Macroeconomic Trade-Offs of Green Fiscal Policies: Evidence from a Cross-Country Panel Study

This paper investigates the short- to medium-run macroeconomic impacts of environmental fiscal instruments—specifically environmental taxes and fossil fuel subsidies—on GDP growth and inflation. Using a balanced panel of 32 countries from 2000 to 2022, we employ a combination of pooled OLS regressions, local projection methods, and three-stage least squares (3SLS) structural modeling to estimate both the direct effects and underlying transmission mechanisms. The empirical results reveal that environmental taxes reduce output growth in the short run by reducing carbon intensity, lowering energy use, and discouraging investment. However, they also contribute to a more stable inflation environment and deliver clear environmental benefits, highlighting a fundamental trade-off between climate mitigation and near-term economic expansion. In contrast, fossil fuel subsidies temporarily stimulate GDP growth and capital formation, but at the cost of higher inflation, increased macroeconomic volatility, and greater environmental degradation due to elevated carbon emissions and investment in fossil-based activities. To conceptually support these findings, we develop a static general equilibrium model that highlights how fiscal instruments alter production costs and price dynamics. Overall, the study reveals the complex trade-offs inherent in green fiscal policy, particularly the tension between fostering economic activity and achieving environmental goals, and provides timely insights for policymakers seeking to balance macroeconomic stability with sustainability. JEL Codes: E31, E62, H23, O44, Q58.