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Land-use restrictions are frequently applied to separate polluting from non-polluting activities. In contrast to the existing literature, we incorporate spatial and intertemporal aspects of the problem simultaneously and determine the border of the zones endogenously. The results, based on a two-stage optimization method, show that non-spatially differentiated Pigouvian taxes on the final emissions are able to establish the socially optimaloutcome. Second-best instruments alone, such as a spatially differentiated tax on inputs or outputs are not able to support the socially optimal outcome and need to be complemented by land-zoning or land-use taxes. We compare the efficiency of different spatial environmental policies such as land-use taxes or land zoning. The necessary changes required to transform a spatially optimal, yet static, environmental policy into an intertemporally and spatially optimal environmental policy are presented and discussed.
