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Environmental Policy in a Federation with Special Interest Politics and Inter-governmental Grants

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  • Divya Datt

    () (Centre for International Trade and Development,Jawaharlal Nehru University
    Centre for International Trade and Development,Jawaharlal Nehru University)

Abstract

The paper explores the potential effect of intergovernmental grants (IGG) on sub-national (local) environmental policy in a federal structure. In the model, a politically-inclined local government receives campaign contributions from the polluters' lobby in return for lower pollution taxes. A benevolent federal government uses IGG as an incentive to reduce the resulting distortion in the local pollution tax. IGG are formulaic transfers that are conditional on pollution levels - lower pollution in a sub-national jurisdiction relative to others translates into a higher share of the grant and vice versa. In equilibrium, the grant effect reduces the distortion created in the pollution tax by the lobby effect, and may even lead to a higher than Pigouvian tax when the local government assigns a large enough weight on social welfare and/or when the grant is large enough. Further, IGG result in the tax levels of jurisdictions becoming interdependent in an interesting way. Environmental policies in two jurisdictions may become strategic complements or substitutes depending on their relative pollution levels. The possibility of strategic substi- tution implies that federal welfare may not increase even when environmental policy becomes stricter in one state.

Suggested Citation

  • Divya Datt, 2015. "Environmental Policy in a Federation with Special Interest Politics and Inter-governmental Grants," Centre for International Trade and Development, Jawaharlal Nehru University, New Delhi Discussion Papers 15-02, Centre for International Trade and Development, Jawaharlal Nehru University, New Delhi, India.
  • Handle: RePEc:ind:citdwp:15-02
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    Cited by:

    1. Fünfgelt, Joachim & Schulze, Günther G., 2016. "Endogenous environmental policy for small open economies with transboundary pollution," Economic Modelling, Elsevier, vol. 57(C), pages 294-310.

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