Growing state–federal conflicts in environmental policy: The role of market-based regulation

In recent years, cases in which state governments chose to override federal environmental regulation with tighter regulations of their own have become increasingly common, even for pollutants that have substantial spillovers across states. This paper argues that this change arose at least in part because of a shift in the type of regulation used at the federal level, from command-and-control regulation toward more incentive-based regulation. Under an incentive-based federal regulation, a state imposing a tighter regulation will bear only part of the additional cost, and thus has more incentive to tighten regulation than it does under federal command-and-control. This difference helps to explain observed patterns of regulation. In addition, it has implications for the choice of regulatory instruments. For a pollutant that causes both local and spillover damage, a federal pollution tax is likely to yield a more efficient outcome than federal command-and-control policy or a federal system of tradable permits.

Research highlights► This paper models pollution regulation by both national and local governments simultaneously. ► The national government’s regulatory instrument choice greatly affects incentives for local regulation. ► National-level command-and-control regulation creates a strong disincentive for local regulation. ► Incentives for local regulation are stronger under national-level pollution taxes or tradable permits. ► Local regulation is more likely to improve welfare under a national pollution tax than under a tradable permit system.