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This study explores an optimal (pre-committed or ex-ante) environmental tax policy in a three-stage game in which polluting firms strategically choose the location of their plants after the government has chosen the optimal emission tax rate. We show not only that the optimal emission tax is non-decreasing with the declining cost of relocation (e.g., setup or fixed costs), or else, the progress of globalization but also that the firms may move back their relocated plants to the home country, causing the resulting welfare to decline. As a consequence, the domestic welfare varies in a non-monotonic way. We also show that such a counterintuitive non-monotonic relationship does not arise under time-consistent (ex-post) emission taxes.

Optimal Emission Tax with Endogenous Location Choice of Duopolistic Firms