Optimal Pollution and Foreign-Investment Taxes in a Small Open Economy

This paper examines pollution and foreign-capital tax policies on the host country?s welfare when foreign-investment tax credits are absent or present in the source country. In the absence of tax credits, the optimal policy is a pollution tax with a foreign-investment tax or subsidy. The presence of tax credits may, however, result in a higher investment tax but lower pollution tax, leading to higher welfare but lower environmental quality in the host country. The source-country?s tax credits may cause a switch in the host-country?s capital subsidy to a tax, which may improve the environment