Shadow economy and ecological footprint: the moderating role of environmental taxes

Abstract

Purpose This study investigates the relationship between the shadow economy and environmental degradation, measured through the ecological footprint, in G7 countries over the period of 1995–2020. It further examines how environmental taxes and the dynamics of financial institutions moderate this relationship. Design/methodology/approach Using macro-level panel data, the analysis applies advanced econometric techniques, including FMOLS, DOLS, AMG, GMM and PSCE, followed by the Dumitrescu and Hurlin (2012) panel causality test. These methods allow for robust estimation of long-run relationships and causal linkages while accounting for cross-sectional dependence and heterogeneity. Findings The results reveal that the shadow economy significantly increases the ecological footprint, as shown in Figure 1. However, this adverse effect is mitigated by higher environmental taxes, while positively moderated by greater access to financial institutions and improved financial efficiency. While environmental taxes and financial depth/efficiency demonstrate a negative association with ecological footprint, financial depth exhibits a positive relationship. Originality/value This study contributes to the literature by integrating the shadow economy, environmental taxation, and financial development dimensions within a single empirical framework for the G7 economies. The findings provide actionable insights for policymakers seeking to design tax reforms and financial sector interventions that jointly curb both the shadow economy and environmental pressures. Graphical abstract Graphical abstract A conceptual diagram shows factors with positive and negative links to an ecological footprint. The conceptual diagram shows a central rectangular box labeled “Ecological footprint”. Five surrounding rectangular boxes are connected to this central box by arrows with directional labels. Above the central box, a rectangle labeled “Environmental Taxes” is connected by a downward arrow labeled “Negative” pointing to “Ecological footprint”. On the left side, a rectangle labeled “Financial Institutions’ Efficiency” is connected to the central box by a rightward arrow labeled “Negative”. At the lower left, a rectangle labeled “Financial Institutions’ Depth” is connected by an upward arrow labeled “Negative” pointing to the central box. On the right side, a rectangle labeled “Financial Institutions’ Access” is connected by a leftward arrow labeled “Positive” pointing toward “Ecological footprint”. At the lower right, a rectangle labeled “Shadow Economy” is connected by an upward arrow labeled “Positive” pointing to the central box.