The Political Economy of Pollution Taxes in a Small Open Economy

This paper develops a positive theory explaining pollution tax policy outcomes in a small open economy. The equilibrium tax rate depends on lobby group membership, the relative importance of lobbying activities, and the tax elasticity of pollution. The equilibrium properties are investigated. The model is extended to incorporate pollution abatement and a pollution abatement subsidy. We show that total pollution may be increasing in the pollution abatement subsidy rate. This effect arises because the equilibrium pollution tax rate may be decreasing in the subsidy rate due to altered political influence of the lobby groups in the political equilibrium.