Carbon Tax: Pollution Solution Or Economic Burden?

The accumulation of greenhouse gases in Earth's atmosphere is largely due to the burning of fossil fuels, which releases carbon dioxide (CO2). A carbon tax is a market-based solution that aims to reduce these emissions by shifting the cost of polluting the air to businesses and consumers. The rationale is that as the cost of emitting CO2 increases, businesses and consumers will be incentivised to reduce their emissions, for example, by switching fuels or adopting new technologies. This, in turn, will reduce pollution.

How does a carbon tax work?

A carbon tax is a fee imposed on each unit of carbon dioxide (CO2) or other greenhouse gas emissions released into the atmosphere. The tax is levied on entities such as fuel suppliers, who then pass on the tax to consumers in the form of higher prices for electricity, gasoline, heating oil, and other products and services that depend on fossil fuels. The aim is to provide an incentive for producers and consumers to reduce energy use and shift to lower-carbon alternatives.

There are two main types of carbon pricing: emissions trading systems (ETS) and carbon taxes. Under a carbon tax, the government sets a price that emitters must pay for each ton of greenhouse gas emissions they emit. This price is typically set in relation to the social cost of carbon, which represents the present value of estimated environmental damages caused by an additional ton of carbon dioxide emitted. The tax rate is also designed to increase over time to reflect the growing damage expected from climate change.

The choice between an ETS and a carbon tax depends on national and economic circumstances. An ETS caps the total level of emissions and allows low-emission industries to sell their extra allowances to larger emitters, creating a market price for emissions. On the other hand, a carbon tax directly sets a price on carbon by defining a tax rate on emissions or the carbon content of fossil fuels. While an ETS provides more certainty about the level of emission reduction, a carbon tax provides more certainty about the cost.

Carbon taxes can be implemented at any point in the energy supply chain, from upstream (such as coal suppliers or oil refineries) to midstream (electric utilities) or downstream (energy-using industries, households, or vehicles). The simplest approach administratively is to levy the tax upstream, where the fewest entities would be subject to it.

The revenue generated from carbon taxes can be significant, and how this revenue is used is a political choice. Some proposals include returning the revenue to consumers in the form of dividends, reinvesting it in climate purposes or advancing low-carbon technologies, or using it to reduce existing taxes on labor and capital.

Carbon taxes have been proposed and implemented in various regions, with 37 programs across the world as of 2024. However, the global average carbon price is only $2 per ton, which is far below what is needed to meet emissions reduction targets.

What are the benefits of a global carbon tax?

A global carbon tax could have several benefits in reducing pollution and addressing climate change.

Firstly, a carbon tax discourages the use of fossil fuels and encourages a shift to less-polluting fuels and cleaner energy alternatives. This would reduce harmful greenhouse gas emissions, which are the primary driver of global warming and climate change. By imposing a fee on each ton of emitted carbon, a carbon tax provides an economic incentive for households, businesses, and other entities to seek lower-emissions alternatives, adopt new technologies, and pursue energy efficiency.

Secondly, a global carbon tax can generate significant revenue for governments, which can be reinvested in global climate adaptation, mitigation, and sustainable development initiatives. This revenue can be used to address pressing domestic needs, fund climate-related projects, and support vulnerable communities. For example, revenues can be used to invest in clean technology research and development, mass public transit upgrades, sustainable infrastructure, and environmental restoration efforts.

Thirdly, a global carbon tax provides a clear economic signal that internalizes the actual cost of carbon emissions. This means that the price of carbon-intensive goods and services will reflect the environmental damage caused by their production and consumption. This can stimulate market innovation and drive the development of new, low-carbon economic growth drivers.

Additionally, a global carbon tax can enhance transparency and predictability, facilitating international cooperation and emissions trading schemes. It provides a standardized approach to carbon pricing, as opposed to the current fragmented system of over 70 different approaches.

Finally, a global carbon tax can address existing inequities in greenhouse gas emissions. For example, Africa produces less than 3-5% of global carbon dioxide emissions but is disproportionately vulnerable to the impacts of climate change. A global carbon tax can be designed to share responsibility based on countries' income status and emission profiles, ensuring that higher-income countries contribute more and provide climate finance to lower-income countries.

What are the challenges of enacting a global carbon tax?

A global carbon tax is a shared global carbon pricing framework that leaders at the African Climate Summit in September called for to address existing inequities in greenhouse gas emissions and combat climate change. While a global carbon tax has significant benefits, there are also challenges to its enactment.

Public Support and Administration

Public support is a significant obstacle to implementing a global carbon tax. There is a fundamental ideology against taxes in many countries, and administering a tax is not always straightforward.

Revenue Use

There is also a debate about what to do with the revenue from a global carbon tax. Options include rebating the tax to people, spending it on clean energy programs and other climate investments, public projects, or reducing other taxes. How the revenue is spent can influence the degree of public support for a global carbon tax.

Cost Burden

Another challenge is that the cost burden of a global carbon tax will be split between producers and consumers. This means that enacting a global carbon tax will not only make fossil fuel companies pay, but also impact consumers.

