This paper provides a model that integrates interjurisdictional tax

competition and environmental policy. Each local government supplies two

public goods - that benefit the local industry and the residents

respectively - which are financed through distortionary taxation on

industrial capital and pollutant emissions. In contrast to traditional

theory of tax competition, we find that overprovision of local public

goods may emerge in equilibrium. Since emission taxes serve to finance

public spendings, the supply of public goods and the environmental

quality are closely related. In the special case of a small region that

cannot affect the national after-tax return to capital, we have the

striking new result that in equilibrium two different regimes can occur.

Either we have underprovision of public goods and an inefficiently high

environmental quality, or we have overprovision of public goods and a

too low environmental quality. These inefficiencies persevere as long as

the federal government is not entitled to apply deliberate

taxation/subsidy schemes. Correspondingly, unless regions are perfectly

identical, we cannot hope to overcome the efficiency problem by

symmetrical cooperative solutions.