PUB - Publikationen an der Universität Bielefeld

In a world where direct trade instruments are banned and firms engage in imperfect competition, governments tend to (ab)use environmental policies in order to influence trade. In our model, when governments engage in tax competition, three possible cases may occur: In the two polar cases, either the environmental quality is too low and the provision level of public services is too high, or the reverse is true; in the medium case, however, both are too low. Hence, tax competition plausibly leads to `ecological dumping'. We contrast the competitive regime with a scenario of cooperative behavior. Due to three main effects—a fiscal, an environmental, and a production effect—governments tend to defect from cooperation by lowering rather than increasing their tax rates. To eliminate these perennial incentives to defect, an environmental agreement has to be sustained by complementary measures.