©1992 New York University Law Review.
REHABILITATING INTERSTATE COMPETITION: RETHINKING THE "RACE-TO-THE-BOTTOM" RATIONALE FOR FEDERAL ENVIRONMENTAL REGULATION
Richard L. Revesz *
* Professor of Law, New York University. I would like to thank the participants at a law and economics workshop at Harvard Law School and at a faculty workshop at New York University School of Law, as well as Vicki Been, Samuel Estreicher, Thomas Griffith, Michael Herz, Louis Kaplow, Michael Schill, Richard Stewart, and Peter Strauss for their comments on earlier drafts. Jeffrey Benz, Matthew Kaplan, and Steven Zwanger provided valuable research assistance. The generous financial support of the Filomen D'Agostino and Max E. Greenberg Research Fund at the New York University School of Law is gratefully acknowledged.
An influential justification for placing responsibility for environmental regulation at the federal level is that otherwise states would engage in a socially undesirable "race to the bottom," making their environmental standards too lax in an effort to attract and retain industry. After discussing the difficulties in empirically testing this theory, Professor Revesz shows that race-to-the-bottom arguments encounter no support in existing models of interjurisdictional competition. He then establishes that even if there were a race to the bottom over environmental standards, federal regulation would not be an effective response: faced with strict federal environmental standards, states concerned with attracting industry would relax regulatory controls in other areas. Professor Revesz concludes by showing that in the corporate-charter and bank-charter literatures, the race-to-the-bottom label has been used to identify issues distinct from those implicated in the term in the environmental context, and he offers a conceptual typology that elucidates the relevant distinctions.
Perhaps the most widely accepted justification for environmental regulation at the federal level is that it prevents states from competing for industry by offering pollution control standards that are too lax. This competition is said to produce a "race to the bottom" - that is, a race from the desirable levels of environmental quality that states would pursue if they did not face competition for industry to the increasingly undesirable levels that they choose in the face of such competition.
Race-to-the-bottom arguments for federal environmental regulation became commonplace following two influential articles published by Professor Richard Stewart in 1977, n1 and were explicitly cited by Congress as [*1211] a central justification for the passage of important federal environmental statutes. n2 More generally, the race to the bottom has been invoked as an overarching reason to vest regulation that imposes costs on mobile capital at the federal rather than the state level, and has been cited as one of the bases for the New Deal. n3
This Article challenges the accepted wisdom on the race to the bottom. It argues that, contrary to prevailing assumptions, competition among states for industry should not be expected to lead to a race that [*1212] decreases social welfare; indeed, as in other areas, such competition can be expected to produce an efficient allocation of industrial activity among the states. It shows, moreover, that federal regulation aimed at dealing with the asserted race to the bottom, far from correcting evils of interstate competition, is likely to produce results that are undesirable.
This challenge to the validity of race-to-the-bottom arguments should lead to serious questioning of the federal environmental statutes. While there are other rationales for regulation at the federal level, they rest upon different empirical foundations and justify different forms of federal intervention than does the race-to-the-bottom rationale. Most importantly, the other prominent market-failure argument for federal environmental regulation is that, in the absence of such regulation, interstate externalities will lead states to underregulate because some of the benefits will accrue to other states. But interstate externalities explain only isolated parts of the federal environmental statutes, with a good portion of the remainder being justified on race-to-the-bottom grounds. Alternatively, one might justify federal regulation on public-choice grounds by arguing that state political processes systematically undervalue the benefits of environmental protection or overvalue the corresponding costs, whereas at the federal level the calculus is more accurate. But this rationale rests upon an empirical claim about failures in the political process rather than failures in the market for industrial location. Thus, at the very least, a different predicate would have to be constructed to defend the federal statutes. n4
I defines the elements of the race-to-the-bottom rationale for
environmental regulation, distinguishes it from competing arguments
for federal intervention, and shows that important parts of the
federal environmental statutes rely on this rationale. Part II sets
the stage for the theoretical critique by addressing the
significance of the recent decisions by a number of states to enact
environmental standards more stringent than the corresponding
federal standards. Although this development might seem to provide
an empirical refutation of the applicability of race-to-the-bottom
arguments in the environmental arena, in fact the presence of more
stringent state standards does not provide such a refutation. Part
III, through an analysis of the relevant theoretical literature,
directly challenges the assumptions underlying race-to-the-bottom
arguments for federal regulation. It suggests that existing models
provide no support for such arguments, and thus that, at the very
least, the burden should be on proponents of race-to-the-bottom
claims to demonstrate the [*1213] analytical
validity of their arguments.
n5 Part IV argues that, even if there were a race to the
bottom over environmental regulation, federal intervention to stop
that race would be inadvisable because it would have the undesirable
effect of skewing other state regulatory or fiscal decisions. This
Part concludes that race-to-the-bottom arguments in favor of federal
environmental regulation represent a frontal attack on all state
fiscal and regulatory powers. Part V moves beyond the environmental
context and examines the use of race-to-the-bottom arguments in a
number of other areas of the law. It claims that the
race-to-the-bottom label has been used to describe problems that are
best kept analytically distinct; attention to these distinctions,
moreover, reveals the wider applicability of the analysis offered in
this Article. This Part concludes that while the Article's arguments
do not extend to the so-called race to the bottom over corporate
charters or banking regulation, they do extend to state efforts to
impose costs, through regulatory measures, on the physical assets of
mobile capital in other regulatory areas.
Because commentators have not paid sufficient attention to the characteristics a race to the bottom over environmental regulation would have, I start by defining the elements of the race. Second, I discuss the assumptions underlying race-to-the-bottom arguments for federal environmental regulation. Third, I distinguish such arguments from competing rationales for federal regulation. Finally, using the Clean Air Act as the primary example, I show the prominent role of race-to-the-bottom arguments in justifying federal intervention.
Definition of the Race
First, consider an "island" jurisdiction - a single jurisdiction surrounded by ocean, which is unaffected by what occurs beyond its borders. This island jurisdiction has a number of firms engaged in industrial activity that produces air pollution. The citizens of the jurisdiction suffer adverse health effects as a result of the pollution.
the absence of regulation, the firms will choose the level of pollution
that maximizes their profits and, as is the case generally
with externalities, will ignore the social costs produced by their
activities - the costs borne by the citizens who must breathe air of
poor quality. The firms will be able to produce their goods more
cheaply and will pollute more than if they were forced to bear these
economic theory holds that the socially optimal level of pollution
reduction is the level that maximizes the benefits that accrue from
such reduction to the individuals who breathe the polluted air,
minus the costs of pollution control. To achieve this optimal
reduction, a regulator must force polluters to internalize the costs
that they impose on breathers.
n6 For the purposes of this discussion, it does not matter
whether the regulator achieves this goal through command-and-control
regulation, Pigouvian taxes, marketable permit schemes, or other
Finally, for comparative purposes, assume that in this island
jurisdiction the level of pollution reduction chosen by the
regulator does not affect entry into or exit from the market. Thus,
the number of polluters in the jurisdiction will be independent of
the actions of the regulator.
consider instead a "competitive" jurisdiction. This
jurisdiction is affected by the actions taken in other
jurisdictions, and, in turn, its own actions have effects beyond its
borders. I have in mind a state within a federal system.
order to focus the discussion on the competition among states to
attract industry, assume for now that there are no
interjurisdictional pollution externalities. Assume further, for
ease of exposition, that the total number of firms across
jurisdictions remains fixed - that although firms can move from one
jurisdiction to another, there is no entry into or exit from the
national market. Within the national market then, other factors
being equal, firms will try to reduce the costs of pollution control
by moving to the jurisdiction that imposes the least stringent
Industrial migration will occur whenever the reduction in the
expected costs of complying with the environmental standards is
lower than the transaction costs involved in moving.
in the island situation, competitive jurisdictions will want to set
a pollution reduction level that takes account of the benefits to
its citizens of such reduction and of the costs to polluters in the
jurisdiction of complying with this level. n8 There will be, however, an additional factor to
consider: the location of a firm can lead to the creation of jobs,
and thus to increases in wages and taxes - important benefits for a
state. n9 As a result of this additional factor, competitive
jurisdictions will consider the potential benefits, in terms of
inflows of industrial activity, of setting standards that are less
stringent than those of other jurisdictions, and, conversely, the
potential costs, in terms of outflows of industrial activity, of
setting more stringent standards.
this background in mind, I present the structure of the
race-to-the-bottom argument. Remember, however, that I am not
positing that a competitive jurisdiction will in fact engage in a
race to the bottom. I am, instead, merely explaining the theoretical
structure of race-to-the-bottom claims.
simplest example of the race to the bottom is one in which there are
two identical jurisdictions. Assume that State 1 initially sets its
level of pollution reduction at the level that would be optimal if
it were an island. State 2 then considers whether setting its
standard at the same level is as desirable as setting it at a less
stringent level. Depending on the benefits of pollution reduction,
costs on polluters, and benefits from the migration of industry, the
less stringent standard may be preferable, and industrial migration
from State 1 to State 2 will ensue.
recover some of its loss of jobs and tax revenues, State 1 then
considers relaxing its standard, and so on. This process of
adjustment and readjustment continues until an equilibrium is
reached, in which neither state has an incentive to change its
standard further. n11
the conclusion of this race, both states will end up with equally
lax standards, and they will not experience any inflow or outflow of
industry. Each of these competitive states will thus have the same
level of industrial activity that it would have had as an island
Social welfare in these states, however, will be less than it would
be in identical island jurisdictions, because, as a result of the
race to the bottom, the states will have adopted suboptimally lax
race to the bottom is the result of non-cooperative action on the
part of the states. If they could enter into an enforceable
agreement to adopt the optimally stringent standard, they could
maximize social welfare without the need for federal regulation.
alternative to an agreement among the states is pressure by the
states for federal regulation. Federal regulation is justified under
the race-to-the-bottom theory because it can eliminate the
undesirable effects of the race.
n15 If the federal regulation sets the standard at the level
that the states would find optimal if they were islands, the states
will be precluded from competing for industry by offering less
stringent standards. They will end up with optimal, rather than
suboptimally lax, standards, and they will not suffer the resulting
loss in social welfare. In short, both states will be better off as
a result of the federal regulation. The problem can thus be
described in principal-agent terms, in which the principals, the
states, empower an agent, the federal government, to achieve their
goal of obtaining protective environmental standards.
race to the bottom is a form of the prisoner's dilemma.
n17 In the typical example of the prisoner's dilemma, two
individuals, who are factually guilty of a felony, are taken into
custody separately and interrogated by a prosecutor who seeks to get
them to confess. If neither confesses, the prosecutor can obtain
only misdemeanor convictions that would result in sentences of one
year for each individual. If only one confesses, the prosecutor is
willing to offer that individual a plea bargain that would lead to a
six-month sentence; the prosecutor can then obtain a felony
conviction and a ten-year sentence for the other. If both confess,
they will each get convicted of a felony but will receive a sentence
of five years. n18
prisoner's dilemma has several defining features. First, each in
[*1218] dividual has a
dominant strategy - a course of action that he follows regardless of
what the other individual does. In this case, the dominant strategy
for both prisoners is to confess: if the first suspect does not
confess, by confessing, the second gets a six-month rather than a
five-year sentence; if the first suspect confesses, by confessing as
well the second suspect gets a five-year rather than a ten-year
sentence. Second, if each individual uses his dominant strategy, the
final outcome is Pareto-inferior in that both would have been better
off with another outcome. Thus, in this case, use of their dominant
strategies will lead both suspects to confess and obtain five-year
sentences even though they could have received one-year sentences if
they both had not confessed. Third, even if the individuals can
communicate beforehand and agree to avoid the Pareto-inferior
outcome, unless they can somehow enter into a binding agreement,
they will ultimately defect and follow their dominant strategies.
see the applicability of the prisoner's dilemma, consider a simple
race-to-the-bottom example in which each of two competitive
jurisdictions has only two choices: it can either set the optimally
stringent standard that it would choose if it were an island, or it
can set a suboptimally lax standard. In the presence of a race to
the bottom, if one jurisdiction sets the optimally stringent
standard, the other will set the lax standard and will benefit from
industrial migration; in contrast, if one jurisdiction sets a
suboptimally lax standard, the other will do so as well to avoid the
outflow of industry. Thus, where the jurisdictions must choose
between only two environmental standards,
n20 the dominant strategy for each is to pick the
suboptimally lax standard, even though they would both be better off
picking the stringent standard.
characterization of the problem as one of non-cooperation, which is
central to the race-to-the-bottom theory, has important implications
for the understanding of federalism. It sees federal regulation not
as an intrusion on the autonomy of states, as it is often portrayed,
but rather as a mechanism by which states can improve the welfare of
their citizens. For example, under this view the presumption against
federal regulation contained in Executive Order 12,612,
n21 which mandates federalism impact statements for federal
regulation, would be misplaced: if one believes in the race to the
bottom, one should not place procedural hurdles against regulation.
it is important to stress that the existence of interstate
competition for industry is not sufficient, by itself, to produce a
race to the bottom or, consequently, to justify federal regulation.
Obviously, a race to the bottom requires not just the existence of a
"race," but also that the race be "to the
This latter element requires, first, that a competitive jurisdiction
adopt a less stringent pollution control standard than an otherwise
identical island jurisdiction would have adopted. Second, it
requires that the less stringent standards that emerge from the
competitive process be socially undesirable.
n24 Otherwise, the case for federal regulation disappears,
or, alternatively, federal regulation must be justified on a
different basis. [*1220]
B. Underlying Assumptions
expositional convenience, the preceding discussion assumed that each
jurisdiction was seeking to maximize social welfare (as
traditionally understood by economists), that the competing
jurisdictions had identical preferences for environmental quality,
and that the number of firms across jurisdictions remained fixed.
