Supply Side Effects of Pollution Tax Rate Asymmetries

Abstract: Emphasizing the strategic interaction between a multi-national manufacturer and its supplier, we investigate the effect of asymmetric per-unit pollution tax rates in two countries on a manufacturer's location decision. We find that an increase in the pollution tax in one country does not necessarily decrease the total profit of a multinational manufacturer. Accounting for supply side effects, we show that a commitment to co-locate in an environ- mentally stringent region might be optimal for the manufacturer. Additionally, we illustrate that neglecting supply side interactions when determining emission tax rates might result in unintended consequences on environmental damage and social welfare.