Strategic Behavior and the Environment > Vol 9 > Issue 1-2

Transboundary Externalities and Reciprocal Taxes: A Differential Game Approach

Charles F. Mason, Department of Economics, University of Wyoming, USA,
Suggested Citation
Charles F. Mason (2021), "Transboundary Externalities and Reciprocal Taxes: A Differential Game Approach", Strategic Behavior and the Environment: Vol. 9: No. 1-2, pp 27-67.

Publication Date: 19 Jul 2021
© 2021 C. F. Mason
Environmental economics,  Public economics,  Economic theory,  International relations,  Game theory,  Climate change
JEL Codes: C73Q50F18
Transboundary pollutiondifferential gametarifftax


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In this article:
Modeling Preliminaries 
Baseline Solutions 
The Socially Optimal Solution 
The Non-cooperative Equilibrium 
Concluding Remarks 
Appendix A. Derivations in the Linear-Quadratic Model 


I investigate the interaction between a country that imports a commodity whose production contributes to a stock pollution from a country that produces that commodity. If the transboundary externality is priced improperly, the application of a tariff or border tax adjustment can provide an indirect policy instrument. But the imposition of such a tariff or tax creates an incentive for the producing country to deploy a domestic pollution tax. This, in turn, creates a strategic interaction between the two countries. Because the externality is linked to a stock pollutant, this strategic interaction will play out over time, which induces a dynamic game. In this modeling context, I describe the nature of the strategic interaction, and characterize the Markov-perfect equilibrium (MPE). Numerical results indicate that MPE can deliver long-run welfare levels similar to the social optimum program, and that the exporting country may be better off in the MPE than in the "business-as-usual" regime.