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Taxing pollution: agglomeration and welfare consequences

  • Marcus Berliant


  • Shin-Kun Peng
  • Ping Wang

This paper demonstrates that a pollution tax with a fixed cost component capturing an “ambient tax” may lead, by itself, to stratification between clean and dirty firms without heterogeneous preferences or increasing returns. We construct a simple model with two locations and two industries (clean and dirty) where pollution is a by-product of dirty good manufacturing. Under proper assumptions, a completely stratified configuration with all dirty firms clustering in one city emerges as the only equilibrium outcome when there is a fixed cost component of the pollution tax. Whereas the fixed component of the pollution tax and decreasing private returns are needed for agglomeration of dirty firms, the Romer-type positive spillovers are not necessary. Moreover, a stratified Pareto optimum can never be supported by a competitive spatial equilibrium with a linear pollution tax that encompasses Pigouvian taxation as a special case. To support such a stratified Pareto optimum, however, an effective but unconventional policy prescription is to redistribute the pollution tax revenue from the dirty to the clean city residents. Copyright Springer-Verlag Berlin Heidelberg 2014

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Article provided by Springer & Society for the Advancement of Economic Theory (SAET) in its journal Economic Theory.

Volume (Year): 55 (2014)
Issue (Month): 3 (April)
Pages: 665-704

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Handle: RePEc:spr:joecth:v:55:y:2014:i:3:p:665-704
DOI: 10.1007/s00199-013-0768-9
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