Carbon Tax 101: Putting a Price on Carbon Pollution

  • Published on October 4th, 2015

carbon tax 101

Most economists agree that putting a price on carbon will allow the market to account for the costs created by the extraction and burning of fossil fuels. But what’s the best way to do this? A carbon tax is one method for using markets to lower the amount of carbon we emit into the Earth’s atmosphere.

  1. What is a carbon tax?

A carbon tax is “a fee assessed on the carbon content of fuels.” All fossil fuels – coal, oil, natural gas – contain carbon, and this carbon is released in the form of CO2 when we burn these fuels. As a greenhouse gas, carbon dioxide contributes to the trapping of heat within in the Earth’s atmosphere, and, by extension, climate change.

A carbon tax represents an effort to put a price not just on carbon itself, but on the environmental impacts created by emitting it into the atmosphere. Traditionally, those who emit large amounts of carbon – power plants, cement plants, large buildings, etc. – have not had to pay any costs associated with carbon pollution; all of those costs become externalities, which are paid by others – often taxpayers. A carbon tax attempts to inform the market of the costs of this pollution, and, thus, create economic benefits for those technologies that emit less of it, or none of it.

If someone – an individual or a business – hurt you or a member of your family, or damaged your property, you’d expect them to pay for that damage or hurt. That financial risk generally modifies behavior, as none of us want to pay the cost of harming someone else. That’s the idea underlying the carbon tax: carbon pollution creates harm and damage, and those that benefit from that pollution should also bear responsibility for the harm caused. That responsibility makes carbon-based energy more expensive, and less financially appealing.

  1. Why would we want to institute one?

There are several good reasons for considering the implementation of a carbon tax.

First, as noted above, a carbon tax represents one method of forcing the emitters of carbon pollution to pay for the costs – environmental and economic – that they create. A “well head” carbon tax assigns the fee to the organization/company that extracts the carbon in the form of coal, oil, or gas. We know the carbon content of these materials, and can assign fees based on that content. A coal mining company, or an oil or natural gas driller, thus has to pay the cost of the carbon pollution created by that material.

But won’t they just pass that cost on to customers? Yes, and that brings up a second good reason for considering a carbon tax. This mechanism allows for the market to see the total costs created by carbon-rich fossil fuels. Miners of coal, which contains the highest density of carbon, would pay the highest fees for the material they extract. Oil and natural gas would have lower fees assigned. Technologies like solar, wind, and geothermal power would only pay such fees through higher costs of materials used in their manufacturing, transportation of materials, and finished products, etc.; the energy they produce wouldn’t be subject to the tax, and, thus, would be cheaper than carbon-based fuels. A carbon tax helps the market position of energy sources that produce little or no carbon pollution.

Over the long term, the shift in demand to low and no-carbon sources of energy will bring down the prices of that technology. We’re already seeing that happening with solar power.

Finally, a carbon tax could be used to reduce other taxes, such as those on income. If governments choose to introduce a revenue-neutral carbon tax, then the amount of taxation levied on carbon with have to be offset by other tax reductions. Such offsets would make the implementation of a carbon tax more politically palatable, and could have additional economic benefits. A reduction on income taxes, for instance, could provide economic stimulus, as individuals and businesses are more likely to make purchases they might have avoided otherwise. A reduction in business taxes could lead to job creation (although it could also simply result in higher profit margins for investors).

But does this work? The Canadian province British Columbia instituted a revenue-neutral carbon tax in 2008, and it’s benefited both the environment and the economy.

  1. Is a carbon tax better than a cap-and-trade system?

Both the carbon tax and the cap-and-trade mechanism have their proponents, and both hold promise for reducing carbon dioxide emissions, and, eventually, decreasing the threats posed by catastrophic climate change. Carbon tax supporters such as former Clinton administration adviser and Columbia professor Joseph Stiglitz prefer the carbon tax for a number of reasons. Stiglitz argues that basic supply and demand dynamics undermine cap-and-trade as a tool for addressing climate change: price hikes of carbon-based fuels will drop demand, but that, in turn, will lead to decreased prices (and, thus, increased demand). A tax, on the other hand, will keep the prices of coal, oil, and natural gas higher regardless of other economic dynamics.

The Carbon Tax Center points to a number of other qualities that make carbon taxes a preferable means for addressing the cost of carbon in the market, including simplicity, transparency, and the ease of implementation.

  1. What are the disadvantages to a carbon tax?

While a carbon tax provides a great sense of certainty to the market in terms of the price of carbon pollution, it offers little guidance about the amount of pollution it will eliminate. Because other market dynamics will continue to effect the prices of energy sources, a tax won’t guarantee that low and no-carbon technologies will always have the price advantage (though it definitely makes this more likely). Furthermore, adjusting a carbon tax, particularly upward, carries with it the usual political difficulties associated with any sort of revenue increase.

