Constant Returns to Scale with Pollution Modeled as an Unpaid Factor (Published)
If pollution emissions enter a constant returns to scale production function, the additional output generated by this unpaid factor cannot be an equilibrium phenomenon. Private factors will engage in rent seeking without some form of rationing. Herein, we propose a shared rationing mechanism and investigate the efficiency implications in a setting of devolved decision making. General equilibrium derived optimal conditions show that taxing capital alone will not provide the revenue for efficient local public good levels. Suboptimal public goods provision then leads to inefficient environmental quality. Interestingly, larger shares of emission rents rationed to mobile capital result in environmental competition becoming more fierce. Conversely, when large shares of rent are captured by locally owned fixed-factors, competition for mobile capital is subdued.
Keywords: capital tax competition, environmental federalism, rent dissipation