This Section demonstrates that none of these conditions is necessary
for the existence of the race to the bottom or for the rationale for
federal regulation that is based upon the existence of such a race.
an island jurisdiction that believes that the benefits to breathers
of environmental protection should not be traded off, dollar for
dollar, against the costs that polluters must bear. It might
subscribe, for example, to some variant of the ecological
perspective on environmental regulation, which is critical of the
economic approach of equating costs and benefits without regard to
the identity of the affected groups.
n26 The jurisdiction thus might believe that the benefits to
breathers are more worthy of social protection than the costs
imposed on polluters and might weight the former by a factor of,
say, two. n27 The
standards set by such a jurisdiction, like the standards of a
jurisdiction that seeks to maximize social welfare, will be forced
downward in the presence of inter-jurisdictional competition for
an island jurisdiction might want to mandate the most stringent
economically feasible standards, even if they cannot be justified on
cost-benefit grounds - a regulatory objective that underlies
federal environmental and health and safety statutes.
n29 Such standards would be set at the point at which any
increase in the stringency of the standards would lead to loss of
industry through bankruptcy. In a competitive setting, however, such
a jurisdiction would have to worry not only about the loss of
industry through bankruptcy but also about its functional equivalent
- the loss through migration - and it would set its standards
accordingly. In both of these cases then, as well as for a wide
variety of other plausible state objectives, the race-to-the-bottom
argument would take the same form that it takes in
welfare-maximizing jurisdictions. For simplicity, the bulk of the
Article will refer to welfare-maximizing jurisdictions.
if the race to the bottom exists when competitive jurisdictions have
identical preferences for environmental quality, it also will exist
when neighboring jurisdictions have different preferences. Consider,
for example, a state that favors high levels of environmental
protection. If this state is placed in a situation of
interjurisdictional competition with a state that prefers less
stringent standards, it will have to trade off its interest in
environmental protection against its interest in retaining industry;
all else being equal, this tradeoff will lead to the adoption of
less stringent standards in the competitive situation than in the
Finally, the existence of a race to the bottom does not turn on the assumption of a fixed number of firms across jurisdictions. If there is potential entry of new firms, states will compete for them, just as they compete to attract firms from other jurisdictions. In fact, new firm entry exacerbates the competitive race. Whereas existing plants must determine whether the savings of complying with less stringent pollution control standards outweigh the transaction costs of moving, new plants do not face such costs. Their location decisions will be sensitive to smaller differences in the costs of compliance with environmental regulations.
Competing Rationales for Federal Regulation
Race-to-the-bottom arguments are not the only rationales for federal regulation. The other plausible rationales do not depend on the existence of a race to the bottom, do not rest on the same empirical foundations [*1222], and justify different forms of federal intervention. Given our system of federalism, in which state and local governments have broad police powers, and in which, throughout most of our history, they have had primary responsibility for health-and-safety regulation, n30 there ought to be an affirmative justification for federal intervention. The justifications most commonly adduced in the environmental area fall into two categories: market-failure and public choice arguments.
most prominent market-failure arguments are premised on the
existence of either a race to the bottom or interstate
The presence of interstate externalities is a powerful reason for
intervention at the federal level: because some of the benefits of a
state's pollution control policies accrue to downwind states, states
have an incentive to underregulate. But this incentive would exist
even in the absence of a race to the bottom. Consider, for example,
a world in which the transaction costs of relocating are so high
that industry never contemplates moving and in which there is thus
no possibility of a race to the bottom. Even in this static world,
states would have the incentive to underregulate because part of the
benefits of regulation would accrue to other states.
n32 Conversely, consider a world in which there are no
interstate spillovers. Even if the adverse effects of pollution are
felt only in the state that generates the pollution, this state
still might choose to compete for industry by offering suboptimally
lax standards. n33
distinction between the race-to-the-bottom and interstate
externality rationales is critical for determining the appropriate
scope of federal regulation.
n34 The concern over interstate externalities can be ad
[*1223] dressed by
limiting the amount of pollution that can cross interstate borders,
thereby "showing" upwind states the costs that they impose
on downwind states. As long as the externality is eliminated, it
would not matter that the upwind state chooses to have poor
environmental quality - a central concern of race-to-the-bottom
advocates. Conversely, one could imagine a situation in which the
environmental quality in the upwind state is very high, but in which
there is nonetheless a serious externality problem because the
sources in the state have tall stacks and are located near the
interstate border, so that their effects are felt only in the
downwind state. n35
race-to-the-bottom rationale for federal regulation is also distinct
from the public choice argument that the political processes at the
state level undervalue environmental benefits. There is a general
perception that groups seeking better levels of environmental
quality are relatively more effective at the federal level, and,
therefore, that federal regulation is likely to be more protective
of the environment. n36
public choice observation has positive and normative components. As
a positive claim, it simply explains that legislation protective of
the environment is more likely to occur at the federal level. The
normative public choice argument for federal regulation, however,
needs to establish not only that environmental groups are relatively
more effective at the federal level, but also that the state
political processes in fact undervalue the benefits of environmental
protection, or overvalue the corresponding costs, whereas the
calculus at the federal level is more accurate.
public choice argument is independent of the race-to-the-bottom
[*1224] claim. Even if
industry were wholly immobile, environmental standards would still
be more protective at the federal level if, as the public choice
argument posits, environmental groups are more effective at this
level. Conversely, the race-to-the-bottom argument is fully
consistent with states properly valuing the benefits of
environmental protection. Indeed, the examples in Section A assumed
that states evaluate social welfare correctly.
choice and race-to-the-bottom arguments also rest on different
empirical foundations. The former must be grounded on a showing of
failures in the political process at the state level and of the
better functioning of the political process at the federal level.
n38 The latter must be grounded on a showing of failures in
the economic markets for industrial location.
surprisingly, these two rationales also call for different types of
federal regulation. For example, while the race-to-the-bottom
argument would not justify federal regulation of industry that is
geographically immobile - for example, small dry cleaners that serve
only a small adjoining area
n39 - the public choice argument would.
The Race to the Bottom and the Clean Air Act
use the Clean Air Act, the oldest and most comprehensive of the
modern federal statutes, to show that, among the market-failure
rationales for regulation at the federal level, the
race-to-the-bottom rationale explains far more of the statutory
scheme than does the argument concerning interstate externalities,
and that Congress explicitly justified important provisions of the
statute by reference to the race to the bottom.
Clean Air Act contains several provisions directed primarily at
interstate externalities. Sections 110(a)(2)(D)
n41 and 126 n42 seek to place limits on the amount of pollution
from upwind states that is permitted to affect air quality in
downwind states. Section 123
n43 places constraints on a state's ability to use tall
stacks as the method to meet ambient air quality standards, on the
ground that the distance that pollution travels in [*1225]
creases with the height of the stack. The acid rain
provisions of the 1990 amendments
n44 create a system of marketable permits to control the
long-distance transport of contaminants that are precursors to acid
far the bulk of the provisions of the Clean Air Act, however, are
wholly unrelated to the control of interstate externalities. The
central provisions of the Act can be classified into two categories:
ambient standards and emission standards. Ambient standards
constrain the permissible concentrations of specified pollutants in
the ambient air. Emission standards limit the quantity of pollutants
that an individual emitter can place in the ambient air. Thus,
ambient standards are not directed against any individual polluter;
they simply constrain the aggregate emissions of all polluters that
affect the ambient air at a particular location. In turn, emission
standards are the vehicle for the achievement of the ambient
standards; if every polluter meets its emission standards, the
ambient standards ought to be achieved.
Clean Air Act contains three types of federally mandated ambient
standards. The national ambient air quality standards (NAAQS) seek
to impose minimum levels of air quality throughout the country.
n45 Some areas, however, have ambient air quality levels that
are better than the NAAQS. These areas are covered by a different,
more stringent set of ambient standards determined by the
"prevention of significant deterioration" (PSD) program.
n46 In turn, there are areas that have not yet met the
ambient standards; the statute labels them "nonattainment
These areas are required to make "reasonable further
progress" toward the achievement of the NAAQS.
two major types of federally prescribed emission standards are the
new source performance standards (NSPS),
n49 which apply to categories of stationary sources, and the
standards for motor vehicles. In addition, new sources in PSD areas
must meet "best available control technology" (BACT)
and new sources in nonattainment areas must meet emission standards
determined by reference to the "lowest achievable emission
rate" (LAER). n51
Finally, existing sources in nonattainment areas must meet
"reasonably available control"
n52 technology standards.
various ambient and emission standards do not address the problem of
interstate externalities, since, as already indicated, a state could
meet the standards and have a high level of air quality but
nonetheless export a great deal of pollution to downwind states.
Instead, the federal ambient standards can be justified, at least in
part, on race-to-the-bottom grounds: one could argue that we need
such standards because competition for industry would otherwise lead
states to enact suboptimally lax state standards in an effort to
attract more firms and to offer existing firms less stringent
emission standards. n53
is important to stress, however, that while this argument justifies
federal intervention in general, it does not justify the particular
ambient standards chosen by the federal statutes. If the states have
different preferences for environmental protection, the standards
that maximize social welfare will be different. Therefore, a uniform
federal standard, such as the NAAQS would not be optimal. n54 Depending on the nature of the differences, it is
also conceivable that even if a race to the bottom exists, uniform
federal standards actually might reduce social welfare.
the comprehensiveness of the ambient standards, the plausibility of
a race-to-the-bottom justification for federally-mandated emission
standards is less clear. Because the ambient standards constrain the
total amount of pollution that a state can accept, a state that
chooses to offer less stringent emission standards will simply be
able to attract fewer sources. The determination of the contours of
this tradeoff could be left to the states without triggering a race
to the bottom. In situations in which the ambient standard is not
binding, however, as is often the case under the PSD program, states
could offer lax standards without facing any tradeoff; in these
cases, federal emission standards can be seen as preventing a race
to the bottom.
evidence that the race-to-the-bottom rationale underlies much of the
Clean Air Act comes from the statute's legislative history. For
example, at the time that it considered the 1977 amendments to the
Clean Air Act, Congress perceived the prospect of the interstate
migration of industry in search of more permissive environmental
standards as a serious threat:
Without national guidelines for
the prevention of significant deterioration a State deciding to
protect its clean air resources will face a double threat. The
prospect is very real that such a State would lose existing
plants to more permissive States. But additionally the State will
likely become the target of "economic-environmental
blackmail" from new industrial plants that will play one State
off against another with threats to locate in whichever State adopts
the most permissive pollution controls. n55
Similarly, the legislative history of the NSPS standards state: "The promulgation of Federal emission standards for new sources ... will preclude efforts on the part of States to compete with each other in trying to attract new plants and facilities without assuring adequate control of extra-hazardous or large-scale emissions therefrom." n56
summary, race-to-the-bottom arguments explain far more of the Clean
Air Act than do interstate externality arguments. It is noteworthy,
given the conclusions of this Article, that the provisions aimed at
controlling interstate externalities have proven remarkably
Thus, a refutation of race-to-the-bottom arguments ought to lead to
serious questioning of the overarching role that the Act assigns to
the federal government.
The Implications of State Regulation
preceding Part set forth the conceptual structure of
race-to-the-bottom arguments for federal regulation of the
environment and suggested that such arguments have had an impact on
the design of federal standards. Much of the rest of the Article
will be devoted to a critique of the cogency and applicability of
such arguments. This Part, however, addresses the significance of a
recent empirical development: the adoption by many states of
environmental standards more stringent than the corresponding
federal standards. On its face, this development would seem to offer
strong evidence that there is no race to the bottom in the
environmental arena, thus providing empirical support for the
general line of critique presented in this Article. This Part
argues, however, that this recent development does not, in itself,
rule out the possibility that there is a race to the bottom: one has
to point to more than the current pattern of state regulation to
undercut race-to-the-bottom claims.
The Proliferation of More Stringent State Regulation
existence of state standards more stringent than the corresponding
federal standards recently received a great deal of attention in
connection with two actions of the Northeastern states. In April
1992, eight Northeastern states announced an agreement to reduce
substantially the emission of nitrogen oxides by electric utilities.
n58 The control of such emissions is covered by the 1990
amendments to the Clean Air Act, but the Environmental Protection
Agency (EPA) had not yet implemented the provisions, and had
indicated that the controls, when imposed, would be weak.
n59 One utility estimated that its cost of compliance with
the independent agreement would range from $ 10 million to $ 50
presumably this increased cost will be passed on to its industrial
customers, who therefore will be placed at a competitive
disadvantage vis-a-vis competitors in states not subject to the
few months earlier, in October 1991, nine Northeastern states had
announced that they would adopt California's pollution control
requirements for automobiles, which are more stringent than the
federal standards. n61
The states that have indicated support for more stringent standards
account for a large percentage of the market for new cars.
n62 Connecticut had initially been a member of this coalition
but later withdrew; n63
its Commissioner of Environmental Protection estimated that the
state's economy would lose 1300 to 8000 jobs if the state adopted
the more stringent California standards.
a wide variety of other environmental areas, states have promulgated
standards more stringent than the federal standards. n65
In doing so, [*1229]
they have raised the cost of in-state industrial activity.
An Example Involving Identical Jurisdictions
proceed to show, by reference to a simple example involving two
identical jurisdictions, that this proliferation of more stringent
state standards is not necessarily inconsistent with the race to the
bottom. Each of these identical jurisdictions has an equal number of
sources that emit air pollution. These sources would each emit ten
units of pollution if they were not subject to any pollution
controls. Now assume that the jurisdictions institute controls, and
let x and y be the required levels of pollution reduction for each
source in States 1 and 2, respectively. The aggregate benefits of
controlling pollution in each state are 10x and 10y, respectively.
