The National Portrait Gallery has become the first major art institution to give up a grant from the controversial Sackler family, in a move that campaigners said was a landmark victory in the battle over the ethics of arts funding.

In a decision hailed as “a powerful acknowledgment” that some sources of income could not be justified, a spokesperson for the gallery said it had “jointly agreed” that it would “not proceed at this time” with a £1m donation from the family, whose US pharmaceutical company Purdue Pharma LP makes the highly-addictive opioid prescription painkiller OxyContin.

The spokesperson added: “We fully respect and support the Sackler family’s decision.”

With some leading members of the Sackler family facing a growing number of lawsuits over their alleged role in the deadly US opioid crisis, the family – which vigorously denies the allegations – claimed the donation to the gallery’s Inspiring People project had been dropped to avoid creating a “distraction” for the gallery.

But while both parties insisted that the decision was mutual, it will be seen as a major blow to the family’s status as leading philanthropists and evidence that a campaign against the Sacklers, led by the American artist Nan Goldin, has been effective.

Goldin, an art photographer who has spoken about becoming addicted to OxyContin after being prescribed the drug, told the Guardian on Tuesday that she was “so happy” with the “important” decision taken by the National Portrait Gallery.

She said she hoped it would influence other museums and cultural and educational institutions in the UK, the US and elsewhere that accepted gifts from the Sackler family to reconsider.

“They did the right thing,” she said of the National Portrait Gallery’s decision. “I hope there is a domino effect now; there needs to be.”

The NPG is one of many British cultural institutions in line for substantial donations from members of the family, but it faced severe pressure from artists and campaigners who argued that accepting funding from the owners of the company that makes OxyContin would make the NPG complicit in its harms.

Reacting to the announcement, Jess Worth, the co-director of campaigning organisation Culture Unstained, said: “The gallery’s decision to reject a donation from those that profited from the opioid crisis is a powerful acknowledgment that some sources of funding cross a red line.”

She argued that there should be wider consequences. “This raises the question of whether the gallery will now apply the same standards to its BP sponsorship deal or continue to promote a fossil fuel company in the midst of a climate crisis,” she said. “Waved through with minimal scrutiny in the past, BP sponsorship now – like the Sackler donation – looks ethically untenable.”

The Sackler family has an estimated worth of $13bn, making them the 19th richest family in America, according to a 2016 estimate by Forbes magazine. They have long made huge philanthropic donations each year.

But after court filings claimed that some members of the family “actively participated in conspiracy and fraud to portray [OxyContin] as non-addictive, even though they knew it was dangerously addictive”, some public institutions – including New York’s Columbia University and Metropolitan Museum of Art – have reviewed whether they would continue to accept their donations.

Goldin said: “I spoke to the National Portrait Gallery this morning. I’m so happy, I’m very glad about it. We have to hold museums to a higher standard, they are supposed to be a repository of the best of humanity, a repository of learning and culture.”

She wants institutions to pledge not to take Sackler money in the future and to take the family’s name down from facades and galleries.

The Sackler trust’s grant to the National Portrait Gallery was awarded in 2016 for the £35.5m project for building development, a new education centre and redisplaying the collection. The money remained a pledge and was not paid, partly because work had not started and the gallery’s ethics committee was considering the implications of funding from the multibillionaire family.

Goldin had threatened to refuse a retrospective of her work to be held at the gallery if it accepted the donation and staged protests at the Guggenheim Museum and the Metropolitan Museum of Art in New York over their links to the arts philanthropists.

The Sackler Trust said: “[We have] has supported institutions playing crucial roles in health, education, science and the arts for almost half a century and we were pleased to have the opportunity to offer a new gift to support the National Portrait Gallery. The giving philosophy of the family has always been to actively support institutions while never getting in the way of their mission”.

”Recent reporting of allegations made against Sackler family members may cause this new donation to deflect the National Portrait Gallery from its important work. The allegations against family members are vigorously denied, but to avoid being a distraction for the NPG, we have decided not to proceed at this time with the donation. We continue to believe strongly in the gallery and the wonderful work it does.”

David Ross, the National Portrait Gallery chair, said: “I acknowledge the generosity of the Sackler family and their support of the arts over the years. We understand and support their decision not to proceed at this time with the donation to the gallery.”

The Sackler name has provided financial support for numerous institutions in the UK, including the Royal Opera House, National Gallery, National Theatre, Shakespeare’s Globe, Royal Ballet school, Tate, Old Vic and Royal College of Art. In 2017, the V&A unveiled a £2m Sackler courtyard.

Meanwhile, the V&A Dundee is under pressure to return a donation to the Sackler family, according to a report in Scotland on Sunday.