Vertical Fiscal Externalities and the Environment
CER-ETH - Center of Economic Research at ETH Zurich, Economic Working Paper Series 16/234
59 Pages Posted: 17 Mar 2016
Date Written: December 2015
We show that imposition of a state-level environmental tax in a federation crowds out 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, even absent any environmental benefits. 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, H77, Q54
Suggested Citation: Suggested Citation