Because the marginal costs of pollution control are likely to
increase exponentially after a certain point, assume further that
the corresponding aggregate costs are x'2' and y'2' . Thus, if these
two states were island jurisdictions, they would maximize social
welfare by requiring each source to reduce its emissions by five
units. Simple differentiation establishes that the expression
10xx'2' is maximized at 102x = 0. Each jurisdiction would thereby
obtain $ 25 of net benefits.
however, there is interjurisdictional competition and a race to the
bottom, the equation would change to account for the net benefits
(or costs) of migration into (or out of) each state. With a minor
explained in the margin,
n66 assume that if State 1 has a standard more stringent than
State 2, it suffers a loss, and State 2 receives a benefit, of
2(xy)'2'. If State 1 has a standard less stringent than State 2, it
receives a benefit, and State 2 suffers a loss, of 2(xy)'2'.
form of this function reflects the intuition that for small
differences between the standards, there is little mobility because
the lower cost of pollution control is outweighed by the transaction
costs of moving. Thus, if the emission reduction standards in the
two states differ by one unit, the state with the less stringent
standard will gain only $ 2 in benefits, but if the standards differ
by three units, it will gain $ 18 in benefits.
payoffs to each of the states for the various combinations of
emission reductions are set forth in Table I. In each box, the first
number represents the payoff to State 1, and the second represents
the payoff to State 2. For example, if State 1 requires three units
of pollution reduction, and State 2 requires five units, State 1's
payoff is $ 29 - the $ 21 that it would have obtained with a
standard of three units in the absence of competition, plus the
additional $ 8 in benefits that it receives from industrial
migration for having a standard that is two units less stringent
than State 2's standard. State 2's payoff is $ 17 - the $ 25 that it
would have obtained with a standard of five in the absence of
competition, minus the $ 8 that it loses through industrial
Table I shows the payoffs for pollution reductions of only five
units or less; if in the absence of interjurisdictional competition
a state would not have adopted a standard more stringent than five
units, it follows a fortiori that it will not do so in a competitive
Payoffs of Emission Reductions
State 1 initially chooses a standard of five units of pollution
reduction, State 2 will pick a standard of zero, through which it
attains the highest payoff: $ 50. State 1 now finds itself with a
payoff of $ 25. Given that State 2 has now adopted a standard of
zero, State 1 maximizes its payoff by picking a standard of two.
n68 State 2 then responds with a standard of two. The choice
by each state of two units of pollution reduction is an equilibrium
solution because, when both states regulate at this level, neither
has an incentive to move to another level. An examination of Table I
also reveals that there is no other equilibrium solution.
The result is that each state receives net benefits of $ 16, rather than the $ 25 that they each would have received as island jurisdictions, or if they had been able to enter into a binding agreement to enact standards of five. Thus, as a result of non-cooperative action, both states are made worse off - the race is, therefore, a race to the bottom. n69
now, the effect of a federal regulatory scheme that sets a minimum
level of pollution control but allows states to impose more
stringent state standards. This approach is followed by most federal
environmental statutes, which have explicit provisions indicating
that more stringent state standards are not preempted.
n70 A federal regulatory standard requiring two or fewer
units of pollution reduction would have no impact on the states'
level of pollution control. Both would continue to require two units
of pollution reduction.
situation is different if the federal standard is set at three units
of pollution reduction. If State 1 initially decides not to enact a
stringent standard, State 2 would improve its situation by
setting a pollution reduction standard of four: its net benefits of
$ 22 are higher than for any of the other possible standards. Absent
the federal standard, State 1 would then maximize its net benefits
by setting a standard of zero, and both states would eventually
reach an equilibrium in which they mandate pollution reductions of
State 1 is precluded by the federal regulation from adopting a
standard less stringent than three. Given this constraint, and given
State 2's choice of a standard of four, State 1 maximizes its net
benefits by choosing a standard of four as well. State 2's optimal
response to the choice by State 1 of a standard of four is to retain
its standard of four. There is an equilibrium solution in which both
states require reductions of four. Table I reveals that this
equilibrium is unique. n71
there are situations in which states that would have raced to the
bottom in the absence of federal regulation, when subject to such
regulation, set state standards that are more stringent than the
federal standards. This example involves states that have equal
preferences for environmental protection. The adoption by one
jurisdiction of standards more stringent than the federal standards
therefore does not stem from its higher valuation of environmental
effect of federal regulation is to constrain the gain in welfare
resulting from industrial migration that a state can obtain by
setting a less stringent standard. In some situations, without the
constraint imposed by federal regulation, this gain would be greater
than the loss in welfare produced by a lax standard. With the
constraint, however, the opposite is sometimes true: the state
sometimes gains more in welfare by having a stricter standard than
it loses through industrial migration.
argument is a limited one. It does not imply, even in the simple
case of two identical jurisdictions, that whenever a federal
standard is set, states will move to set more stringent state
standards. First, if the federal standard is at the level that would
be optimal for the states if they were island jurisdictions, or at a
more stringent level, then the states will not respond with a more
stringent standard. Second, if the federal standard is set at the
level that the states would choose absent regulation, or at a less
stringent level, it will not have any impact on the environmental
quality in the states.
there will be some instances in which states will not move to enact
more stringent standards as a result of federal regulation, even if
federal standard is between the optimal level for the states as
islands and the equilibrium that they would reach under competition
in the absence of federal regulation. In the example represented in
Table I, for instance, although the states will react to a federal
standard set at three units by setting their own standards at four,
they will not respond to a federal standard set at four units by
setting their own at five: in the latter situation they will remain
at four units. It is only for particular tradeoffs between the
various goals, as illustrated by the effects of different federal
standards in Table I, that more stringent state standards will
case of jurisdictions with different preferences concerning
environmental quality is conceptually similar. In the absence of
federal regulation, the jurisdictions will reach an equilibrium in
which the jurisdiction with the higher preference generally will
enact a more stringent standard. If the federal regulation is more
stringent for each state than their optimal levels as island
jurisdictions, the states will not react by enacting more stringent
standards. In contrast, the federal regulation will have no effect
if it is less stringent, for both states, than the equilibrium that
they would reach in the absence of such regulation. But when the
federal regulation is, for at least one of the states, between the
island level and the competitive level, it might induce state
standards more stringent than the federal standards.
III. The Uncertain Theoretical Foundation of Race-to-the-Bottom Arguments
preceding discussion establishes the need for a theoretical inquiry
into the plausibility of race-to-the-bottom claims. Until now, the
legal literature has done little more than assert in a conclusory
fashion that interstate competition to attract industry will reduce
a jurisdiction's social welfare. It has not shown why, when an
island jurisdiction is placed in a competitive situation, it becomes
a participant in a race to the bottom. This Part demonstrates that
there is no support in the theoretical literature on
interjurisdictional competition for the claim that, without federal
intervention, there will be a race to the bottom over environmental
A. An Initial Hurdle
advocates must clear an initial hurdle: for the competition among
states to attract industry to be a race to the bottom, interstate
competition must be socially undesirable. But interstate competition
can be seen as competition among producers of a good - the right to
locate within the jurisdiction. These producers compete to at
[*1234] tract potential
consumers of that good - firms interested in locating in the
jurisdiction. Even though states might not have the legal authority
to prevent firms from locating within their borders, such firms must
comply with the fiscal and regulatory regime of the state; the
resulting costs to the firms can be analogized to the sale price of
a traditional good.
one believes that competition among sellers of widgets is socially
desirable, why is competition among sellers of location rights
socially undesirable? If federal regulation mandating a
supra-competitive price for widgets is socially undesirable, why is
federal regulation mandating a supra-competitive price for location
rights socially desirable?
is easy to identify possible distinctions between a state as seller
of location rights and a firm as seller of widgets. These
differences, however, provide scant support for race-to-the-bottom
claims. n74 In
what follows, I briefly discuss each of the key differences between
the state, as seller of location rights, and the market competitor,
showing that none of the differences suggests that interstate
competition in the environmental area will decrease welfare.
if individuals are mobile across jurisdictions, the costs that
polluters impose on a state's residents will depend on who ends up
being a resident of the state; the resulting supply curve is thus
far more complex than that of a widget seller.
n75 The mobility of individuals, however, is not an element
of race-to-the-bottom claims and should not be relevant to the
plausibility of the claim that competition among states will
decrease welfare. n76
to the extent that the shareholders of a polluting firm reside in
the jurisdiction, the state as seller of location rights would at
least attempt to take their welfare interests into account in
computing the price to charge. In contrast, the seller of widgets
would be indifferent to the effect of the sale price on the welfare
of the good's purchaser. If a [*1235]
firm's shareholders do not reside in the regulating
jurisdiction, and if firms are immobile, a state could extract
monopoly profits by setting suboptimally stringent standards; if
firms are mobile, competition would eliminate this problem. n77 The converse - that if shareholders reside in the
jurisdiction, the environmental standards will be suboptimally lax -
does not follow.
states are not subject to the discipline of the market. If a
producer of widgets sells at a price that does not cover its average
costs, it will have to declare bankruptcy. A state, in contrast,
will continue in existence even if it recklessly compromises the
health of its residents. The difference merely establishes that a
state might undervalue environmental benefits.
n78 But such undervaluation is possible even for an island
jurisdiction and is not a consequence of the competition among
states to attract firms.
states do not sell "location rights" at a single-component
price; they require that firms comply with a variety of regulatory
standards and pay taxes. The resulting market is thus more complex
than one involving the sale of a traditional good. For example, a
jurisdiction that imposes a lax worker-safety standard but a
stringent pollution standard will be desirable for a
labor-intensive, non-polluting firm, whereas a jurisdiction with
stringent worker-safety and lax pollution standards will be
desirable for a capital intensive, polluting firm. It is far from
clear, however, why this additional complexity in the market would
make interstate competition destructive.
sum, while the analogy between interstate competition for industrial
activity and markets for traditional goods is not perfect, it raises
serious questions about race-to-the-bottom claims. At the very
least, it should place on race-to-the-bottom advocates the burden of
identifying the relevant differences between the two markets and
explaining why they turn otherwise desirable competition into a race
to the bottom. n81
B. The Theoretical Literature
than undertake the daunting task of describing the numerous economic
models that shed some light on the race-to-the-bottom question, I
center my account of the development and current state of the
literature on a discussion of three principal works. Some extensions
are discussed in the margin.
his influential article published in 1956, Charles Tiebout argues
that a decentralized governmental structure, with multiple
jurisdictions competing for residents, produces a Pareto-optimal
Tiebout makes seven important assumptions.
n83 First, individuals are fully mobile and choose the
jurisdiction in which they wish to live based on the taxes that the
jurisdiction imposes on its residents and the bundle of services,
such as parks, police protection, roads, and schools, that it
provides. Second, individuals have full knowledge of the tax and
services packages offered by the communities. Third, there exist a
large number of communities in which individuals can choose to live.
Fourth, in making their decisions, individuals do not consider the
employment opportunities offered by the communities; everyone is
assumed to live on dividend income. Fifth, the public services
provided by the communities do not impose positive or negative
externalities on other communities. Sixth, every community has an
optimal size, defined as the number of residents for which the
bundle of services can be produced at the lowest average cost.
Seventh, communities below the optimal size seek to attract new
residents in order to lower the average cost of providing services.
argues that individuals will sort themselves into the jurisdictions
offering the mix of taxes and public services that they prefer and
that these jurisdictions will be of the optimal size.
n84 He concludes that it is therefore preferable to provide
public services at the local level, rather than at the federal level
and, more pertinently, that inter-jurisdictional competition is
of Tiebout's assumptions are problematic for my purposes. His fourth
assumption - that individuals do not consider the employment
opportunities of their prospective communities and that no
productive activities take place in those communities - assumes away
the issue that is central to the race-to-the-bottom argument: the
effects on the environment of efforts by jurisdictions to attract
firms in order to provide jobs
[*1237] for their residents. Second, much of the legal literature has
dismissed as unrealistic the assumption of perfect mobility by
There may, indeed, be substantial transaction costs in exiting one
jurisdiction and moving to another, particularly in a world in which
individuals have jobs and do not live solely on dividend income.
his article published in 1975, William Fischel extends the Tiebout
analysis to deal with the problem of industrial location.
n87 In his model, firms are owned by outsiders to the
jurisdiction, do not employ any of the jurisdiction's residents, and
all of their production is for export from the jurisdiction.
n88 The environmental externalities produced by these firms
are uniformly distributed over all the residents, and there are no
n89 Each firm has the same impact on environmental quality,
and this impact is additive across firms, so that two firms have
twice the impact of one firm.
contemplates that jurisdictions are able to exclude firms through
zoning decisions. n91 They will refuse to permit a firm to locate unless
it makes a direct cash payment to the zoning board, to be divided
equally among the residents. The minimum amount that a jurisdiction
would demand for the deterioration of its environmental quality is
equal to the environmental harm caused by the firm. Any amount over
this minimum constitutes a "profit," which competition
among jurisdictions will drive to zero.
that value environmental quality highly will allow fewer firms to
locate and therefore obtain a smaller payment. If an individual
values environmental quality less highly than his neighbors, he will
move to a jurisdiction in which more firms are accepted, and the
corresponding payments are higher. The result is that, in each
jurisdic [*1238] tion,
individuals will have the same preference for environmental quality.
n93 Fischel argues that, under these restrictive assumptions,
the problem of environmental externalities is solved in a
Pareto-efficient manner: firms compensate residents fully for the
environmental harms that they cause.
Fischel model suggests that competition among jurisdictions leads to
economically desirable results, rather than to a race to the bottom.
Two of his assumptions, however, are troubling. First, under his
model, firms do not hire residents of the jurisdiction in which they
locate. n95 Thus,
like Tiebout, he assumes away one of the cornerstones of
race-to-the-bottom arguments: that jurisdictions will relax their
environmental standards to suboptimal levels in order to provide
jobs for their residents. Second, also like Tiebout, Fischel assumes
that individuals are perfectly mobile. n96
two shortcomings are addressed by Wallace Oates and Robert Schwab in
an article published in 1988.
n97 In their model, jurisdictions compete for a
mobile stock of capital by lowering taxes and relaxing environmental
standards that would otherwise deflect capital elsewhere. In return
for an increased capital stock, residents receive higher incomes in
the form of higher wages. The community must, however, weigh the
benefits of higher wages against the cost of foregone tax revenues
and lower environmental quality.
