Growth and welfare effects of environmental tax reform and public spending policy

•I consider the implications of environmental tax reform and public spending policy for growth and welfare.•I Use an endogenous growth model where the interactions between health, education, and the environment are considered.•Revenue-positive tax reforms combined with a change in public spending structure may improve long-run growth and welfare.•Long term welfare gain incurs relatively high welfare cost during the transition phase.

This paper considers the implications of environmental tax reform and public spending policy for growth and welfare. Using a two-sector endogenous growth model where the interactions between health, education, and the environment are taken into account, we show that revenue-positive tax reforms combined with a change in the public spending structure may improve long-run growth and welfare. However, this outcome incurs relatively high welfare cost during the transition phase. This is particularly the case when the spending policy favors education spending.