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This study highlights the importance of fiscal decentralization in promoting a sustainable environment. The literature on the importance of fiscal decentralization in affecting environmental quality is scant, and thus, this study attempts to fill the gap by incorporating the linear and nonlinear terms of fiscal decentralization as possible determinants for CO2 emissions. Particularly, we utilize data from seven highly fiscally decentralized countries, that is, Australia, Austria, Belgium, Canada, Germany, Spain, and Switzerland, over the period 1990–2018. For empirical analysis, advanced panel data econometric tools are used that can deal with both heterogeneous coefficients and dependence of cross‐sections. The findings confirm that linear and nonlinear terms of fiscal decentralization improve the environment by reducing CO2 emissions. Moreover, gross domestic product (GDP) increases, while eco‐innovation and renewable energy usage reduce CO2 emissions. This study recommends that any policy that targets green growth will affect CO2 emissions. Moreover, policies targeting fiscal decentralization, GDP, eco‐innovation, and renewable energy will play the role in more than 1 year, namely in the long run.