Oates and Schwab envision jurisdictions that are large enough to allow individuals to live and work in the same jurisdiction. n99 Moreover, they assume that there are no interjurisdictional externalities: pollution generated in one jurisdiction does not spill over into another.
jurisdiction produces the same single good, which is sold in a
national market. The production of the good requires capital and
labor and produces waste emissions. The instrument of environmental
policy is command-and-control regulation: each jurisdiction sets the
total amount of allowable emissions.
n100 In addition, each jurisdiction raises revenues by
levying a tax on each unit of capital. Capital is perfectly mobile
across jurisdictions and seeks to maximize its after-tax earnings.
capital, however, labor is perfectly immobile.
n101 Each individual in the community, who is identical in
both tastes and productive capacity, puts in a fixed period of work
each week, and everyone is employed. Additional capital raises the
productivity of workers and, therefore, their wages.
and Schwab describe the role of an individual resident of a
jurisdiction as follows:
First, he is a consumer, seeking
in the usual way to maximize utility over a bundle of goods and
services that includes a local public good, environmental quality.
And, second, he supplies labor for productive purposes in return for
his income. From the latter perspective, residents have a clear
incentive to encourage the entry of more capital as a means to
increase their wages. But this jurisdiction must compete against
other jurisdictions. To attract capital, the community must reduce
taxes on capital (which lowers income and, therefore, indirectly
lowers utility) and/or relax environmental standards (which lowers
utility directly). These are the tradeoffs inherent in
jurisdiction makes two policy decisions: it sets a tax rate on
capital and an environmental standard. Oates and Schwab show that
competitive jurisdictions will set a tax rate on capital of zero.
n103 For positive tax rates, the revenues are less than the
loss in wages that results from the move of capital to other
jurisdictions; subsidies would cost the jurisdiction more than the
increase in wages that additional capital would generate.
turn, competitive jurisdictions will set an environmental standard
that is defined by equating the willingness to pay for an additional
unit of environmental quality with the corresponding change in
Pollution beyond this level generates an increment to wage income
that is less [*1240]
than the value of the damage to residents from the increased
pollution; in contrast, less pollution creates a loss in wage income
greater than the corresponding decrease in pollution damages.
and Schwab show that these choices of tax rates and environmental
standards are socially optimal.
n106 First, consider tax rates. One condition for optimality
is that the marginal product of capital - the increase in the output
of the good produced by an additional unit of capital - must be the
same across jurisdictions. Otherwise, it would be possible to
increase aggregate output, and, consequently, aggregate social
welfare, by moving capital from a jurisdiction where the marginal
product of capital is low to one where it is high. Because capital
is fully mobile, the market will establish a single rate of return
on capital. This rate is equal to the marginal product of capital
minus the tax on capital. The choice by a competitive jurisdiction
of a tax of zero equalizes the marginal product of capital across
jurisdictions and is therefore consistent with optimality.
respect to the environmental standard, competitive jurisdictions
equate the marginal private cost of improving environmental quality
(measured in terms of forgone consumption) with the marginal private
benefit. For tax rates of zero, the marginal private cost is, as
noted above, the decrease in wage income produced by the marginal
unit of environmental protection. This decrease is also the marginal
social cost, since it represents society's forgone consumption.
n108 Oates and Schwab conclude that "competition among
jurisdictions is thus [*1241]
conducive to efficient outcomes."
n109 Thus, there is no race to the bottom.
situation is different, however, if jurisdictions choose to tax
capital. They might do so, for example, because they cannot finance
the provision of public goods through a non-distortionary tax, such
as a head tax. If jurisdictions do tax capital, environmental
standards will be suboptimally lax because the jurisdiction will
continue to relax the standards beyond the optimal level in order to
attract the additional tax revenue that results from attracting
additional capital. n111
their model, Oates and Schwab assume that capital does not require
the provision of public services, such as roads, and police and fire
If it does, the optimal tax rate on capital, rather than zero, is
the rate that exactly covers the cost of these services. It follows
from the preceding discussion that, for this rate of taxation,
jurisdictions would set environmental standards at the optimal
level. If, in contrast, the tax on capital is set at a rate higher
than that needed to meet the public service demands of capital,
environmental standards will be suboptimally lax.
corollary, not explored by Oates and Schwab, is that environmental
standards will be suboptimally stringent if, for whatever reason, a
jurisdiction picks a tax rate on capital that is less than the cost
of the public services that capital requires. The reason for this
result is that the jurisdiction will continue to strengthen the
standards beyond the optimal level in order to induce capital to
move elsewhere and thereby not continue to impose net costs on the
jurisdiction in the form of subsidized public services.
Lessons from the Theoretical Literature
conclusions that emerge from this review of the theoretical
literature point strongly against race-to-the-bottom claims. Tiebout,
Fischel, and Oates and Schwab all conclude, in situations
progressively more analogous to the problem of this Article, that
interstate competition is not inconsistent with the maximization of
social welfare. There are no formal models supporting the
proposition that competition among states creates a prisoner's
dilemma in which states, contrary to their interests, compete for
industry by offering progressively laxer standards. n113
central insight of the Oates and Schwab study is that jurisdictions
that seek to maximize their social welfare will not set suboptimally
lax environmental standards. It follows from their analysis that no
improvements would result from the imposition of federal standards.
In [*1243] fact, if the federal standards were different from the ones
that each jurisdiction would have chosen by itself, there will be a
social loss resulting from the federal intervention.
conclusion that environmental standards will be suboptimally lax if
states set taxes on capital, however, requires further discussion.
While this result appears to be consistent with race-to-the-bottom
arguments, in fact it is not. Recall from the discussion in Part I
and the example in Part II that the race-to-the-bottom argument was
premised on the assumption that states seek to maximize social
welfare but find themselves in a prisoner's dilemma.
the Oates and Schwab model, if states seek to maximize social
welfare, they should set the net tax rate on capital at zero. Then,
despite interstate competition, social welfare will be maximized.
Thus, if those same states set a positive net tax rate on capital,
inducing interstate competition that leads to suboptimal results,
the outcome is due to an "error" on the part of state
regulators rather than to a structural failure of state autonomy in
a federal system. It is true that once states choose to set a
positive net tax on capital, interstate competition will lead them
to set suboptimally lax environmental standards as a means of
attracting industry. But, here, unlike in traditional
race-to-the-bottom scenarios, a but-for cause for the loss in
welfare is the state's failure to act in an economically rational
state that sets a positive net tax on capital is undervaluing the
benefits of environmental regulation. The reason might be that the
beneficiaries of environmental regulation have difficulty
understanding the amount of the benefit conferred upon them, whereas
tax revenues are more tangible. Alternatively, the potential
benefits of environmental regulation might be concentrated among
those who are not successful at protecting their interests through
the political process. These latter two arguments, however, are
versions of the public choice claim that advocates of environmental
quality are more successful with federal than with state
institutions, and the arguments thus have no bearing on the
if one were prepared to classify the problem of positive net tax
rates under the rubric of the race to bottom, one would still need
whether states in fact impose suboptimally high tax rates on
capital. There is an extensive literature on whether local property
taxes are nondistortionary benefit taxes or user fees on public
services received by the property owners or, whether, instead, they
are distortionary taxes on capital that are borne primarily by the
owners of capital. n115
But neither the theoretical nor the empirical work points clearly in
one direction. n116
should not overstate the nature of my claim against
race-to-the-bottom justifications for environmental regulation. The
fact that there are no models consistent with race-to-the-bottom
claims does not rule out the possibility that further research will
yield such models. n117
Modeling, by necessity, involves making strong sets of assumptions.
The Oates and Schwab work, which has studied the problem in the most
systematic way, is no exception. A theoretical literature evolves as
assumptions are relaxed, often one at a time. It is certainly
conceivable that the next generation of theoretical work will
provide support for race-to-the-bottom arguments. But the fact
remains that race-to-the-bottom arguments in the environmental area
have been made for the last two decades with essentially no
The Implications of the Environmental Race to the Bottom
shown in Part III that the race-to-the-bottom hypothesis, though
influential, lacks a sound theoretical basis, this Part shows that
[*1245] even if
there were such a race in the environmental arena, federal
regulation would not necessarily be an appropriate response. The
analysis centers on two important consequences of race-to-the-bottom
arguments in favor of federal environmental regulation. First, if
the premises underlying the race to the bottom hold, federal
environmental regulation will have undesirable effects on other
state regulatory or fiscal interests; the supposed benefits of
federal environmental regulation should therefore be balanced
against these undesirable effects. Second, logic compels the
conclusion that arguments in favor of federal environmental
regulation are a frontal challenge to federalism, because the
problems that they seek to correct can be addressed only by
exclusive federal regulatory and fiscal powers. Both these
consequences, which have been unexplored in the literature, ought to
cast even more doubt on the validity of race-to-the-bottom arguments
for federal environmental regulation.
arguments appear to assume, at least implicitly, that jurisdictions
compete over only one variable - in this case, environmental
quality. So, jurisdictions that would choose to have stringent
environmental quality standards in the absence of interstate
competition adopt less stringent standards as a result of such
competition, and, consequently, suffer a reduction in social
instead, the problem in a context in which states compete over two
variables - for example, environmental protection and worker safety.
Assume that, in the absence of federal regulation, State 1 chooses a
low level of environmental protection and a high level of worker
safety. State 2 does the opposite: it chooses a high level of
environmental protection and a low level of worker safety
protection. Both states are in a competitive equilibrium: industry
is not migrating from one to the other.
that federal regulation then imposes on both states a high level of
environmental protection. The federal scheme does not add to the
costs imposed upon industry in State 2, but it does in State 1.
Thus, the federal regulation will upset the competitive equilibrium,
and unless State 1 responds, industry will migrate from State 1 to
State 2. The logical response of State 1 is to adopt less stringent
worker-safety standards. This response will mitigate the magnitude
of the industrial migration that would otherwise occur.
federal environmental standards can have adverse effects on other
state programs. Such secondary effects must be considered in
evaluating the desirability of federal environmental regulation.
Most importantly, the presence of such effects suggests that federal
regulation will not be able to eliminate the negative effects of
interstate competition. Recall that the central tenet of
race-to-the-bottom claims is that competition will lead to the
reduction of social welfare; the assertion that states enact
suboptimally lax environmental standards is simply a consequence of
this more basic problem. In the face of federal environmental
regulation, however, states will continue to compete for industry by
adjusting the incentive structure of other state programs. Federal
regulation thus will not solve the prisoner's dilemma.
an example in which State 1 and State 2, as island states, would
impose high levels of both environmental protection and worker
safety. When placed in a competitive situation, they respond in the
different ways set forth above: State 1 chooses a low level of
environmental protection and a high level of worker safety, whereas
State 2 does the opposite. After the adoption of federal regulation,
they both end up with high levels of environmental protection but
low levels of worker safety; their social welfare has therefore been
reduced by competition despite federal environmental regulation.
might respond to these arguments by saying that worker safety should
also be the subject of federal regulation. But states would then
compete over minimum wage laws, fair labor standards, and so on. It
is difficult to imagine a federal system in which all the regulatory
requirements that impose costs on industry are mandated at the
however, that this were the case. States impose burdens on industry
not only through regulation but also through taxes, which fund a
variety of state programs and functions. So, if all regulatory
programs are federalized, states still will be able to compete
through their fiscal powers. Consider, now, an example in which
State 1 and State 2, as island states, would impose both stringent
regulatory standards and high corporate taxes. When placed in a
competitive situation, State 1 chooses stringent regulatory
standards and low corporate taxes, whereas State 2 does the
opposite. If the federal government then requires stringent
regulatory standards, State 2 will respond by lowering its taxes,
and by, say, decreasing the size of its income maintenance programs.
n119 This reduction is a direct by-product of the federal
Thus, even if all regulatory functions are federalized, federal regulation [*1247] will continue to have an adverse effect on other issues of state concern - in this example, social welfare programs. Moreover, such a scheme will not eliminate the reduction in social welfare that results from competition among the states.
The next logical step, of course, is to suggest preemption of state taxes, because otherwise the supposedly evil effects of interstate competition will persist. The race-to-the-bottom rationale for federal environmental regulation is, therefore, radically underinclusive. It seeks to solve a problem that can be addressed only by wholly eliminating state autonomy. The prisoner's dilemma will not be solved through federal environmental regulation alone, as the race-to-the-bottom argument posits. States will simply respond by competing over another variable. Thus, the only logical answer is to eliminate the possibility of any competition altogether. n120 In essence, then, the race-to-the-bottom argument is an argument against federalism. n121
V. A Taxonomy of Races to the Bottom
challenge to race-to-the-bottom arguments in the environmental
context does not extend to races to the bottom in all areas of law,
although it does apply, more generally, whenever states impose costs
on the physical assets of mobile firms to promote the welfare of
their citizens. Unfortunately, the legal literature has included
under the race-to-the-bottom rubric a variety of problems that are
analytically distinct, even though they all involve competition
among states to attract economic activity. By discussing the nature
of alleged races to the bottom over corporate charters and bank
charters, this Part explains the differences among various races,
proposes a taxonomy, and advocates abandoning the race-to-the-bottom
label altogether. In light of these differences, this Article should
not be seen as a general indictment of federal regulation designed
to cure problems traditionally defined in race-to-the-bottom terms.
