Abstract:
This paper examines the impacts of tightening environmental regulations on optimal trade and investment
policies. We find that for a small open two-sector economy with an importable sector relying on foreign capital while
emitting pollution, a more stringent environmental measure leads to a higher optimal tariff and possibly a higher optimal
tax on foreign capital. This result holds whether or not there are capital tax credits in the foreign country. When such tax
credits are in place in the foreign country, three possible cases regarding the domestic capital tax rate relative to the foreign
rate are identified and examined. In one such case, multiple equilibria of optimal policies may exist.
