Subsidies, costs, and local taxes: a theoretical note on circular economy investments

This paper develops a theoretical model to examine how investment subsidies for circular economy projects influence local taxation in decentralized governance systems. When environmental infrastructure is co-financed by higher-level governments but operated locally, fiscal effects depend on how investments modify cost structures. Using a principal agent framework, I show that the relationship between subsidies and local taxes is non-monotonic: at low investment levels, subsidies reduce costs and taxes, but beyond the efficiency threshold, further investment raises operational complexity and fiscal pressure. A dynamic extension incorporating transition costs explains why local taxes may temporarily increase before efficiency gains materialize. The model offers a tractable framework to interpret the fiscal implications of circular economy policies within multi-level European governance, with specific relevance to current EU funding schemes.