A. Principal-Agent Problems: The Case of Corporate Charters
most comprehensive legal literature on the race to the bottom is
directed at the problem of state chartering of corporations. There
is a [*1248]
longstanding debate about whether state competition for
corporate charters is socially desirable. The beginning of this
debate can be traced to the work of William Cary, who argued that
state competition for charters creates an undesirable race in which
states offer legal regimes that are attractive to corporate managers
who are responsible for reincorporation decisions, permitting them
to enrich themselves at the expense of shareholders.
n122 To remedy this race to the bottom, Cary advocated
federal standards. n123
Ralph Winter responded that market forces discipline the decisions of managers by penalizing them if they seek to hurt shareholder interests: incorporation decisions that decrease corporate value make the firm a more desirable target for takeovers, as well as a more likely candidate for bankruptcy, and therefore imperil managers' jobs, lower managers' compensation, and hurt managers' job prospects. n124 On Winter's assumptions, states will offer the charter provisions that are most beneficial to shareholders. The race is thus a race to the top (to socially desirable outcomes), rather than to the bottom. According to Winter, federal intervention is undesirable because federal regulators are unlikely to do as well as market forces in designing the optimal chartering arrangements. n125
recently, Lucian Bebchuk has argued that there are some areas in
which market discipline is likely to align the interests of managers
and shareholders sufficiently such that state chartering is
desirable and federal involvement unnecessary, but that there are
other areas in which the opposite is likely to hold. n126
race for corporate charters is conceptually different from the race
in the environmental area. Most importantly, in the corporate area,
problem alleged by race-to-the-bottom advocates is the
principal-agent problem that arises between managers and
shareholders when managers make decisions about where to
incorporate. Except for this principal-agent problem, however, the
corporate literature does not point to any problems caused by the
competition among states for corporate charters.
n127 In contrast, race-to-the-bottom arguments in the
environmental area do not refer to any principal-agent problems
between managers and shareholders in deciding where to locate a
plant, even though commentators have suggested that such problems
Instead, they focus on a posited prisoner's dilemma among the
two literatures can be classified by reference to the two-by-two
matrix in Table II. It shows that the defects to be corrected by
regulation can arise either in the locational decisionmaking
process of private actors or in the competitive process among
states. Race-to-the-bottom advocates in the corporate literature fit
in Box 2: they believe that locational decisions are defective but
that the competitive process among the states is not.
n130 Race-to-the-bottom advocates in the environmental
literature fit in Box 3: they believe that the competitive process
is defective but that locational decisions are not. Thus, the two
literatures do not deal with analogous issues.
Interstate Externalities: The Case of Bank Charters
Butler and Jonathan Macey argue that state chartering of banks gives
rise to a "destructive "race to the bottom.' "
n131 They maintain that the major cause for this race is that
the Federal Deposit Insurance Corporation (FDIC) charges banks a
deposit insurance premium that is independent of the banks' risk of
two distinct reasons, states then have an incentive to set
suboptimally lax regulatory regimes. n133 First, if a state's sole interest is in attracting
banks and thereby obtaining chartering fees and legal business, it
will offer the regulatory regime most attractive to bank
shareholders, who will naturally prefer to make risk choices that
are unconstrained by any such regime.
n134 Second, if a state's sole interest is in promoting the
interests of in-state depositors, it also will provide a lax
regulatory re [*1251] gime.
If banks can engage in riskier activities, they may pay depositors
higher interest rates. If the risky projects fail, the depositors
are protected by FDIC insurance. Thus, depositors capture the
benefits of higher risk but do not bear any of the costs. In any
event, given the possibility of making deposits across state lines,
depositors will bank in the state that offers the laxest provisions,
independent of their state of residence. n135
undesirable effects in both instances are caused by the presence of
an interstate externality. n136 Bank shareholders and depositors capture the
benefits of increased risk, but the corresponding cost is borne by
the FDIC and, indirectly, by the nation's taxpayers. While some of
these taxpayers will be residents of the state that adopted the
suboptimally lax regulatory structure, most will not.
Butler and Macey argue that this problem would be cured if the FDIC imposed appropriately risk-adjusted rates. n137 Then, bank shareholders would maximize their returns by choosing the optimal level of risk: additional risk would not be worth the additional insurance premium. n138
the environmental context, I noted that race-to-the-bottom
justifications [*1252] for
federal regulation are distinct from externality-based
I thus use the term "race to the bottom" in the
environmental area to refer exclusively to the destructiveness of
interstate competition for industry that is alleged to occur even in
the absence of interstate pollution externalities. The banking
literature, in contrast, refers to only one problem, rather than
two, and assumes that the problem would be corrected by eliminating
distinction between the two literatures is illustrated in Table III.
It shows that the defects to be corrected by federal regulation can
arise either from interstate externalities or from the competitive
process among states. Banking race-to-the-bottom advocates fit in
Box B: they believe that there are interstate externalities but that
the competitive process among the states is not otherwise flawed.
The environmental race to the bottom, as distinguished from the
problem of interstate pollution externalities, fits in Box C. These
literatures therefore also do not deal with analogous issues, even
though they both make use of the race-to-the-bottom label.
Table III shows, defects in the competitive process might exist not
only with respect to a state's attempts to attract polluting firms
but also with respect to its attempts to attract banks. Note also
that while the banking literature addresses a problem different from
that addressed in the corporate literature, the former could learn
from the latter: just as there is a principal-agent problem when
corporations decide where to incorporate, so, too, there could be a
divergence of interests between bank managers and shareholders over
the bank chartering decision.
C. Implications of the Taxonomy
have isolated three different types of problems addressed by
race-to-the-bottom theorists: (1) defects in the interstate
competitive process, (2) divergence of interests over locational
decisions between principals [*1253]
and their agents,
n140 and (3) interstate externalities. The environmental,
corporate, and banking literatures have focused, respectively, on
one problem each, and have attached to that problem the
race-to-the-bottom label. Given the analytic differences discussed
above, it would be helpful to abandon the conclusory label and focus
instead on the underlying causes of the socially undesirable
results. At the very least, it is important to recognize the
distinct nature of the problems.
taxonomy helps to define the scope of my project. The analysis is
relevant not only to whether states compete for the location of
industrial plants by offering firms suboptimally lax environmental
standards, but also to whether interstate competition leads to
socially undesirable results in other regulatory programs or in the
setting of tax rates. My challenge to race-to-the-bottom arguments
in the environmental area applies with equal force whenever states
impose costs on the physical assets of mobile capital to promote the
welfare of their citizens.
Article should not be read as a definitive refutation of
race-to-the-bottom arguments in the environmental area. It is
intended, instead, to question the underpinnings of such arguments
and to suggest that the forces of interstate competition, far from
being conclusively undesirable, are at least presumptively
beneficial. If this project proves successful, it will be followed,
without a doubt, by studies attempting to define specific
circumstances in which federal regulation could improve upon the
results of interstate competition.
development of the race-to-the-bottom literature in corporate law
has followed a similar pattern. The first generation, exemplified by
William Cary, n141
equated interstate competition over corporate charters with
undesirable social outcomes. The second generation, led by Ralph
Winter, n142 took
the diametrically opposite view. A third generation, exemplified by
Lucian Bebchuk, n143 has generally accepted the presumptive benefits of
competition but has defined conditions under which competition would
fail to produce the socially optimal outcome.
Article does second- and third-generation work. Just as Ralph Winter
pointed out that market forces discipline the decisions of managers,
n144 it argues that the costs imposed by industrial pollution
(not just the benefits that derive from industrial location) are
relevant to state decisions [*1254]. Just as the subsequent
literature in the corporate area had to accept the fact that the
race-to-the-bottom argument had overlooked a concededly relevant
factor, the same should be true in the environmental area and, more
generally, in all areas involving state regulation of economic
in a third-generation vein, this Article suggests some specific
instances in which interstate competition, though generally
beneficial, nevertheless might not work properly - for example, as a
result of the existence of public choice problems at the state level
- but it resists the automatic pinning of the race-to-the-bottom
label on such competitive failures. Extensions of existing
theoretical models will undoubtedly lead to further third-generation
Richard B. Stewart, Pyramids of Sacrifice? Problems of Federalism in
Mandating State Implementation of National Environmental Policy, 86
Yale L.J. 1196, 1212 (1977) hereinafter Stewart, Pyramids of
Sacrifice? ("Given the mobility of industry and commerce, any
individual state or community may rationally decline unilaterally to
adopt high environmental standards that entail substantial costs for
industry and obstacles to economic development for fear that the
resulting environmental gains will be more than offset by movement
of capital to other areas with lower standards."); Richard B.
Stewart, The Development of Administrative and Quasi-Constitutional
Law in Judicial Review of Environmental Decisionmaking: Lessons from
the Clean Air Act, 62 Iowa L. Rev. 713, 747 (1977) hereinafter
Stewart, Environmental Decisionmaking ("In the absence of a
nondegradation requirement, "clean' states might compete with
one another for new development, leading to a "commons' dilemma
in which each state permits more degradation than it would prefer or
allow if transaction costs did not preclude agreement with competing
subsequent academic discussions of the race to the bottom in the
environmental context, see Vicki Been, "Exit" as a
Constraint on Land Use Exactions: Rethinking the Unconstitutional
Conditions Doctrine, 91 Colum. L. Rev. 473, 509 (1991); Gary M.
Bowman, Judicial Ordering of Intergovernmental Roles in Hazardous
Materials Transportation, 18 Transp. L.J. 31, 35 (1989); John C.
Dernbach, Pennsylvania's Implementation of the Surface Mining
Control and Reclamation Act: An Assessment of How "Cooperative
Federalism" Can Make State Regulatory Programs More Effective,
19 U. Mich. J.L. Ref. 903, 904 (1986); Susan Bartlett Foote,
Administrative Preemption: An Experiment in Regulatory Federalism,
70 Va. L. Rev. 1429, 1462 (1984); Susan Bartlett Foote, Beyond the
Politics of Federalism: An Alternative Model, 1 Yale J. on Reg. 217,
220 (1984); David B. Goetze & C.K. Rowland, Explaining Hazardous
Waste Regulation at the State Level, 14 Pol'y Stud. J. 111, 116-18
(1985); Craig N. Oren, Prevention of Significant Deterioration:
Control-Compelling Versus Site-Shifting, 74 Iowa L. Rev. 1, 29
(1988); Michael H. Schill, Uniformity or Diversity: Residential Real
Estate Finance Law in the 1990s and the Implications of Changing
Financial Markets, 64 S. Cal. L. Rev. 1261, 1290-91 (1991); Richard
B. Stewart, Federalism and Rights, 19 Ga. L. Rev. 917, 919-20
(1985); James P. Young, Comment, Expanding State Initiation and
Enforcement Under Superfund, 57 U. Chi. L. Rev. 985, 1003 (1990).
See text accompanying notes 40-57 infra.
See, e.g., Alfred C. Aman, Jr., Administrative Law in a Global Era:
Progress, Deregulatory Change, and the Rise of the Administrative
Presidency, 73 Cornell L. Rev. 1101, 1194 (1988); Cass R. Sunstein,
Constitutionalism After the New Deal, 101 Harv. L. Rev. 421, 505
Supreme Court itself has invoked the race-to-the-bottom
justification for federal regulation, particularly in New Deal cases
under the commerce clause. In upholding federal minimum wage and
maximum hour regulations, the Court stated:
The motive and purpose of the
present regulation are plainly to make effective the Congressional
conception of public policy that interstate commerce should not be
made the instrument of competition in the distribution of goods
produced under substandard labor conditions, which competition is
injurious to the commerce and to the states from and to which the
United States v. Darby, 312 U.S.
100, 115 (1941); see also Hodel v. Virginia Surface Mining &
Reclamation Ass'n, 452 U.S. 264, 281-82 (1981) (upholding mining
Another argument for federal intervention might be the presence of
economies of scale in regulation. For a comprehensive discussion of
the various rationales for federal environmental regulation, see
Stewart, Pyramids of Sacrifice?, supra note 1, at 1211-19.
A recent empirical study supports the central conclusion of this
Article. See Stephen M. Meyer, Environmentalism and Economic
Prosperity: Testing the Environmental Impact Hypothesis 23
(Massachusetts Institute of Technology, Project on Environmental
Politics and Policy, Oct. 5, 1992) (on file with the New York
University Law Review) (rejecting the claim that robust economic
growth and development are more likely to be found among states with
relatively lax environmental policies).
This discussion assumes that the transaction costs of bargaining
between polluters and breathers are sufficiently high to preclude
bargaining from yielding the socially optimal outcome. See generally
Ronald H. Coase, The Problem of Social Cost, 3 J.L. & Econ. 1
Command-and-control regulation, which is prevalent under the federal
environmental statutes, simply directs firms to produce no more than
a given number of units of particular pollutants (often the
standards are expressed as units of pollution, e.g., pounds of
sulfur dioxide emissions, per unit of product, e.g., million B.T.U.
of electricity). Pigouvian taxes are taxes per unit of pollution set
at a level equal to the marginal social damage of pollution. Firms
are not restricted in the amount that they can pollute, but they
must pay a tax for each unit of pollution that they generate.
Pigouvian taxes thus force the polluter to internalize the
externality. Finally, under marketable permit schemes, a
governmental body defines a number of permits equal to the
permissible number of units of pollution in the jurisdiction. The
permits can then be traded freely in the market, and each firm is
entitled to pollute a number of units equal to the number of permits
that it holds. For discussions and comparisons of these strategies,
see, e.g., William J. Baumol & Wallace E. Oates, The Theory of
Environmental Policy 21-23, 155-234 (2d ed. 1988); Bruce A. Ackerman
& Richard B. Stewart, Reforming Environmental Law, 37 Stan. L.
Rev. 1333 (1985).
Note, however, that if the costs of moving were infinitely high, a
jurisdiction with contiguous neighbors would be functionally
equivalent to an island jurisdiction. At this point, assume for
simplicity that the impact of these costs will be faced exclusively
within the jurisdiction. For example, the polluting firms may be
sole proprietorships owned by a resident of the jurisdiction or
corporations whose shareholders all reside in the jurisdiction. If
there are out-of-state shareholders, the jurisdiction's calculus
will be different, as it will not consider the costs to such
shareholders, thus giving rise to an externality. This possibility
is considered below, see text accompanying notes 76-77 infra, but
does not have important consequences for the current discussion.
It is conceivable, however, that a firm could bargain with the state
so effectively at the time that it considers where to locate that it
could capture all of these benefits. The clearest example is a firm
with exclusively out-of-state shareholders that induces a state to
give up all the benefits that would otherwise accrue to it. But
there is little theoretical or empirical support for this view. See
note 10 infra (discussing empirical literature).
different lines, Richard Stewart points out that "under perfect
market conditions, displacement of industry or economic development
might not occur, because the costs of environmental controls would
tend to be offset by lower wage rates reflecting more pleasant
working and living conditions." Stewart, Pyramids of
Sacrifice?, supra note 1, at 1212 n.6. He then notes, however, that
in practice these adjustments will not take place because
"labor and capital are imperfectly mobile, governmental and
union policies inhibit wage rate adjustments, and individuals may be
ignorant of some of the benefits of environmental quality, such as
lessened health risks." Id.
importantly, unless the full benefits of environmental controls are
captured by the firm's workers, the firm will not be able to recover
the costs of these controls through lower wages. In general,
pollution disperses over a large area; many of the beneficiaries are
therefore non-workers. Professor Stewart's argument is more
pertinent for worker-safety standards, where the benefits of the
regulatory scheme fall almost exclusively on individuals in a
contractual relationship with the regulated party.
