A carbon tax is an environmental tax on the emissions of carbon dioxide – a heat-trapping “greenhouse” gas. It is a form of carbon pricing. Carbon tax is levied on the production, distribution or use of fossil fuels based on how much carbon is emitted upon their combustion.
Carbon is found in all hydrocarbon fuels, including coal, petroleum, and natural gas. When hydrocarbon fuels are burned, carbon and hydrogen atoms react with oxygen in air, releasing heat energy and carbon dioxide.
The amount of carbon dioxide caused by the combustion of a fossil fuel is proportional to the fuel’s carbon content. Because of this, carbon tax is simple to document and measure. In fact, the tax can be levied at any point in the product cycle of the fuel.
The goal of a carbon tax is to reduce greenhouse gas emissions in the atmosphere. The tax makes those who do pollute pay an amount in proportion to their emissions. This can be a powerful incentive for an economy to be more energy-efficient and move to non-carbon fuels.
Economists often describe carbon taxes as ‘internalizing the externality’. That is, making polluters pay for the environmental and health costs that their emissions impose on society.
Carbon tax aims to change behavior and guide purchases and investments. The increase in prices for consumers are proportional to the carbon content of a fuel, which sends a price signal to producers and consumers, encouraging them to reduce their consumption and use products generating the least carbon dioxide.
According to the UNFCCC, over 40 national jurisdictions have implemented some form of carbon pricing, whether through a carbon tax or cap-and-trade system
For example, Sweden introduced its carbon tax in 1991, and as of 2023, it stands at one of the highest rates globally — over US$130 per metric ton of CO2.
Canada has also implemented a federal carbon pricing system. In 2023, it rose to $65 CAD per metric ton, with further increments scheduled each year until it reaches $170 CAD in 2030.
How is the tax revenue used?
Governments can use the revenue from carbon taxes in different ways. Some return part of the revenue directly to households through rebates, making the scheme ‘revenue-neutral.’ Others use the funds to invest in renewable energy, energy-efficient infrastructure, or to offset other taxes, further encouraging a transition to cleaner options.
Government and corporate leaders on why they support a price on carbon
Government leaders have made the following comments on their support for carbon pricing:
“Climate change poses great dangers to us all. Carbon pricing makes investments in low-carbon or carbon-free technologies attractive and ensures that fossil fuels are used efficiently.” – Germany Chancellor Angela Merkel
“There has to be a price on carbon because there is a price on carbon: it’s the consequences to health and the economy and to our climate. We face an existential challenge with the changes in our climate. The time to act is now.” – US State of California Governor Jerry Brown.
“Cities that take action on climate change now are building a more resilient, prosperous future for their citizens tomorrow. In Vancouver, our efforts to reduce carbon pollution have helped grow our economy while protecting the environment – a win-win.” – Gregor Robertso, 39th Mayor of Vancouver, British Columbia, from 2008 to 2018.
Challenges and debates
Some critics worry that carbon taxes could disproportionately affect low-income households, who spend a larger share of their income on energy. Others argue that certain industries (like heavy manufacturing) might face international competitiveness issues. Governments can address these concerns by providing rebates or tax credits to low-income groups, and by gradually phasing in the tax to allow industries time to adapt.
According to The Economist, in 2020, only 20% of emissions were subject to a carbon price, and in many places, the tax rate is well below what is deemed necessary to cut emissions. As a result, carbon taxes sometimes lack the power to drive deep emission reductions.
Another challenge involves long-term certainty. If governments later repeal or weaken carbon taxes, businesses may be reluctant to invest in low-carbon technologies. Australia, for example, cancelled its carbon tax in 2014. This shows just how fragile such policies can be in shifting political winds.
Companies that rely heavily on fossil fuels also fear they’ll be at a competitive disadvantage if overseas rivals don’t face similar taxes. One proposed solution is a border carbon adjustment (BCA), which charges imports from places without carbon taxes. However, implementing BCAs is complicated and could spark trade disputes.