Dual Regulation and Tax Evasion

The variety expansion model, including pollution emissions, is extended to an overlapped double regulation. The impact of corruption and tax evasion, which are determined through negotiations between bureaucrats and manufacturing firms, is analysed. Besides reducing pollution, lowering the emission allowance boosts the economy through the distribution effect. However, raising the environmental tax lowers the economic growth rate because it hinders this distribution effect. Furthermore, since emission allowances cap production volume, environmental taxes do not affect the amount of pollution. Reduced environmental tax rate due to tax evasion increases the allowance allocation rent through a rise in the emission allowance prices, hence, the economic growth rate rises. An increase in the environmental tax rate increases the tax evasion rate, therefore, the economic growth rate falls through a drop in the emission allowance prices and an increase in bribes. Therefore, a reduced tax rate promotes sustainable development. Improving the quality of the political system by reducing the fines and the negotiating power of bureaucrats improves the sustainability of society through an increased economic growth rate. While environmental taxes cannot improve the welfare of households and bureaucrats, there is room for total emissions allowances to improve the welfare of both.