Environmental risks, and, in particular, climate change and environmental pollution are some of the key challenges which modern governments face nowadays. Environmental risks are associated with specific costs and expenditures necessary to mitigate their negative effects. In this context, the financial system plays a significant role, particularly the public financial system, which allocates and redistributes public resources and has an impact on market participants by imposing environmental taxes. The article assesses the interdependence between environmental degradation and public expenditure, financial sector development, environmental taxes, and related socio-economic policies. The paper aims to diagnose and define the relationship between environmental degradation and sustainable fiscal instruments used in the financial system. The original research approach adopted in the article is expressed in the inclusion of variables representing the sustainable approach to the assessment of the financial system. Two groups of the European Union countries are analysed for the 2008-2017 period: converging economies from Central and Eastern Europe and the largest developed economies of Western Europe. The authors find a strong relationship between greenhouse gas emissions and fiscal instruments, especially the expenditure on Research & Development, and the development of the financial sector. In the case of environmental taxes, their impact differs depending on the country, and it is predominantly beneficial in countries with higher greenhouse gas emissions but unfavourable in countries with lower emissions levels.