See Stewart, Pyramids of Sacrifice?, supra note 1, at 1212.
empirical studies of the impact of environmental regulation on firm
location, see, e.g., Timothy J. Bartik, The Effects of Environmental
Regulation on Business Location in the United States, Growth &
Change, Summer 1988, at 22, 25-37; Virginia D. McConnell &
Robert M. Schwab, The Impact of Environmental Regulation on Industry
Location Decisions: The Motor Vehicle Industry, 66 Land Econ. 67
(1990); Howard A. Stafford, Environmental Protection and Industrial
Location, 75 Annals Ass'n Am. Geographers 227 (1985). These studies
reach somewhat mixed conclusions about the impact of environmental
regulation on business location. A more recent study by the
California Business Roundtable concluded that environmental
regulation is one of the most important reasons for businesses in
California to relocate to other states. See Environmental
Regulations Force Commerce Out of State, Business Roundtable Survey
Finds, 22 Current Developments Env't Rep. (BNA) 1839 (Nov. 29,
In fact, if each state has perfect information about the interests
of the other, they will skip the intermediate steps and directly
adopt the suboptimal standard. This phenomenon is not conceptually
different, and will be considered subsumed under the
See Steven Kelman, The Ethics of Regulatory Competition, Regulation,
May-June1982, at 39, 39.
Race-to-the-bottom arguments have the same structure in the
international context. See Richard B. Stewart, Environmental
Regulation and International Competitiveness, 102 Yale L.J. 2039,
2058-59 (1993). The available policy instruments, however, are
broader: they include not only environmental standards but also
tariffs and quotas on foreign products.
See Stewart, Environmental Decisionmaking, supra note 1, at 747
(arguing that transaction costs impede states from forming
cooperative agreements and that federal regulation can be justified
as forcing states to adopt standards that they would have selected
under such agreements).
See id. at 743.
States in a race-to-the-bottom ... want to engender certain
cooperation, and each of them wants to attain a particular standard
individualized to its individual preferences. But the only way to do
this is if they all agree to do it. The federal government is then
brought in as an agent of the multiple principals to achieve the
ends that these multiple principals have. That might lead to the
design of a very different kind of environmental protection policy
at a national level, but it involves the preferences of the states,
or those of the citizens of the states, being fulfilled rather than
the preferences of the federal government being fulfilled.
Colloquy, Comments on Professor
Rosenberg's Paper, 1990 Ann. Surv. Am. L. 51, 64 (1990) (remarks of
Professor Alvin K. Klevorick) hereinafter Remarks of Professor Alvin
See, e.g., Daniel A. Farber & Philip P. Frickey, The
Jurisprudence of Public Choice, 65 Tex. L. Rev. 873, 906-07 (1987);
Goetze & Rowland, supra note 1, at 117; Kelman, supra note 12,
at 40; Schill, supra note 1, at 1290-91; Stewart, supra note 13, at
2058 & n.84; John C. Anjier, Comment, Anti-Takeover Statutes,
Shareholders, Stakeholders and Risk, 51 La. L. Rev. 561, 613 (1991);
Peter M. Yu, Note, To Form a More Perfect Union?: Federalism and
Informal Interstate Cooperation, 102 Harv. L. Rev. 842, 844-46
(1989); Remarks of Professor Alvin K. Klevorick, supra note 16, at
See, e.g., R. Duncan Luce & Howard Raiffa, Games and Decisions:
Introduction and Critical Survey 94-97 (1957); Peter C. Ordeshook,
Game Theory and Political Theory: An Introduction 206-10 (1986).
See P. Ordeshook, supra note 18, at 207.
Part IV discusses the situation in which each jurisdiction has more
than two choices. See notes 118-121 and accompanying text infra.
Exec. Order No. 12,612, 52 Fed. Reg. 41,685 (1987).
Section 2 sets forth "Fundamental Federalism Principles."
For example, section 2(e) provides: "In most areas of
governmental concern, the States uniquely possess the constitutional
authority, the resources, and the competence to discern the
sentiments of the people and to govern accordingly." Id. 2(e),
52 Fed. Reg. at 41,685. Similarly, section 2(f) provides: "The
nature of our constitutional system encourages a healthy diversity
in the public policies adopted by the peoples of the several States
according to their own conditions, needs, and desires." Id.
2(f), 52 Fed. Reg. at 41,685.
3 sets forth "Federalism Policymaking Criteria." It
stresses: "It is important to recognize the distinction between
problems of national scope (which may justify Federal action) and
problems that are merely common to the States (which will not
justify Federal action) because individual States, acting
individually or together, can effectively deal with them." Id.
3(b)(1), 52 Fed. Reg. at 41,686.
The distinction between a race to less stringent standards and a
race to lower levels of social welfare is not always well
understood. For example, in the context of an argument against a
national antisodomy law, William Van Alstyne states:
An enormous amount of
question-begging analysis has been expended upon demonstrating how
Congress must be able to intervene, in order to head off the
so-called "race to the bottom." Given the mobility of
capital and labor, so this claim holds, the "lowest"
standards will tend to control unless Congress intervenes. But whose
policy is "low" and whose is "high" depends
wholly on one's point of view ....
William Van Alstyne, Federalism,
Congress, the States and the Tenth Amendment: Adrift in the
Cellophane Sea, 1987 Duke L.J. 769, 780 n.40. His characterization
of the race to the bottom misconstrues what I take to be its
distinctive characteristic: that as a result of the mobility of
capital, jurisdictions face a prisoner's dilemma that leads to an
overall reduction in social welfare.
The mirror image of the race to the bottom is the not-in-my-backyard
(NIMBY) syndrome. The NIMBY problem is that no jurisdiction wants to
locate within its borders certain types of facilities that have
undesirable environmental consequences, even though these
jurisdictions would be collectively better off by having such
facilities. For discussion of this phenomenon, see Kent E. Portney,
Siting Hazardous Waste Treatment Facilities: The NIMBY Syndrome 23
(1991); Vicki Been, What's Fairness Got to Do with It?:
Environmental Equity and the Siting of Locally Undesirable Land
Uses, 78 Cornell L. Rev. (forthcoming July 1993).
solutions to these two problems are also diametrically opposed. The
solution to race-to-the-bottom problems is federal minimum standards
(federal floors), which would preempt less stringent but not more
stringent state standards. In contrast, the solution to NIMBY
problems is federal maximum standards (federal ceilings), which
would preempt more stringent but not less stringent state standards.
advocates who believe in both the race to the bottom and NIMBY ought
to have the burden of explaining why interstate competition can
sometimes produce suboptimally lax standards, whereas at other times
it can lead to suboptimally stringent standards. Further analysis of
this important paradox is beyond the scope of this Article.
The discussion also assumes that individuals, unlike firms, are
immobile. It is not uncommon to assume that, unlike capital,
individuals do not migrate. Thus, they express their preferences
through "voice" rather than "exit." See Susan
Rose-Ackerman, Does Federalism Matter? Political Choice in a Federal
Republic, 89 J. Pol. Econ. 152, 155 (1981). See generally Albert O.
Hirschman, Exit, Voice, and Loyalty: Responses to Decline in Firms,
Organizations and States (1970). For further discussion of this
assumption, see text accompanying notes 76, 84, 96, 101 infra.
Exponents of this perspective include William Ophuls, Ecology and
the Politics of Scarcity: Prologue to a Political Theory of the
Steady State (1977); Mark Sagoff, The Economy of the Earth:
Philosophy, Law, and the Environment (1988); Christopher D. Stone,
Earth and Other Ethics: The Case for Moral Pluralism (1987).
Supporters of the ecological perspective might object to this
objective function as well. I do not understand this perspective,
however, to advocate the protection of environmental quality without
any regard to cost. Thus, some type of balancing must be necessary.
Obviously, there is nothing special about the factor of two, and the
argument would proceed in the same way for any other factor.
Note that there is a distinction between a jurisdiction that
considers the preferences of its residents and then weights the
benefits of environmental protection by a factor of two, and a
jurisdiction that does not give added weight to its residents'
preferences, but where the residents value environmental protection
very highly. The former is not acting consistently with traditional
economic postulates, but the latter is.
See, e.g., 29 U.S.C. 655(b)(5) (1988) (Occupational Safety and
Health Act); 33 U.S.C. 1311(b)(2)(A), 1316 (1988) (Clean Water Act);
42 U.S.C. 300g-1(4) (1988) (Safe Drinking Water Act); 42 U.S.C.
7411(a)(1) (Supp. II 1990) (Clean Air Act). Even though these
statutes typically require the consideration of costs, they do not
require cost-benefit analysis. See, e.g., American Textile Mfrs.
Inst. v. Donovan, 452 U.S. 490, 506-22 (1981) (Occupational Safety
and Health Act); American Meat Inst. v. EPA, 526 F.2d 442, 462-63
(7th Cir. 1975) (Clean Water Act); Portland Cement Ass'n v.
Ruckelshaus, 486 F.2d 375, 387-88 (D.C. Cir. 1973), cert. denied,
417 U.S. 921 (1974) (Clean Air Act).
See Hillsborough County v. Automated Medical Lab., Inc., 471 U.S.
707, 715-16 (1985).
See Stewart, Pyramids of Sacrifice?, supra note 1, at 1211-16.
Interstate competition, however, exacerbates the problem of
interstate externalities. It adds the ability to attract industry to
the benefits that a state obtains from suboptimally lax standards.
Frank Easterbrook writes:
One of the common justifications
for federal air pollution legislation is that, because no one
state's residents can collect all of the benefits of cleaner air
(which, after all, drifts east, while dirty air comes in with the
breeze), the states lack the proper incentives to legislate. If one
state adopts optimally "tough" laws, businesses will
Frank H. Easterbrook, Antitrust
and the Economics of Federalism, 26 J.L. & Econ. 23, 29 (1983).
This statement appears to conflate externalities with the race to
the bottom and not to recognize that the externality argument is
independent of the possibility of interstate migration.
Economic theorists sometimes distinguish between technological (or
real) externalities and pecuniary (or pseudo) externalities. See W.
Baumol & W. Oates, supra note 7, at 29. A technological
externality "is present whenever some individual's (say A's)
utility or production relationships include real (that is,
nonmonetary) variables, whose values are chosen by others (persons,
corporations, governments) without particular attention to the
effects on A's welfare." Id. at 17. Thus, for example, the
pollution from an upwind state that decreases the utilities of
individuals in the downwind state is a paradigmatic technological
externality. Technological externalities lead to a misallocation of
resources. Id. at 29-31. In the preceding example, firms employ
production processes that produce more pollution than is socially
contrast, in the case of a pecuniary externality, one individual's
decisions affect the financial circumstances of another, but there
is no misallocation of resources. Id. at 29. For example, "an
increase in the number of shoes demanded raises the price of leather
and hence affects the welfare of the purchasers of handbags."
Id. Such price effects "are merely the normal competitive
mechanisms for the reallocation of resources in response to changes
in demands and factor supplies." Id. at 30. This pecuniary
externality does not lead to the production of handbags in a manner
that departs from the social optimum.
externalities exist whenever a state relaxes a pollution control
standard, since such an action affects the welfare of other states
by luring away industry. But nothing is gained analytically by
referring to the race to the bottom as a pecuniary externality.
Thus, this Article uses the term "externality" to apply
only to technological (or real) externalities.
See 42 U.S.C. 7423 (1988) (Clean Air Act).
See, e.g., Stewart, Pyramids of Sacrifice?, supra note 1, at
It could be that even though environmental interests are less
influential at the state than the federal level, they produce an
overvaluation of environmental benefits, or an undervaluation of
environmental costs at both the federal and state levels. In this
hypothetical, there is a public choice explanation for federal
regulation (a positive claim) but no normative public choice
argument for such regulation.
It may be, for example, that a state fails to take into account the
effects of pollution on future generations. To make a normative
public choice claim for federal regulation however, one needs to
establish that future generations will be better protected at the
Obviously, such dry cleaners could move to another area. I treat
them as geographically immobile, however, because if they move, they
cannot continue to satisfy their customers. In contrast, a steel
plant can sell products in the national market regardless of its
Because there is no evidence that the normative component of the
public choice argument played an important role in shaping the
statutory scheme, this Section contrasts only the two market-failure
42 U.S.C. 7410(a)(2)(D) (Supp. II 1990).
42 U.S.C. 7426 (1988 & Supp. II 1990).
42 U.S.C. 7423 (1988).
42 U.S.C. 7651-7651o (Supp. II 1990).
See 42 U.S.C. 7409 (1988).
See 42 U.S.C. 7470-92 (1988 & Supp. II 1990). For commentary on
the PSD program, see Oren, supra note 1.
See 42 U.S.C. 7501-15 (1988 & Supp. II 1990).
See id. 7502(c)(2).
See id. 7411.
See 42 U.S.C. 7475(a)(4) (1988).
See id. 7503(a)(2).
See id. 7502(c)(1).
This paragraph assumes that there are no federally prescribed
emission standards. To the extent that such standards exist, a
state's ability to offer lax emission standards will be constrained.
See James E. Krier, The Irrational National Air Quality Standards:
Macro- and Micro-Mistakes, 22 U.C.L.A. L. Rev. 323, 324-35 (1974)
(arguing against uniform federal ambient standards).
