Vertical Fiscal Externalities and the Environment
47 Pages Posted: 5 Nov 2014 Last revised: 6 Nov 2014
Date Written: November 4, 2014
We show that the imposition of a state-level environmental tax in a federation crowds outs pre-existing federal taxes. We explain how this vertical fiscal externality can lead unilateral state-level environmental policy to generate a welfare gain in the implementing state, at the expense of other states. Using a computable general equilibrium model of the Canadian federation, we show that vertical fiscal externalities can be the major determinant of the welfare change following environmental policy implementation by a state government. Our numerical simulations indicate that -- as a consequence of vertical fiscal externalities -- state governments can reduce greenhouse gas emissions by over 20 percent without any net cost to themselves.
Keywords: fiscal externality, climate policy, federalism, computable general equilibrium
JEL Classification: C68, H7, Q40
Suggested Citation: Suggested Citation