Correlated pollutants, interregional redistribution and labor attachment in a federation

We examine the efficiency of federal policies in a federation characterized by decentralized leadership, imperfect labor mobility and transboundary pollution. Selfish regional governments regulate correlated pollutant emissions by choosing pollution tax and abatement levels in anticipation of the center's redistributive policy. The center's objective function obeys a proportional equity principle, which implies that its choice of interregional transfer satisfies the equalization of weighted regional welfare levels. Regional and central governments make their choices subject to migration incentives. We show that the subgame perfect equilibrium for the sequential game played by regional and central governments yields socially optimal policies.