On their own, carbon taxes are usually regressive, since lower-income households tend to spend a greater proportion of their income on emissions-heavy goods and services like transportation than higher-income households. As such, carbon taxes negatively effect the welfare of poorer people by making their consumption more expensive, even if the taxes are more progressive. To make them more progressive, policymakers can try to redistribute the revenue generated from carbon taxes to low-income groups by lowering income taxes or offering rebates, then as part of the politics of climate change, the overall policy initiative can be referred to as a carbon fee and dividend, rather than a tax. Carbon taxes can also increase electricity prices.
A June to July 2021 poll conducted by GlobeScan on 31 countries and territories found that 62 percent on average are supportive of a carbon tax, while only 33 percent are opposed to a carbon tax. In 28 of the 31 countries and territories listed in the poll, a majority of their populations are supportive of a carbon tax.
Carbon dioxide is one of several heat-trapping greenhouse gases (others include methane and water vapor) emitted as a result of human activities. The scientific consensus is that human-induced greenhouse gas emissions are the primary cause of global warming, and that carbon dioxide is the most important of the anthropogenic greenhouse gases. Worldwide, 27 billion tonnes of carbon dioxide are produced by human activity annually. The physical effect of CO2 in the atmosphere can be measured as a change in the Earth-atmosphere system's energy balance – the radiative forcing of CO2. Different greenhouse gases have different physical properties: the global warming potential is an internationally accepted scale of equivalence for other greenhouse gases in units of tonnes of carbon dioxide equivalent.
David Gordon Wilson first proposed a carbon tax in 1973. A carbon tax is a form of pollution tax. Unlike classic command and control regulations, which explicitly limit or prohibit emissions by each individual polluter, a carbon tax aims to allow market forces to determine the most efficient way to reduce pollution. A carbon tax is an indirect tax—a tax on a transaction—as opposed to a direct tax, which taxes income. Carbon taxes are price instruments since they set a price rather than an emission limit. In addition to creating incentives for energy conservation, a carbon tax puts renewable energy such as wind, solar and geothermal on a more competitive footing.
In economic theory, pollution is considered a negative externality, a negative effect on a third party not directly involved in a transaction, and is a type of market failure. To confront the issue, economist Arthur Pigou proposed taxing the goods (in this case hydrocarbon fuels), that were the source of the externality (CO 2) so as to accurately reflect the cost of the goods to society, thereby internalizing the production costs. A tax on a negative externality is called a Pigovian tax, which should equal the cost.
Within Pigou's framework, the changes involved are marginal, and the size of the externality is assumed to be small enough not to distort the economy. Climate change is claimed to result in catastrophe (non-marginal) changes. "Non-marginal" means that the impact could significantly reduce the growth rate in income and welfare. The amount of resources that should be devoted to climate change mitigation is controversial. Policies designed to reduce carbon emissions could have a non-marginal impact, but are asserted to not be catastrophic.
The design of a carbon tax involves two primary factors: the level of the tax, and the use of the revenue. The former is based on the social cost of carbon (SCC), which attempts to calculate the numeric cost of the externalities of carbon pollution. The precise number is the subject of debate in environmental and policy circles. A higher SCC corresponds with a higher evaluation of the costs of carbon pollution on society. Stanford University scientists have estimated the social cost of carbon to be upwards of $200 per ton. More conservative estimates pin the cost at around $50.
The use of the revenue is another subject of debate in carbon tax proposals. A government may use revenue to increase its discretionary spending, or address deficits. However, such proposals often run the risk of being regressive, and sparking backlash among the public due to an increased cost of energy associated with such taxes. To avoid this and increase the popularity of a carbon tax, a government may make the carbon tax revenue-neutral. This can be done by reducing income tax proportionate to the level of the carbon tax, or by returning carbon tax revenues to citizens as a dividend.
Carbon leakage happens when the regulation of emissions in one country/sector pushes those emissions to other places that with less regulation. Leakage effects can be both negative (i.e., increasing the effectiveness of reducing overall emissions) and positive (reducing the effectiveness of reducing overall emissions). Negative leakages, which are desirable, can be referred to as "spill-over".
