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Description
Abstract
Introduction: The distributional effects of environmental taxes are widely debated in fiscal policy and governance. Although essential for sustainability, these taxes may be regressive, disproportionately affecting low-income households. This study examines their impact on income inequality across the 27 EU member states over the period 2013–2023, with a particular focus on whether governance quality mediates this relationship and can mitigate their regressive effects.
Methods: The study uses a quantitative approach based on Eurostat and World Bank data, carried out in three stages: KNN clustering to group EU countries, multiple regression to test the direct effect of environmental taxes on inequality, and mediation analysis to assess institutional transmission channels. Inequality is measured using the Palma ratio, while environmental tax revenue, governance effectiveness (GE), and regulatory quality (RQ) serve as key variables. Unemployment and social protection expenditure are included as control variables to ensure robustness.
Results: The cluster analysis reveals substantial heterogeneity among EU member states in institutional and distributional terms. The regression results show no statistically significant direct effect of environmental taxation on income inequality, indicating the need to consider indirect transmission channels. In this respect, the mediation analysis identifies contrasting effects: governance effectiveness (GE) exerts a positive indirect influence, while regulatory quality (RQ) has an opposing effect, resulting in a significant net indirect impact. Finally, control variables confirm that social protection reduces inequality, whereas unemployment increases it, highlighting important redistributive dynamics within the EU fiscal context
Discussion: These results show that the impact of environmental taxes is nonlinear and depends on institutional quality. Strong governance can mitigate regressive effects through efficient revenue use and compensation mechanisms, while weak governance may increase inequality. Overall, the findings highlight cross-country heterogeneity in the EU and suggest that uniform green fiscal policies are inadequate, as institutions shape whether environmental taxes support sustainability or deepen inequality.
Conclusions: The study shows that while environmental taxes are necessary, their fairness depends on the regulatory capacity of public institutions. Targeted revenue recycling, such as lowering labour taxes or funding social transfers, is essential to offset regressive effects. Strengthening institutional quality and social safety nets is, therefore, key to ensuring that environmental taxes do not increase income inequality.
Keywords: Environmental taxation, Income inequality, Governance quality, Mediation analysis
JEL classification: D63, H23, Q58
Acknowledgement: This work was supported by a grant, PNRR, CF 193/28.11.2022, Funding Contract no. 760078/23.05.2023
