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Environmental risks, in particular climate change and environmental pollution, are among the key challenges faced by modern governments nowadays. Environmental risks are associated with specific costs and expenditures necessary to mitigate their negative effects. In this context, the financial system plays a significant role, particularly the public financial system, which allocates and redistributes public resources and has an impact on market participants by imposing environmental taxes. This study assessed the interdependence between environmental degradation and public expenditure, financial sector development, environmental taxes, and related socioeconomic policies. The aim was to diagnose and define the relationship between environmental degradation and sustainable fiscal instruments used in the financial system. The original research approach adopted in the study is the inclusion of variables representing a sustainable approach to assessment of the financial system. Two groups of European Union countries were analyzed for the period 2008–2017, namely, converging economies from Central and Eastern Europe and the largest developed economies of Western Europe. The authors found a strong relationship between greenhouse gas emissions and fiscal instruments, especially expenditure on research and development, and the development of the financial sector. In the case of environmental taxes, their impact differed depending on the country, being predominantly beneficial in countries with higher greenhouse gas emissions but unfavorable in countries with lower emissions levels.

Patterns of Interdependence between Financial Development, Fiscal Instruments, and Environmental Degradation in Developed and Converging EU Countries