In an influential paper, Ogawa and Wildasin (2009) challenge this result and find that tax competition for mobile capital leads to a first-best outcome regardless of transboundary pollution and hence, that there is no need for international environmental policy coordination. However, the latter result has recently been put into question by Yamagishi (2019), who emphasizes that Ogawa and Wildasin 's efficiency result crucially depends on the assumption that the level of environmental standards is exogenous - or put differently, that governments have no say in environmental regulations. Relaxing this assumption leads back to the more intuitive result that competition between countries or regions leads to weak environmental standards at equilibrium. Neither paper consider differently sized or differently developed countries. Nor do they consider the effects of economic integration on equilibrium levels of corporate taxes and environmental standards, since standard tax competition models assume that capital is perfectly mobile and boils down to a continuum of investors of insignificant size. Finally, countries are assumed to have the same environmental preferences, which, of course, is quite a stretch.
The environmental economics literature has likewise mostly ignored the interactions between tax and environmental competition, focusing mainly on the optimal environmental policy in a strategic setting to address the issues of carbon leakage and pollution havens (Naegele and Zaklan, 2019). Some of these papers endogenize firms' choice of location as a reaction to exogenous unilateral pollution reduction measures (Markusen et al., 1993; Motta and Thisse, 1994; Petrakis and Xepapadeas, 2003; Sanna-Randaccio and Sestini, 2012; Sanna-Randaccio et al., 2017), while a different strand of the literature endogenizes both the environmental policy and the choice of location. However, most of these models assume that countries are perfectly symmetric, that pollution is local and that there are no transport costs (Ulph and Valentini, 2001; Abe and Zhao, 2005; Ikefuji et al., 2016). The key argument in this literature is that when jurisdictions compete for FDI, this leads to a race to the bottom in terms of environmental standards.
To the best of our knowledge, our research project is the first to jointly tackle tax and environmental competition between a rich and a poor country in a very simple framework where firms are imperfectly mobile and countries differ in their levels of environmental concern. Our contribution to the literature is thus twofold. On the one hand, we go further the existing literature while bridging two different strands of research. On the other hand, we can derive some policy implications which so far are still missing and offer empirical support to the model by testing through a causal model the relation between political program and environmental outcomes. The empirical analysis will also plan to use data from the 'European Union Statistics on Income and Living Conditions (EU-SILC) and the Annual Regional Database of the European Commission's Directorate General for Regional and Urban Policy to empirically test the theoretical predictions.