According to one study, short-term leakage effects need to be judged against long-term effects.: 28 A policy that, for example, establishes carbon taxes only in developed countries might leak emissions to developing countries. However, a desirable negative leakage could occur due to reduced demand for coal, oil, and gas in developed countries, lowering prices. This could allow developing countries to substitute oil or gas for coal, lowering emissions. In the long-run, however, if less polluting technologies are delayed, this substitution might have no long-term benefit.
Carbon leakage is central to climate policy, given the 2030 Energy and Climate Framework and the review of the European Union's third carbon leakage list.
Border adjustments, tariffs and bans
Policies have been suggested to address concerns over competitive losses experienced by countries that introduce a carbon tax versus countries that do not.: 5 Border tax adjustments, tariffs and trade bans have been proposed to encourage countries to introduce carbon taxes.
Border tax adjustments compensate for emissions attributable to imports from nations without a carbon price. An alternative would be trade bans or tariffs applied to such countries. Such approaches could be inadmissible at the World Trade Organization. Case law there has not provided specific rulings on climate-related taxes. The administrative aspects of border tax adjustments have been discussed.
Many corporations calculate an "internal price on carbon". Companies use this internal price to assess the risk of future projects into their investment decisions. Companies usually assess a higher internal price when the company a) emits large amounts of CO2, and b) projects further into the future. Oil company have assets (factories, refineries) with a long lifespan that can be affected by future energy policies.
Research shows that carbon taxes effectively reduce greenhouse gas emissions. Most economists assert that carbon taxes are the most efficient and effective way to curb climate change, with the least adverse economic effects.
One study found that Sweden's carbon tax successfully reduced carbon dioxide emissions from transport by 11%. A 2015 British Columbia study found that the taxes reduced greenhouse gas emissions by 5–15% while having negligible overall economic effects. A 2017 British Columbia study found that industries on the whole benefited from the tax and "small but statistically significant 0.74 percent annual increases in employment" but that carbon-intensive and trade-sensitive industries were adversely affected. A 2020 study of carbon taxes in wealthy democracies showed that carbon taxes had not limited economic growth.
Carbon taxes appear to not adversely affect employment or GDP growth in Europe. Their economic impact ranges from zero to modest positive.
Negative impacts and trade-offs
A number of studies have found that in the absence of an increase in social benefits and tax credits, a carbon tax would hit poor households harder than rich households.Gilbert E. Metcalf disputed that carbon taxes would be regressive in the US.
In 1979, economist Milton Friedman expressed support for ecotaxes in general in an interview on The Phil Donahue Show, saying "...the best way to [deal with pollution] is to impose a tax on the cost of the pollutants emitted by a car and make an incentive for car manufacturers and for consumers to keep down the amount of pollution." In Free to Choose (1980), Friedman reiterated his support ecotaxes especially as compared with increased environmental regulation, stating "The preservation of the environment and the avoidance of undue pollution are real problems and they are problems concerning which the government has an important role to play. ... Most economists agree that a far better way to control pollution than the present method of specific regulation and supervision is to introduce market discipline by imposing effluent charges."
Greg Mankiw, head of the Council of Economic Advisers under the George W. Bush administration, economic adviser to Mitt Romney for his 2012 presidential campaign and economics professor at Harvard University since 1985, has been advocating for increased carbon/oil taxation since at least 1999.
In 2006, he founded the Pigou Club of economists advocating for Pigovian taxes, a carbon tax among them. The club's manifesto states "[h]igher gasoline taxes, perhaps as part of a broader carbon tax, would be the most direct and least invasive policy to address environmental concerns."
In 2001, environmental scientist Lester Brown, founder of the Worldwatch Institute and founder and president of the Earth Policy Institute, outlined a detailed "tax shifting" structure that would not lead to an overall higher tax level: "It means reducing income taxes and offsetting them with taxes on environmentally destructive activities such as carbon emissions, the generation of toxic waste, the use of virgin raw materials, the use of non-refillable beverage containers, mercury emissions, the generation of garbage, the use of pesticides, and the use of throwaway products... activities that should be discouraged by taxing."
Former US Federal Reserve chairman Paul Volcker suggested (6 February 2007) that "it would be wiser to impose a tax on oil, for example, than wait for the market to drive up oil prices. A tax would give the government 'some leverage that you can use for other things.'", supporting a carbon tax.
