Transboundary pollution, tax competition and the efficiency of uncoordinated environmental regulation

Under capital tax competition, surprisingly, Ogawa and Wildasin (2009) find that uncoordinated policymaking leads to a first-best outcome even in the presence of transboundary pollution. However, I show that if the level of environmental regulation is endogenized, the regulation level becomes too loose compared with the optimum (race to the bottom). Thus, despite the efficiency result of Ogawa and Wildasin (2009), efforts to achieve international environmental policy coordination are needed. I then examine the dependence of this result on the level of decisive voter's capital endowment. The regulation is inefficiently loose in many cases, but it can be too strict if the decisive voter's capital endowment is above the average. Thus, the possibility of race to the top cannot be eliminated. The inefficiency result does not generally depend on the timing of policymaking, although the efficiency may be restored in the limit case where the decisive voter has no capital at all.