  1. What are the political obstacles to implementing a carbon tax?

No one likes taxes, and many respond negatively to the word… even if it’s revenue neutral. Politicians who’ve made commitments such as “no new taxes” pledges likely won’t support a carbon tax regardless of the circumstances: the risk of political damage, or being portrayed as a “flip-flopper” may be just too great. And legislators that don’t accept climate science themselves, or represent constituencies that reject the scientific consensus on global warming, won’t see the need for such a tax.

Of course, industries that rely on fossil fuels for their revenue won’t support a carbon tax, and will likely lobby legislators to oppose one. For decades, we’ve watched industries such as oil, gas, and coal companies, petrochemical manufacturers, and other interested parties not only lobby the US Congress, but also fund think tanks such the Heartland Institute and the American Enterprise Institute, which have, in turn, argued for these industries’ positions.

What do you think? Is a carbon tax the best market-based tool for reducing our carbon emissions? Share your thoughts with us in the comments?

Photo Credit: Calin Tatu via Shutterstock

About the Author

Jeff McIntire-Strasburg is the founder and editor of sustainablog. You can keep up with all of his writing at Facebook, and at
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  • jfreed27

    Yes, a “carbon fee and dividend” makes enormous sense!

    This way citizens would RECEIVE the carbon 
fees as a monthly dividend. That would cancel out any price spikes in dirty energy.

    Polluters PAY the fees, so it holds fossil fuel corporations responsible for the damages they cause, hundreds of billions of dollars per year (Harvard School of Medicine).

    It would rapidly lower emissions, as happened in BC Canada with a similar policy. BC lowered both emissions and taxes with their fees.

    A study by respected Regional Economic Modeling, Inc. found the dividends would help to create 2.9 million additional jobs in 20 years.

    To those who reject the science: perhaps nothing will change
 your mind. But what have you got against cleaner air, less asthma in our kids, fewer heart attacks, and more money (the dividend) in your pockets?

    To those accepting the science: Any effort to
 limit the problem of climate change is worth it.

    For example: the cost of sea level rise ALONE is so great that no effort to prevent it is unwarranted.

    Why even bother with the paid deniers who thrive creating the 
delay of a false debate? IMO we must take action by supporting responsible adults, of either party, for Congress.

  • Bart_R

    Another model to describe carbon pricing is privatization of the capacity of air to dispose of CO2 from fossil. This service is a new commodity, only as old as burning coal and oil, and we know it meets the six SCREAM conditions Lin Ostrom and Market experts talk about for privatizing a shared common resource:

    Scarce – the level of undisposed fossil CO2 in air backing up and clogging the carbon cycle is demonstrably growing, therefore the service of disposal of CO2 from coal, oil, gas and limestone is limited and will run out if use is unlimited.

    Commodifiable – can the service of disposal of CO2 from fossil be made a commodity with alternatives and workarounds and a means of relative pricing? The case of the British Columbia Revenue Neutral Carbon Tax Act tells us this is so: figure out how much fossil carbon is in a commodity for sale (or in the case of fugitive emissions from processing, how much is leaked in the production of commodities), and that there are means for making these commodities with greater CO2-efficiency or to sequester CO2 produced.

    Rivalrous – no two people can benefit in the same human lifespan from the same change in CO2 level due fossil waste dumping in air. Carbon is essentially forever in the environment once liberated from fossil underground sources, lasting hundreds to tens of thousands of years.

    Excludable – again British Columbia shows that by tying the CO2 emission to the excludable commodity (coal, oil, gas or cement) indexed by carbon content, the same excludability of the source commodity makes the service of disposal likewise excludable. Of course, internationally trading partners must do what subnational governments can’t: impose tariffs at their borders where the goods imported have not already paid a carbon price.

    Administrable – again British Columbia, by folding its carbon fees into a pre-existing retail tax system and returning all fees collected to taxpayers through lowering income taxes and business taxes proved carbon pricing is administrable. Note this distinction here between Cap & Trade and Carbon Tax: C&T treats the disposal capacity of air as a resource of the state, for sale or license in exchange for fees paid to the state; Revenue Neutral Carbon Tax forces the state to hand over every penny to the manifestly inalienable owners of air, every person with lungs equally.

    Merchantable – No one is doing this right now, but there’s no reason not to set the carbon price by the Law of Supply and Demand, so high as the Market will bear, until the next penny of increased price results in net lower revenue to the owners of air.

    Governments that fail to enforce Market price on CO2 waste dumping are failing their obligations to the capital markets of their nations.