Political Viability

Political viability is a primary challenge to enacting a global carbon tax. In regions with influential fossil fuel lobbies or high use of coal, oil, and gas, there may be major political and public opposition to carbon tax proposals. Lawsuits, repeal of laws, election defeats for supporters, and widespread protests against fuel taxes demonstrate the difficulty of stakeholder alignment.

Competitiveness and Leakage

A global carbon tax could put domestic energy-intensive, trade-exposed industries (EITEs) at a competitive disadvantage against international competitors that do not face an equivalent price. This could result in "emissions leakage," where demand shifts to countries without a carbon tax, reducing the climate benefit of the policy.

Policy Design

Choosing appropriate and adjustable tax levels that match policy priorities and economic diversity is complex across emissions-intensive sectors. Cost uncertainty creates opposition, and exemptions degrade the efficacy of a global carbon tax. Calibration requires balancing numerous stakeholders and objectives.

How does a carbon tax impact businesses and consumers?

A carbon tax is a levy imposed on the carbon dioxide and other greenhouse gas emissions produced by burning fossil fuels. The aim is to encourage people, businesses, and governments to produce less of these emissions, which are harmful to the environment. The tax is imposed on the entity emitting the gases, but the cost is often passed on to the consumer in the form of higher prices for goods and services.

Impact on businesses

The impact of a carbon tax on businesses depends on the industry and the energy sources used. Energy-intensive industries, such as chemicals, cement/concrete, and steel, are likely to be heavely impacted by a carbon tax as their production processes are often dependent on fossil fuels. These businesses may need to pass on the increased costs to their customers or risk seeing their profits reduced.

The impact of a carbon tax on businesses also depends on the competitiveness of their industry. If there is a lot of competition, businesses may find it difficult to pass on the full cost of the carbon tax to their customers without losing market share. In this case, their profits may be reduced, or they may need to absorb the cost of the tax themselves.

Additionally, the impact of a carbon tax on businesses can depend on the region in which they operate. For example, businesses in regions that depend heavily on carbon-intensive fuels, such as coal, are likely to be more affected than those in regions that use cleaner energy sources.

Impact on consumers

The impact of a carbon tax on consumers can be significant, as it often leads to higher prices for goods and services, particularly those that are energy-intensive. For example, a carbon tax could add several cents to the price of a litre of gasoline or increase the cost of electricity.

The impact of a carbon tax on consumers also depends on their income level. Lower-income households spend a larger share of their income on energy, so a carbon tax that increases energy costs can have a disproportionate impact on these individuals.

However, it's important to note that the impact of a carbon tax on consumers can be mitigated by how the revenue from the tax is used. For example, if the revenue is used to reduce taxes on labour or capital, or if it is returned to consumers in the form of a dividend, the negative impact of the tax on consumers may be lessened.

What are the environmental benefits of a carbon tax?

A carbon tax is a tax levied on firms that produce carbon dioxide (CO2) through their operations. It is designed to reduce greenhouse gas emissions and protect the environment from the harmful effects of excessive carbon dioxide emissions. Here are some of the key environmental benefits of a carbon tax:

Discouraging the Use of Fossil Fuels

A carbon tax can play a crucial role in reducing the burning of fossil fuels, which releases carbon dioxide into the atmosphere. By imposing a tax on carbon emissions, businesses and consumers are incentivised to switch to less-polluting fuels and renewable energy sources. This shift can help limit the amount of carbon dioxide released into the atmosphere, which is the most prevalent greenhouse gas.

Reducing Greenhouse Gas Emissions

Carbon taxes are specifically designed to reduce greenhouse gas emissions, which contribute to climate change. By placing a monetary cost on carbon emissions, businesses and consumers are encouraged to reduce their carbon footprint and transition to cleaner technologies. This can help slow down the accumulation of heat-trapping gases in the Earth's atmosphere, mitigating the impacts of global warming.

Providing Incentives for Research and Investment

In addition to discouraging polluting activities, carbon taxes also provide incentives for research and investment in more efficient and low-emission technologies. Businesses may be motivated to invest in renewable energy sources and develop innovative solutions to reduce their carbon emissions. This can drive the development and adoption of cleaner technologies, further contributing to environmental protection.

Reducing Local Air Pollution and Its Health Impacts

Carbon taxes can bring more immediate environmental and health benefits by reducing local air pollution. Lowering carbon emissions can improve air quality, reducing the incidence of respiratory issues and other health problems associated with polluted air. This can lead to a decrease in pollution-related deaths and improve the overall health of the population.

Stimulating Clean Technology and Market Innovation

By placing a price on carbon, a carbon tax stimulates the development and adoption of clean technologies. It encourages innovation in the market, fuelling the growth of new, low-carbon economic drivers. This can lead to the creation of more sustainable industries and a reduction in the environmental impact of traditional fossil fuel-based industries.

Overall, a carbon tax has the potential to bring about significant environmental benefits by reducing greenhouse gas emissions, encouraging the adoption of cleaner technologies, and improving air quality. However, it is important to note that the effectiveness of a carbon tax depends on various factors, including the specific design and implementation of the tax, the level of the tax rate, and the existence of complementary policies.

Frequently asked questions