Fiscal Rules and Environmental Spending: Navigating the Trade- off between Discipline and Green Priorities

Environmental concerns are becoming more pressing as the climate emergency intensifies, posing a major challenge for many governments: increasing green investments to promote better adaptation and resilience to climate events, while maintaining fiscal discipline. This raises the question of whether governments that operate under fiscal rules tend to safeguard environmental spending in light of the climate emergency, or whether they are more inclined to scale it back to meet their fiscal targets, given that such investments require substantial public funding. Using data covering 31 advanced economies between 1995 and 2021, we find robust evidence that the strengthening of fiscal rules significantly reduces environmental spending, in particular debt rules and expenditure rules. Moreover, the adverse impact of fiscal rules on environmental expenditures is amplified during election periods, whereas it is mitigated in the presence of sound past fiscal conditions, the Kyoto Protocol, and stringent environmental policies. Further analysis reveals that although fiscal rules tend to reduce environmental spending, they are associated with greater efficiency in such spending.