H.R. Rep. No. 294, 95th Cong., 1st Sess. 134 (1977), reprinted in
1977 U.S.C.C.A.N.1077, 1213.
H.R. Rep. No. 1146, 91st Cong., 2d Sess. 3 (1970), reprinted in 1970
U.S.C.C.A.N. 5356, 5358.
No downwind state has been able successfully to invoke the
provisions of section 110(a)(2)(D) (formerly section 110(a)(2)(E))
and section 126(b). See New York v. EPA, 852 F.2d 574, 581 (D.C.
Cir. 1988) (R.B. Ginsburg, J., concurring), cert. denied, 489 U.S.
See Matthew L. Wald, To Fight Smog, 8 Northeast States Adopt New
Curbs on Power Plants, N.Y. Times, Apr. 3, 1992, at A1.
See id. at D15.
See Northeast, Mid-Atlantic States Reach Pact on Low-Emission Cars,
Reformulated Gasoline, 22 Current Developments Env't Rep. (BNA) 1643
(Nov. 1, 1991) hereinafter Northeast, Mid-Atlantic States Reach
Pact. The Clean Air Act gives California the option to set
automobile standards more stringent than the federal standards; the
other states have the choice of being covered by the federal
standards, or, alternatively, of adopting the California standards.
See 42 U.S.C. 7543 (1988 & Supp. II 1990).
See Northeast, Mid-Atlantic States Reach Pact, supra note 61, at
See Connecticut Bucks Northeastern Trend, Will Not Mandate
Low-Emitting California Cars, 22 Current Developments Env't Rep.
(BNA) 1767 (Nov. 15, 1991).
See Matthew L. Wald, Weicker Drops State From Regional Clean-Air
Effort, N.Y. Times, Nov. 8, 1991, at B5.
See, e.g., William R. Lowry, The Dimensions of Federalism: State
Governments and Pollution Control Policies 73-75, 90-93, 112-17
(1992); D. Craig Bell & Norman K. Johnson, State Water Laws and
Federal Water Uses: The History of Conflict, the Prospects for
Accommodation, 21 Envtl. L. 1, 29-55 (1991); State Air Board
Tightens Rules on Burning Hazardous Waste as Fuel, 22 Current
Developments Env't Rep. (BNA) 139 (May 17, 1991) (Texas standards
for burning hazardous wastes as fuel); New Oil Spill Planning
Requirements Will Be Enforced in June, Department Says, 21 Current
Developments Env't Rep. (BNA) 2136 (Mar. 29, 1991) (Alaska oil spill
requirements); Comprehensive New Landfill Standards Focus on Liners,
Leachate, Ground Water, 21 Current Developments Env't Rep. (BNA)
1056 (Sept. 21, 1990) (Illinois landfill regulations for solid
wastes); State Community Right-To-Know Law Imposes Fees to Finance
Compliance, 19 Current Developments Env't Rep. (BNA) 1766 (Dec. 23,
1988) (Ohio community right-to-know law); Governor Signs
Right-to-Know Statute Giving State Authority to Enforce Federal Law,
19 Current Developments Env't Rep. (BNA) 50 (May 13, 1988)
(Wisconsin community right-to-know law); Illinois Prepares to Adopt
"Model" Rules Covering Non-Hazardous Solid Waste Disposal,
18 Current Developments Env't Rep. (BNA) 675 (June 19, 1987)
(Illinois landfill regulations for solid wastes).
phenomenon of states enacting more stringent standards has not gone
unnoticed by the popular press:
new age of environmental federalism has dawned. In a stunning
switch, the states are no longer merely implementing federal
standards but are setting the environmental agenda. Passing more -
and more stringent - controls on pollution than Congress ever
considered, states and cities are protecting ground water, recycling
garbage, mandating "clean" fuels and reducing acid rain.
Every state now regulates the emission of toxic chemicals into the
air; the city of Philadelphia alone has set standards for 99 toxics,
while the U.S. Environmental Protection Agency has issued only
seven. The states are forging ahead on their own because Congress
and the White House can't or won't champion meaningful environmental
reform - even on issues such as the greenhouse effect that have
causes and consequences far beyond any state's borders.
E Pluribus, Plures: Without
Leadership from Washington, the States Set the Environmental Agenda
for the Nation, Newsweek, Nov. 13, 1989, at 70.
See notes 67, 69 infra.
The departures from the formula occur for the (2,3) and (2,4) pairs,
where State 2's payoff is 15 and 12, respectively, rather than 19
and 16, and for the (3,2) and (4,2) pairs, where State 1's payoff is
15 and 12, respectively, rather than 19 and 16. The reason for this
modification is set forth in note 69 infra.
Part I gave the example of states that could choose among two
possible standards and showed that the structure of their
relationship was akin to a prisoner's dilemma, in that the dominant
strategy for each was to choose the suboptimally lax standard. See
text accompanying notes 17-20 supra. Where the states face more than
two choices, there is no longer a dominant strategy equilibrium: the
choice for each state depends on the other state's choice. This
weaker notion of an equilibrium is known as a Nash equilibrium. See
P. Ordeshook, supra note 18, at 118. Thus, technically, Table I does
not represent a prisoner's dilemma, although it does represent a
more general form of a non-cooperative game. It captures, however,
the defining element of the race to the bottom: that, as a result of
their inability to coordinate their actions, states suffer a loss in
The reason for the modifications discussed in note 67 supra is to
avoid an equilibrium in mixed strategies. With the payoffs dictated
by the formula discussed in the text, if State 1 initially chooses a
standard of 5, State 2 responds with 0, State 1 with 2, State 2 with
3, State 1 with 4, State 2 with 0, and so on. But despite the lack
of an equilibrium in pure strategies, there is a race to the bottom,
since under this combination of strategies the states are worse off
than they would have been as island jurisdictions choosing a
standard of 5.
pure strategy equilibria, the actors' choices are determined with
certainty; in mixed strategy equilibria, the actors assign a
probability to a set of outcomes, so that the probabilities sum to
one. See R. Luce & H. Raiffa, supra note 18, at 68-70; P.
Ordeshook, supra note 18, at 133-34.
See, e.g., 33 U.S.C. 1370 (1988) (Clean Water Act); 42 U.S.C. 6991g
(1988) (Resource Conservation and Recovery Act); 42 U.S.C. 7416
(1988) (Clean Air Act).
If the federal standard were 4 or 5, the state would not adopt more
stringent state standards.
There is, on this account, the possibility of a corrective mechanism
for federal standards that are too lax: states can enact more
stringent standards. No similar corrective mechanism exists for
federal standards that are too stringent.
Steven Kelman attempts to provide an answer. He notes that
traditional social welfare functions take into account both the
benefits that individuals get from pollution control and the costs
that pollution control measures impose on industry. See Kelman,
supra note 12, at 42. Then he asks: "What if the desire of
states for strict environmental regulation or welfare measures ...
should not simply be thrown in together with the desire of
businesses to avoid regulation or taxes?" Id. He argues that
the preferences of industry should be taken into account only if
they are ethically justifiable. He admits that "to state
questions of this nature is not to answer them." Id. at 43.
Thus, in the end, Kelman does not provide an argument for
supra-competitive profits on the part of states. For a forceful
rejoinder, see Walter Olson, Competition Among States: A Response,
Regulation, May-June 1982, at 44.
In isolated instances, the legal literature has alluded to the
analogy between a firm as seller of a good and a jurisdiction as
seller of a location right, but it has not considered the obvious
difficulties raised by the analogy. See Easterbrook, supra note 33,
Because race-to-the-bottom advocates do not face this complexity,
they must assume implicitly that individuals are not mobile.
This Article proceeds on the assumption that individuals are
immobile. See note 25 supra.
See note 8 supra.
It is conceivable that a state would charge too much for the right
to locate. A producer of widgets that sets its price too high will
just as surely go out of business as one that sets its price too
low. If states systematically charged too much, however, there would
be no race-to-the-bottom problem.
In a public choice model, such undervaluation is likely to occur if
environmental groups are ineffective at the state level. See text
accompanying notes 36-39 supra.
I do not consider the difference in the markets that arises from the
presence of interstate externalities, because I treat this problem
as distinct. See text accompanying notes 31-35 supra.
It is paradoxical that, in the environmental area, the generally
accepted premise is that jurisdictions extract too low a price from
firms. In the land-use context, as illustrated by Nollan v.
California Coastal Comm'n, 483 U.S. 825 (1987), influential support
exists for the proposition that the price that jurisdictions extract
is too high. For a comprehensive discussion of this problem, see
generally Been, supra note 1.
Charles M. Tiebout, A Pure Theory of Local Expenditures, 64 J. Pol.
Econ. 416 (1956).
Id. at 419.
Id. at 420.
See id. at 418. For refinements of Tiebout's model, see, e.g.,
Truman F. Bewley, A Critique of Tiebout's Theory of Local Public
Expenditures, 49 Econometrica 713 (1981); Pierre Pestieau, The
Optimality Limits of the Tiebout Model, in The Political Economy of
Fiscal Federalism 173 (Wallace E. Oates ed., 1977).
See, e.g., James M. Buchanan & Charles J. Goetz, Efficiency
Limits of Fiscal Mobility: An Assessment of the Tiebout Model, 1 J.
Pub. Econ. 25 (1972); Carol M. Rose, Planning and Dealing: Piecemeal
Land Controls as a Problem of Local Legitimacy, 71 Cal. L. Rev. 837,
See William A. Fischel, Fiscal and Environmental Considerations in
the Location of Firms in Suburban Communities, in Fiscal Zoning and
Land Use Controls 119 (Edwin S. Mills & Wallace E. Oates eds.,
See id. at 126.
See id. A more realistic model would view pollution as an input to
the production process; a firm's level of emissions would then be a
function of the amount that it has to pay in order to pollute. If a
firm has to pay the social cost of its pollution, it will pollute
the socially optimal amount. The prospect of making such payments
will induce it to reduce its pollution until the cost of a unit of
further reduction is higher than the harm caused by that unit. While
Fischel eventually relaxes the assumption of equal environmental
impacts, he continues to assume that each firm has a fixed impact on
environmental quality, which is not affected by the size of the
payment that it must make to the community in which it locates. See
id. at 136-41.
See id. at 126.
See id. at 127-28.
See id. at 128-29.
See id. at 129. After establishing this result, Fischel relaxes some
of the preceding assumptions. See id. at 129-49.
See text accompanying note 88 supra.
See Fischel, supra note 87, at 128-129.
Wallace E. Oates & Robert M. Schwab, Economic Competition Among
Jurisdictions: Efficiency Enhancing or Distortion Inducing?, 35 J.
Pub. Econ. 333 (1988).
Id. at 336.
The assumptions of the model are set forth in id. at 336-38.
Oates and Schwab point out that the results would be no different
if, instead, the jurisdictions set Pigouvian taxes. See id. at 336
Id. at 337. In a companion, unpublished manuscript, Oates and Schwab
argue that their conclusion that competition among states produces
efficient outcomes holds even if individuals are mobile. See Wallace
E. Oates & Robert M. Schwab, Pricing Instruments for
Environmental Protection: The Problems of Cross-Media Pollution,
Interjurisdictional Competition and Interregional Effects (Nov.
1987) (unpublished manuscript, on file with the New York University
Law Review) (cited in Oates & Schwab, supra note 97, at 337
individuals are mobile, they will sort out, as in the Tiebout model,
by reference to their preferences for environmental protection.
Individuals who are willing to trade off a great deal in wages for
better environmental quality will move to jurisdictions that impose
stringent controls on industry; individuals who attach less
importance to environmental quality will go to dirtier areas. Thus,
environmental protection does not raise the same problem as income
redistribution. As explained below, redistribution is unlikely to be
effective at the state level. See note 114 infra.
Oates & Schwab, supra note 97, at 338 (citations omitted).
Id. at 339. A jurisdiction should therefore raise its revenues in
some other way - for example, through head taxes.
Id. at 340-41.
See W. Baumol & W. Oates, supra note 7, at 291 (discussing
simplified version of the model).
Oates & Schwab, supra note 97, at 342.
Id. at 341-42.
Id. at 342.
international trade literature addresses problems similar to those
studied by Oates and Schwab. Consistent with the view that
international trade is motivated, at least in part, by the
comparative advantage of some nations, or the existence of economies
of scale, see Paul R. Krugman, Rethinking International Trade 1-8
(1990), the literature considers these factors as well as the effect
of tariffs. See, e.g., Ralph C. d'Arge & Allen V. Kneese,
Environmental Quality and International Trade, 26 Int'l Org. 419
(1972); Kerry Krutilla, Environmental Regulation in an Open Economy,
20 J. Envtl. Econ. & Mgmt. 127 (1991); Rudiger Pethig,
Pollution, Welfare, and Environmental Policy in the Theory of
Comparative Advantage, 2 J. Envtl. Econ. & Mgmt. 160 (1976).
Krutilla's model, a nation's production of a commodity is
sufficiently large to affect the world price; the policy instrument
for environmental control is taxes rather than command-and-control
standards. See Krutilla, supra, at 128. The model shows that if
there are no tariffs, a nation will impose suboptimally high
environmental taxes (and therefore will induce a suboptimally
stringent level of environmental quality) if it is a net exporter of
a "pollution externality" good (a good for which the
production process generates pollution), but will set suboptimally
lax taxes (and, consequently, induce a suboptimally lax level of
environmental quality) if it is a net importer of such a good. See
id. at 132. The reason for this result is that when a nation imposes
a tax, the domestic supply of the good decreases, and the world
price rises. A net exporter therefore benefits, but a net importer
suffers. See id. at 132-33.
Krutilla model appears implicitly to assume that firms are immobile.
It does not consider the effect of higher environmental taxes on
Oates & Schwab, supra note 97, at 342.
concurring opinion in a case involving the Comprehensive
Environmental Response, Compensation, and Liability Act, 42 U.S.C.
9601-59, revealed an intuition consistent with the Oates and Schwab
fears that states will engage in a "race to the bottom" in
their effort to attract corporate business and enact laws that limit
vicarious liability are in my opinion groundless. States have a
substantial interest in protecting their citizens and state
resources. Most states have their own counterparts to CERCLA and the
EPA and they share a complementary interest with the United States
in enforcement of laws like CERCLA that are used to remedy
environmental contamination. I see no necessity to create federal
common law in this area to guard against the risk that states will
create safe havens for polluters.
