Transboundary Pollution From Consumption In A Reciprocal Dumping Model

We analyse transboundary pollution externalities caused by consumption of goods. The model is of a reciprocal dumping type in which there are two countries and two firms. Each firm produces a homogeneous good to be consumed in both markets. There are two policies available to the governments of the two countries: consumption taxes and import tariffs. We characterise the Nash optimal levels of the instruments in the two countries. Our results suggest that the conditions satisfying higher consumption taxes in one country satisfy lower tariffs in that country. It is found that starting from non-cooperative solutions, an infinitesimal uniform reduction is unambiguously Pareto improving for each country and for the global welfare. This is because the gain from an increase in consumer surplus due to reform is larger than the loss in the tax revenues of the governments. Moreover, a revenue neutral reform which increases consumption taxes and reduce tariffs, is strictly Pareto improving.