Trade Liberalization and Environmental Taxation in Federal Systems

• DOI: http://doi.org/10.1111/sjoe.12127
• Author: Per G. Fredriksson,Xenia Matschke
• Published date: 01 January 2016
• Date: 01 January 2016

Scand. J. of Economics 118(1), 150–167, 2016

DOI: 10.1111/sjoe.12127

Trade Liberalization and Environmental

Taxation in Federal Systems∗

Per G. Fredriksson

University of Louisville, Louisville, KY 40292, USA

per.fredriksson@louisville.edu

Xenia Matschke

University of Trier, DE-54286 Trier, Germany

matschke@uni-trier.de

Abstract

The literature on trade liberalization and environment has not yet considered federal struc-

tures. In this paper, we show how the design of environmental policy in a federal system has

implications for the effects of trade reform. Trade liberalization leads to a decline in pollu-

tion taxes, regardless of whether pollution taxes are set at the federal (centralized) or local

(decentralized) level, and it increases social welfare. The effect under a decentralized system

is smaller than if these taxes are set by the federal government, and pollution emissions

therefore decline in this case. Moreover, majority bias interacts with trade liberalization if

federal taxes are used.

Keywords: Environmental federalism; environmental policy; majority bias; political economy;

trade liberalization

JEL classification:F1; H2; H7; Q2

I. Introduction

The relationship between trade liberalization and the environment is a

highly contentious public policy issue. For example, the environmental

provisions of the current negotiations over the Trans-Pacific Partnership,

which would be one of the world’s largest trade agreements, have exposed

deep rifts over environmental policy between the US and 11 other Pa-

cific Rim nations. The environmental parts of the trade deal have, as of

early 2014, been among the most highly disputed elements of the treaty

∗We thank Paola Conconi, several anonymous referees, and participants at the Conference in

Honor of Bill Ethier, Vanderbilt University, and at the Workshop on the Political Economy

of Sustainable Development, Montpellier, for helpful comments. Per Fredriksson is g rateful

for the hospitality at Resources for the Future (RFF) while visiting. The usual disclaimers

apply.

CThe editors of The Scandinavian Journal of Economics 2015.

P. G. Fredriksson and X. Matschke 151

negotiations.1Moreover, the Sierra Club2raises significant concerns about

the Transatlantic Trade and Investment Par tnership (TTIP) being negoti-

ated in 2014 by the European Union and the US. In particular, the Sierra

Club argues that any harmonization within TTIP must be towards stricter

policies, and must provide governments with the flexibility to maintain or

strengthen environmental and climate policies without constraints. Mean-

while, the literature analyzing the effects of trade liberalization on envi-

ronmental policy and quality continues to present contradicting results (see

Copeland and Taylor, 2004 for a survey). One def iciency of this literature

is that it has not sufficiently taken political institutions into account, in

particular the presence of a federal system (see Gulati and Kellenberg,

2013). Federations can assign authority over environmental policy to either

local or federal levels of government – Oates (2002) provides a sur vey –

and thus different levels of gover nment might respond differently to trade

liberalization depending on the institutional design. We investigate the ef-

fects of exogenous trade liberalization on pollution taxes in a federation

with majoritarian electoral rule under decentralized and centralized envi-

ronmental policy designs. We are not aware of any previous studies that

analyze this particular issue.

Many countries currently take part in trade-liberalizing efforts, be it at

the multilateral, bilateral, or even unilateral level. Trade liberalization ef-

forts can, in turn, affect domestic policies as well. Ederington and Minier

(2003) suggest that unilateral incentives might emerge for governments to

distort domestic environmental policies as a secondary tool of protection.

The influence on environmental taxation is an important issue, given the

double dividend debate pertaining to environmental taxation (e.g., Parry

and Bento, 2001; Jaeger, 2011). Moreover, trade liberalization and environ-

mental taxation occur in a variety of countries ranging from federal states,

such as the US and Canada, to more centralized states, such as France, and

from states with majoritarian electoral systems to states with proportional

presentation. It seems an important question to ask whether the impact

of trade liberalization on environmental taxation hinges on political institu-

tions (e.g., the governmental level at which environmental policy is decided

and the electoral system). The question of whether free trade agreements

should also include addenda on environmental policies to counteract neg-

ative environmental consequences might actually depend to some degree

1See the article by C. Davenport, “Administration Is Seen as Retreating on Environment

in Talks on Pacific Trade”, New York Times, January 15, 2014 (http://www.nytimes.com/

2014/01/15/us/politics/administration-is-seen-as-retreating-on-environment-in-talks-on-pacific

-trade.html?_r=0).

2See the 2013 report, “The Transatlantic Free Trade Agreement: What’s at Stake for Com-

munities and the Environment”, published by the Sierra Club, Washington, DC (available

online at http://action.sierraclub.org/site/DocServer/TTIP_Report_2.pdf?docID=13561).

CThe editors of The Scandinavian Journal of Economics 2015.