International Environmental Policy Reforms, Tax Distortions, and the Labor Market

This paper concerns the welfare consequences of environmental policy cooperation in a two-country economy. We assume that the countries finance their public expenditures by using distortionary taxes, and that they differ with respect to competition in the labor market. The purpose is to characterize the welfare effect of a policy reform, where the countries agree to slightly increase their expenditures on abatement. We show how the welfare effect of the policy reform depends on changes in the environmental damage, employment, and work hours. We also relate the welfare effect to the strategic interaction among the countries in the prereform equilibrium.