Anspec Co. v. Johnson Controls,
Inc., 922 F.2d 1240, 1250 (6th Cir. 1991) (Kennedy, J., concurring).
In deriving this result, Oates and Schwab initially assume that the
residents of each jurisdiction are identical in terms of both their
preferences and their productive capacities. Then, competition
yields the socially efficient result regardless of whether the
decisions on tax rates are made by the median voter or a
governmental actor seeking to maximize the residents' welfare. See
Oates & Schwab, supra note 97, at 338-39 & n.10.
then consider situations in which the preferences are not
homogeneous. If the majority of the individuals in one jurisdiction
are wage earners, but a minority derives no income from wages, the
median voter (a wage earner) will favor a subsidy to capital and
suboptimally stringent environmental standards. Workers prefer to
increase their wages by subsidizing industry rather than by relaxing
environmental standards, because part of the burden of higher taxes
is borne by individuals without wage income. See id. at 347.
in contrast, the majority of the individuals are not wage earners,
but a minority is, the median voter (in this case, not a wage
earner) will favor a tax on capital because the cost will be borne
by workers in the form of lower wages. Oates and Schwab have not
been able to show how the corresponding environmental standards
compare generally to those in the jurisdiction in which wage earners
are in the majority. See id. at 348 & n.15. It appears that, on
the one hand, non-workers would favor more stringent environmental
standards because the impact is felt solely by workers in the form
of lower wages. On the other hand, however, stringent environmental
standards would create incentives for firms to leave the
jurisdiction, thereby reducing tax revenues.
Oates and Schwab do not address the issue explicitly, it follows
from their analysis that if the choice of taxes and environmental
standards is made by a public decisionmaker seeking to maximize
social welfare rather than by the median voter, these problems would
not arise. The decisionmaker would avoid the problem of one group
imposing costs on the other, and would pick the optimal tax and
environmental protection levels, even where a jurisdiction's
population is not homogeneous.
Id. at 342-43.
Id. at 337 & n.6.
As is explained in more detail below, the Oates and Schwab
discussion of a jurisdiction choosing a positive net tax rate is not
to the contrary because it concerns a jurisdiction that chooses to
act suboptimally, rather than one that is driven to a suboptimal
outcome by interstate competition. See text accompanying note 114
and Schwab point to only two works in the local public finance
literature, both by John Cumberland, consistent with the
race-to-the-bottom claim. See Oates & Schwab, supra note 97, at
334. But Cumberland's articles, far from setting forth a supporting
theoretical model, focus on issues not directly analogous, such as
interstate externalities, undervaluation by states of the benefits
of pollution control, and market-based approaches to pollution
control. See John H. Cumberland, Efficiency and Equity in
Interregional Environmental Management, 10 Rev. Regional Stud. 1
(1981); John H. Cumberland, Interregional Pollution Spillovers and
Consistency of Environmental Policy, in Regional Environmental
Policy: The Economic Issues 255 (Horst Siebert et al. eds., 1979).
Conversely, a state that gives capital a net subsidy is overvaluing
the benefits of environmental regulation. For example, it is highly
plausible that a state would undervalue the benefits of income
maintenance programs because their beneficiaries are often
politically powerless. As a result, it would unduly sacrifice such
programs, and, therefore, use part of its tax revenues to subsidize
industry, thereby allowing more stringent environmental standards.
Federal environmental regulation that, on race-to-the-bottom
grounds, made these standards even more stringent would lead to a
further reduction of taxes. The result would be a further decline in
social welfare, rather than the increase that race-to-the-bottom
arguments would suggest.
For a comprehensive review of this literature, see Peter Mieszkowski
& George R. Zodrow, Taxation and the Tiebout Model: The
Differential Effects of Head Taxes, Taxes on Land Rents, and
Property Taxes, 27 J. Econ. Lit. 1098 (1989). For support for the
benefit characterization, see, e.g., Fischel, supra note 87; Bruce
W. Hamilton, Capitalization and Jurisdictional Differences in Local
Tax Prices, 66 Am. Econ. Rev. 743 (1976); Bruce W. Hamilton, Zoning
and Property Taxation in a System of Local Governments, 12 Urban
Stud. 205 (1975); Michelle J. White, Firm Location in a Zoned
Metropolitan Area, in Fiscal Zoning and Land Use Controls: The
Economic Issues 175 (Edwin S. Mills & Wallace E. Oates eds.,
1975). For support for the distortionary view, see, e.g., Peter
Mieszkowski, The Property Tax: An Excise Tax or a Profits Tax?, 1 J.
Pub. Econ. 73 (1972); George R. Zodrow & Peter Mieszkowski, The
New View of the Urban Property Tax: A Reformulation, 16 Reg. Sci.
Urban Econ. 309 (1986).
See Mieszkowski & Zodrow, supra note 115, at 1107-19 (discussing
theoretical work); id. at 1127-31 (discussing empirical work).
Traditional economic models, like the Oates and Schwab model, assume
that production functions exhibit constant returns to scale. See
Oates & Schwab, supra note 97, at 337. A recent working paper
departs from this tradition by assuming increasing returns to scale.
See James R. Markusen et al.,
Noncooperative Equilibria in Regional Environmental Policies When
Plant Locations Are Endogenous 3, 25 (National Bureau of Economic
Research Working Paper No. 4051, 1992). Depending on the
specifications of the relevant parameters, their model can yield
either suboptimally high or suboptimally low levels of pollution.
See id. at 1-2, 25-26.
The response to such a competitive disadvantage is thus more complex
than suggested by Susan Rose-Ackerman's analysis of an analogous
problem. She gives the example of state minimum wage laws, which
produce capital flow to states that have not enacted such laws. She
argues that residents of states with minimum wage laws will urge the
adoption of federal minimum wage laws as a way to impose costs on
states that do not have minimum wage laws and thereby to gain a
competitive advantage. See Rose-Ackerman, supra note 25, at 160.
This competitive advantage will be reduced, however, when, in the
face of federal intervention, states that had not previously adopted
minimum wage laws reduce other costs that they impose on industry.
If one believes that corporate taxes are undesirable, on the ground
perhaps that it is preferable to tax directly the income of
shareholders, one might favor federal regulation that forces states
to compete over corporate taxes, rather than over regulatory
Such a scheme would help states that have naturally attractive
characteristics, such as proximity to water.
Recent evaluations of the desirability of federalism include
Competition Among States and Local Governments: Efficiency and
Equity in American Federalism (Daphne A. Kenyon & John Kincaid
eds., 1991); Thomas R. Dye, American Federalism: Competition Among
William L. Cary, Federalism and Corporate Law: Reflections Upon
Delaware, 83 Yale L.J. 663, 663-84 (1974).
Id. at 700-03.
Ralph K. Winter, State Law, Shareholder Protection, and the Theory
of the Corporation, 6 J. Legal Stud. 251, 262-73 (1977). The
important recent pieces in this debate include Lucian A. Bebchuk,
Federalism and the Corporation: The Desirable Limits on State
Competition in Corporate Law, 105 Harv. L. Rev. 1435 (1992);
Jonathan R. Macey & Geoffrey P. Miller, Toward an Interest-Group
Theory of Delaware Corporate Law, 65 Tex. L. Rev. 469 (1987);
Roberta Romano, The State Competition Debate in Corporate Law, 8
Cardozo L. Rev. 709 (1987) hereinafter Romano, State Competition;
Roberta Romano, Law as a Product: Some Pieces of the Incorporation
Puzzle, 1 J.L. Econ. & Org. 225 (1985) hereinafter Romano, Law
as a Product.
Winter, supra note 124, at 290-92. The preceding discussion reveals
that the two sides of the corporate chartering debate agree on
important issues: that states compete for corporate charters by
offering provisions that are attractive to corporate decisionmakers,
that the socially desirable arrangements are those that maximize
shareholder wealth, and that the desirability of federal chartering
depends on whether state competition in fact maximizes shareholder
See Bebchuk, supra note 124, at 1458-84.
But see id. at 1485-95 (arguing that certain provisions that
maximize shareholder wealth are not socially desirable because they
impose externalities on other groups, such as creditors).
See Daniel Z. Czamanski & Smadar Fogel, Industrial Location and
the Divorce of Management and Ownership, 19 Annals Reg. Sci. 77
There are other formal differences between the corporate and
environmental races to the bottom. First, the corporate literature
assumes that the purpose of chartering provisions is merely to raise
funds, and not to enhance the interests of in-state shareholders.
Indeed, the race-to-the-bottom argument implies that if a state
tried to create a desirable climate for shareholders, it would lose
incorporation business to other states, and its in-state
shareholders would therefore not receive the intended protection.
Thus, states do not consider the tradeoff between their interest in
attracting firms and in protecting their shareholders.
contrast, state environmental laws affect the welfare of in-state
breathers, at least if the breathers are locationally immobile.
Thus, states must engage in a tradeoff between the benefits of
attracting industrial activity and the costs that such activity
imposes on in-state breathers. Another difference is that moving an
industrial plant from one state to another, unlike changing the
state of incorporation, entails substantial costs. The presence of
such moving costs can make it possible for states to impose
suboptimally stringent environmental standards.
corporate problem bears some resemblance to the problem that states
would face in engaging in economic redistribution if their residents
were mobile. Wealthy individuals would have an incentive to move to
jurisdictions that did not engage in redistribution, and poor
individuals would move to jurisdictions that did. But then, of
course, there would be no money in the latter jurisdictions to
redistribute, and these jurisdictions would be unable to achieve
their goals. See, e.g., Gary J. Miller, Cities by Contract: The
Politics of Municipal Incorporation 97-99, 163-89, 196-202 (1981);
David F. Bradford & Wallace E. Oates, Suburban Exploitation of
Central Cities and Governmental Structure, in Redistribution Through
Public Choice 43, 51-60, 65-71, 84-86 (Harold E. Hochman &
George E. Peterson eds., 1974); Susan Rose-Ackerman, Beyond Tiebout:
Modeling the Political Economy of Local Government, in Local
Provision of Public Services: The Tiebout Model After Twenty-Five
Years 55, 73-74 (George R. Zodrow ed., 1983). Redistribution is thus
more likely to be imposed at the federal level. In the corporate
problem, jurisdictions would similarly be frustrated, as a result of
a different mobility phenomenon, if they attempted to protect
interstate competition over corporate chartering is a zero-sum game
for the states. Corporations either incorporate in one state or
another, and they pay their fees and take their legal business only
to the state in which they incorporate. Thus, federal regulation
cannot help all of the states interested in competing for charters;
in fact, if the federal intervention takes the form of federal
chartering rather than mandatory standards, the states will lose
this business altogether. In the environmental area, in contrast,
the race to the bottom posits a prisoner's dilemma, in which all
states lose as a result of competition, and in which they all could
benefit from federal regulation.
Competition among the states can exacerbate the principal-agent
problem by increasing the opportunity for managerial enrichment.
Nonetheless, if the principal-agent problem could be corrected,
interstate competition would not have undesirable effects.
Henry N. Butler & Jonathan R. Macey, The Myth of Competition in
the Dual Banking System, 73 Cornell L. Rev. 677, 715 (1988).
See id. at 680, 712, 714.
Butler and Macey do not distinguish between these reasons, and it is
not clear which forms the basis for their argument. See id. at
As indicated below, this literature does not consider the
possibility of principal-agent problems between bank managers and
shareholders. At least when a bank's net worth declines to a point
at which it is vulnerable to regulatory sanctions, however, bank
managers can be expected to share shareholders' preferences for
The problem, under either formulation, is different from the alleged
race to the bottom that arises from the existence of a choice
between federal and state chartering. See Kenneth E. Scott, The Dual
Banking System: A Model of Competition in Regulation, 30 Stan. L.
Rev. 1, 12-13 (1977) (quoting Arthur Burns). For a view that this
competition is beneficial, see Daniel R. Fischel et al., The
Regulation of Banks and Bank Holding Companies, 73 Va. L. Rev. 301,
Races to the bottom premised on interstate externalities are also
said to exist in the products liability area. Michael McConnell
argues that states have an incentive to enact pro-plaintiff
provisions to favor their residents at the expense of out-of-state
manufacturers. See Michael W. McConnell, A Choice-of-Law Approach to
Products Liability Reform, in New Directions in Liability Law 90, 91
(Walter Olson ed., 1988). While the resulting race is toward more
stringent product liability rules, it can appropriately be
characterized as a race to the bottom because it produces a decrease
in social welfare. Bruce Hay responds by pointing out that such a
state will find its laws invoked not only by resident consumers
against nonresident manufacturers but also by nonresident consumers
suing resident manufacturers. As a result, there is a restraining
force that pushes states toward the socially optimal standards. See
Bruce L. Hay, Conflicts of Law and State Competition in the Product
Liability System, 80 Geo. L.J. 617 (1992). For further discussion of
these issues, see Richard Neely, The Product Liability Mess: How
Business Can Be Rescued from the Politics of State Courts 57-79
(1988); Michael H. Gottesman, Draining the Dismal Swamp: The Case
for Federal Choice of Law Statutes, 80 Geo. L.J. 1, 43-44, 49 &
See Butler & Macey, supra note 131, at 714-15.
Butler and Macey write:
Risk-adjusted insurance rates
would prevent the possibility of a destructive "race to the
bottom." Whenever a state adopted regulations (such as granting
new bank powers, increasing lending limits, or lowering reserve
requirements) that threatened to increase the risk of failure of
banks operating under its laws, banks chartered by that state would
suffer from higher deposit insurance premiums.
Id. at 715.
See text accompanying notes 31-35 supra.
This problem could be described as an externality as well, but I
believe that it is conceptually clearer to place it in a different
See notes 122-23 and accompanying text supra.
See notes 124-25 and accompanying text supra.
See note 126 and accompanying text supra.
n144. See text accompanying note 124 supra.