Can Taxes Save the Planet? Assessing the Role of Pigouvian Taxation in Addressing Environmental Externalities in Pakistan

Abstract

The capacity of Pigouvian taxation to internalize environmental externalities remains empirically contested in developing economies characterized by structural constraints and governance weaknesses. This study evaluates the interaction between fiscal policy, institutional quality, and carbon emissions in Pakistan over the period 1996–2024. The analysis incorporates per capita CO₂ emissions as the dependent variable and examines the effects of energy consumption, fossil fuel dependence, renewable energy penetration, tax revenue, economic growth, and government effectiveness using time-series data from the World Development Indicators and Worldwide Governance Indicators. To ensure econometric robustness, unit root tests and diagnostic procedures are implemented to address non-stationarity and potential heteroskedasticity. The empirical model is estimated using Robust Least Squares with heteroskedasticity-consistent standard errors. The results indicate that total energy consumption and fossil fuel reliance exert significant positive effects on emissions, whereas government effectiveness has a statistically significant mitigating impact, emphasizing the importance of institutional capacity in environmental governance. Tax revenue is positively associated with emissions, suggesting weak environmental targeting of fiscal instruments. Furthermore, the empirical evidence does not support the presence of an Environmental Kuznets Curve during the sample period. The findings suggest that environmental taxation in Pakistan cannot operate effectively in isolation but must be embedded within institutional reforms and structural energy transition policies to achieve sustainable emission reductions.