Citizens' Climate Lobby advocates for carbon tax legislation (specifically a progressive fee and dividend model). The organization has about 165 chapters in the United States, Canada, and several other countries including Bangladesh and Sweden.
According to economist Laura D'Andrea Tyson, "The beauty of a carbon tax is its market-based simplicity. Economists since Adam Smith have insisted that prices are by far the most efficient way to guide the decisions of producers and consumers. Carbon emissions have an 'unpriced' societal cost in terms of their deleterious effects on the earth's climate. A tax on carbon would reflect these costs and send a powerful price signal that would discourage carbon emissions."
In January 2019, economists published a statement in the Wall Street Journal calling for a carbon tax, describing it as "the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary." In October 2021, the statement had been signed by more than 3,600 U.S. economists, including 28 Nobel Laureates.
Carl Pope, former executive director of the Sierra Club, supports a carbon tax over cap-and-trade because employers will know exactly what their emissions cost, and because cap-and-trade (with grandfathered permits) rewards those who have the highest emissions.
In 2008, Rex Tillerson, then CEO of ExxonMobil, said a carbon tax is "a more direct, more transparent and more effective approach" than a cap and trade program, which he said, "inevitably introduces unnecessary cost and complexity." He said that he hoped that the revenues from a carbon tax would be used to lower other taxes.
In 2016 in Washington state, the Sierra Club, the Washington Environmental Council, Climate Solutions, and the Alliance for Jobs and Clean Energy opposed a proposed tax of $25 per tonne on fossil fuels arguing that the enactment would undermine state finances. In 2018, they instead supported a $15 per tonne tax in that state, along with many other environmental groups, in part because the proceeds would fund projects that would steer the state away from fossil fuels.
In 2015, BG Group, BP, Eni, Royal Dutch Shell, Statoil, and Total sent an open letter to the UNFCCC calling for carbon pricing and eventually link it into a global system.
A 2019 International Monetary Fund report stated that "a global tax of $75 per ton by the year 2030 could limit the planet's warming to 2 degrees Celsius."
This section needs to be updated. Please help update this article to reflect recent events or newly available information. (March 2023)
As of 2015, developing countries were responsible for 63% of carbon emissions. Various barriers stand in the way of developing countries from adopting plans to slow carbon emissions, including a carbon tax. Developing countries often prioritize economic growth over lower emissions. Nuclear power is under development in multiple countries as an emissions-free energy source.
Wind energy and solar energy are other alternatives to fossil fuels. Wind turbines are a sustainable and renewable source of power.
Ben Ho, professor of economics at Vassar College, has argued that "while carbon taxes are part of the optimal portfolio of policies to fight climate change, they are not the most important part."
Cap and trade is another approach. Emission levels are limited and emission permits traded among emitters. The permits can be issued via government auctions or by offered without charge based on existing emissions (grandfathering). Auctions raise revenues that can be used to reduce other taxes or to fund government programs. Variations include setting price-floor and/or price-ceiling for permits. A carbon tax can combined with trading.
A cap with grandfathered permits can have an efficiency advantage since it applies to all industries. Cap and trade provides an equal incentive for all producers at the margin to reduce their emissions. This is an advantage over a tax that exempts or has reduced rates for certain sectors.
Both carbon taxes and trading systems aim to reduce emissions by creating a price for emitting CO2. In the absence of uncertainty both systems will result in the efficient market quantity and price of CO2. When the environmental damage and therefore the appropriate tax of each unit of CO2 cannot be accurately calculated, a permit system may be more advantageous. In the case of uncertainty regarding the costs of CO2 abatement for firms, a tax is preferable.
Permit systems regulate total emissions. In practice the limit has often been set so high that permit prices are not significant. In the first phase of the European Union Emissions Trading System, firms reduced their emissions to their allotted quantity without the purchase of any additional permits. This drove permit prices to nearly zero two years later, crashing the system and requiring reforms that would eventually appear in EUETS Phase 3.
