From policy to progress: Environmental taxation to mitigate air pollution in OECD countries

Abstract

Environmental taxes play a critical role in mitigating air pollution and fostering sustainability by internalizing the social costs of environmental damage. By imposing financial disincentives on polluters, these taxes encourage cleaner practices and technological innovation. Using panel ARDL models, this study examines the impact of environmental taxes on CO₂ emissions across 38 OECD countries, accounting for cross-sectional dependence, non-stationarity, and heterogeneity. Findings reveal a significant long-run negative relationship between environmental taxes and CO₂ emissions and support the Environmental Kuznets Curve (EKC) hypothesis in high-income nations. The analysis highlights that while environmental taxes effectively reduce emissions at moderate and high levels, their impact diminishes at lower emission levels. Moreover, disaggregated analysis of fossil fuel consumption demonstrates a substantial decline in coal and oil usage, whereas natural gas consumption exhibits a positive association with taxes, reflecting a shift toward less carbon-intensive energy sources. The study emphasizes the importance of well-designed environmental tax schemes to maximize policy effectiveness. • Environmental taxes significantly reduce CO 2 emissions in OECD countries. • Taxation most effectively reduces emissions at moderate to high levels. • Shifting to cleaner energy sources, such as natural gas, as taxes increase. • The effectiveness of environmental taxes varies among the group of countries. • Strengthening environmental tax policies can drive cleaner energy transitions.