Environmental Policy and Optimal Taxation in a Decentralized Economic Federation∗

This paper deals with environmental policy in an economic federation, where each national government faces a mixed tax problem. We assume that the federal government sets emission targets, which are implemented at the national level. We also assume that the economic federation is decentralized, meaning that the national governments are first movers vis-a-vis the federal government. Our results show that each country uses it policy instruments, at least in part, to influence the emission target. This has several implications; first, the commodity taxes do not satisfy the so called additivity property often ∗The authors would like to thank Laurent Simula for helpful comments and suggestions as well as thank the other participants in the HECER workshop on fiscal federalism in Helsinki held at November 18-19, 2005. A research grant from FORMAS is also gratefully acknowledged.