The Effectiveness of Environmental Policy : Does the Source of Revenue Matter?

It is widely believed that government intervention and especially public spending is required to overcome the market failure in providing public goods such as environmental quality. Nevertheless, the extent to which the fiscal environmental policy contributes to an improvement in environment is not clear. In this paper, we address the question of whether the source of government expenditures allocated to environmental protection matters to environmental quality. We develop a Ramsey growth model in which government spending on environmental protection is financed through two alternative sources: Taxes and natural resources rents. The model suggests that, along the balanced growth path, the natural resource rent and tax revenues affect the effectiveness of environmental spending in opposite directions. That is, spending financed by taxes improves the environmental quality but spending out of rents deteriorates it. The model also shows that the link between the environmental protection expenditures and environmental outcome can be better understood by examining the socio-political institutions governing the economy. We test the propositions derived from the model using a panel data of 58 countries for the period 1995-2015. The empirical findings support the proposition that the funding sources of the environmental protection expenditures matter to environmental outcome. The results also indicate that the higher institutional quality such as greater state capacity increases the effectiveness of the government’s environmental spending on the environmental quality