Transboundary Pollution Control in Federal Systems

We examine the effectiveness of federal environmental policy designed to control transboundary pollution. Federal policy is shaped after the hierarchy of the system, and is controlled simultaneously by regional and central governments; each level controls one of two policy instruments: pollution abatement and tax. We obtain larger than socially desirable levels of transboundary pollution when the central government is the policy leader. Federal policy, however, may be socially efficient when regional governments are leaders whenever income transfers, chosen by the central government, provide incentives for efficient decentralized behavior. Our findings are useful to environmental policy design in the European Union.