What Is a Carbon Tax: Basics, Implementation, Offsets

What Is a Carbon Tax?

A carbon tax is a type of penalty that businesses must pay for excessive greenhouse gas emissions. The tax is usually levied per ton of greenhouse gas emissions emitted.

Carbon taxes have been implemented in 35 countries to date. The United States has not enacted a carbon tax although a number of proposals for one have been submitted to the U.S. Congress.

A carbon tax is paid by businesses and industries that produce carbon dioxide through their operations. The tax is designed to encourage such businesses to reduce their output of greenhouse gases and carbon dioxide, a colorless and odorless incombustible gas, into the atmosphere.

Understanding the Carbon Tax

A tax designed to mitigate or remove the negative externalities of carbon emission, a carbon tax is a type of Pigouvian tax. Carbon is found in every kind of hydrocarbon fuel (including coal, petroleum, and natural gas) and is released as the harmful toxin carbon dioxide (CO₂) when this kind of fuel is burned. CO₂ is the compound primarily responsible for the "greenhouse" effect of trapping heat within the Earth's atmosphere, and is thus one of the primary causes of global warming.

Government Regulation

A carbon tax is also referred to as a form of carbon pricing on greenhouse gas emissions where a fixed price is set by the government for carbon emissions in certain sectors. The price is passed through from businesses to consumers. By increasing the cost of greenhouse emissions, governments hope to curb consumption, reduce the demand for fossil fuels, and push more companies toward creating environmentally-friendly substitutes.

A carbon tax is a way for a state to exert some control over carbon emissions without resorting to the levers of a command economy, by which the state could control the means of production and mandate a halt in production and services producing carbon emissions.

Implementing a Carbon Tax

In a carbon tax regime, carbon contained in manufactured products generally is not taxed until it is released into the atmosphere, for example, by burning. The same applies to any CO₂ that is permanently isolated from production and is not released into the atmosphere. But the tax is levied during the upstream process, or when the fuel or gas is extracted from the Earth. Producers can then pass on the tax to the market by as much as they can. This, in turn, gives consumers a chance to reduce their own carbon footprints. 

Examples of Carbon Taxes

Carbon taxes have been implemented in a number of countries around the world. They take several different forms, but most amount to a straightforward rate of taxation per ton of hydrocarbon fuel used. The first country to implement a carbon tax was Finland, in 1990. As of April 2021, that levy stood at $73.02 per ton of carbon. The Finns were quickly followed by other Nordic countries — Sweden and Norway both implemented their own carbon taxes in 1991. At a rate of $69.00 per ton of CO2 used in gasoline, the Norwegian tax is among the most stringent in the world. 

The United States has not enacted a carbon tax.

Carbon Tax Offsets

Although controversial, carbon tax offsets seemingly have a direct effect on the net carbon effect of individuals and companies. They are purchased through non-profits that use the funds to cut or remove a specific quantity of greenhouse gases from the atmosphere.

The criticism centers around carbon offsets being purchased for two reasons: to lower a carbon tax levied on a company, or to claim you or your company are net-zero for carbon emissions. This doesn't mean that you or your company doesn't emit carbon, but that the offsets you purchased "negate" the corresponding emissions. These mechanisms are popular because it is often less expensive for a company to buy offsets than change their machinery or manufacturing process.

Failed Carbon Taxes

Most forms of carbon taxation have been deployed successfully, but Australia's failed attempt from 2012-2014 stands in stark contrast. The minority Green party was able to broker the carbon tax during a period of economic stagnation in 2011, but the tax never garnered the support of either of the main parties in Australia, the left-leaning Labor Party (which reluctantly agreed to the tax to form a government with the Greens) and the center-right Liberals, whose leader Tony Abbott spearheaded the 2014 repeal. Like most economic initiatives to combat climate change, carbon taxes remain highly controversial.