Collusion Inducing Taxation of a Polluting Oligopoly

We show that an environmental regulation such as a tax on pollution can act as a collusive device and induce stable cartelization in an oligopolistic polluting industry. We consider a dynamic game where pollution is allowed to accumulate into a stock over time and a cartel that includes all the firms in the industry. We show that a tax on pollution emissions can make it unprofitable for any firm to leave the cartel. Moreover the cartel formation can diminish the welfare gain from environmental regulation. We provide an example where social welfare under environmental regulation and collusion of firms is below social welfare under a laisser-faire policy.