Environmental taxation and the double dividend in decentralized jurisdictions

This research explores the implications for jurisdictional welfare of sharing environmental rents between private and public consumption. An integrated model is developed from research literatures on jurisdictional competition, the “double dividend,” and on the design of tax-refund instruments. This model shows that jurisdictional welfare increases as environmental rents are initially allocated towards public consumption, yielding a “double dividend”, but that this dividend may or may not continue as all rents are shifted to public finance. When the double dividend occurs, the rent allocation both improves the efficiency of the tax system and reduces the private-public consumption distortion that decentralized jurisdictional decision-making creates. In some parameter configurations, there is an optimal rental allocation between the private sector and the local government. At this optimum, environmental and fiscal policies are set at their first-best levels and decentralized jurisdictional decision-making is globally efficient. If less rents are allocated to public finance than this optimum, fiscal and environmental policies will be suboptimal, whereas, if too much rent is allocated for public consumption, fiscal and environmental policies will be set at levels above the global efficiency standard. These results illustrate the crucial importance of environmental rent sharing for the efficiency of jurisdictional decision-making.