The distinction between carbon taxes and permit systems can get blurred when hybrid systems are allowed. A hybrid sets limits on price movements, potentially softening the cap. When the price gets too high, the issuing authority issues additional permits at that price. A price floor may be breached when emissions are so low that no one needs to buy a permit. Economist Gilbert Metcalf has proposed such a system, the Emissions Assurance Mechanism, and the idea, in principle, has been adopted by the Climate Leadership Council.
Two related taxes are emissions taxes and energy taxes. An emissions tax on greenhouse gas emissions requires individual emitters to pay a fee, charge, or tax for every tonne of greenhouse gas, while an energy tax is applied to the fuels themselves.
Energy taxes increase the price of energy regardless of emissions.: 416 An ad valorem energy tax is levied according to the energy content of a fuel or the value of an energy product, which may or may not be consistent with the emitted greenhouse gas amounts and their respective global warming potentials. Studies indicate that to reduce emissions by a certain amount, ad valorem energy taxes would be more costly than carbon taxes. However, although greenhouse gas emissions are an externality, using energy services may result in other negative externalities, e.g., air pollution not covered by the carbon tax (such as ammonia or fine particles). A combined carbon-energy tax may therefore be better at reducing air pollution than a carbon tax alone.
Any of these taxes can be combined with a rebate, where the money collected by the tax is returned to qualifying parties, taxing heavy emitters and subsidizing those that emit less carbon.
Because carbon taxes only target carbon dioxide, they do not target other greenhouse gasses, such as methane, which have a greater warming potential.
Petroleum (gasoline, diesel, jet fuel) taxes
Many countries tax fuel directly; for example, the UK imposes a hydrocarbon oil duty directly on vehicle hydrocarbon oils, including petrol and diesel fuel.
While a direct tax sends a clear signal to the consumer, its efficiency at influencing consumers' fuel use has been challenged for reasons including:
Possible delays of a decade or more as inefficient vehicles are replaced by newer models and the older models filter through the fleet.
Political pressures that deter policymakers from increasing taxes.
Limited relationship between consumer decisions on fuel economy and fuel prices. Other efforts, such as fuel efficiency standards, or changing income tax rules on taxable benefits, may be more effective.
The historical use of fuel taxes as a source of general revenue, given fuel's low price elasticity, which allows higher rates without reducing fuel volumes. In these circumstances, the policy rational may be unclear.
Vehicle fuel taxes may reduce the "rebound effect" that occurs when vehicle efficiency improves. Consumers may make additional journeys or purchase heavier and more powerful vehicles, offsetting the efficiency gains.
Comparison of alternatives
A 2018 survey of leading economists found that 58% of the surveyed economists agreed with the assertion, "Carbon taxes are a better way to implement climate policy than cap-and-trade," 31% stated that they had no opinion or that it was uncertain, but none of the respondents disagreed.
In a review study in 1996 the authors concluded that the choice between an international quota (cap) system, or an international carbon tax, remained ambiguous.: 430 Another study in 2012 compared a carbon tax, emissions trading, and command-and-control regulation at the industry level, concluding that market-based mechanisms would perform better than emission standards in achieving emission targets without affecting industrial production.
In Europe, many countries have imposed energy taxes or energy taxes based partly on carbon content. These include Denmark, Finland, Germany, Ireland, Italy, the Netherlands, Norway, Slovenia, Sweden, Switzerland, and the UK. None of these countries has been able to introduce a uniform carbon tax for fuels in all sectors.
During the 1990s, a carbon/energy tax was proposed at the EU level but failed due to industrial lobbying. In 2010, the European Commission considered implementing a pan-European minimum tax on pollution permits purchased under the European Union Greenhouse Gas Emissions Trading Scheme (EU ETS) in which the proposed new tax would be calculated in terms of carbon content. The suggested rate of €4 to €30 per tonne of CO2.
In 1997, Costa Rica imposed a 3.5 percent carbon tax on hydrocarbon fuels. A portion of the proceeds go to the "Payment for Environmental Services" (PSA) program which gives incentives to property owners to practice sustainable development and forest conservation. Approximately 11% of Costa Rica's national territory is protected by the plan. The program now pays out roughly $15 million a year to around 8,000 property owners.
In the 2008 Canadian federal election, a carbon tax proposed by Liberal Party leader Stéphane Dion, known as the Green Shift, became a central issue. It would have been revenue-neutral, balancing increased taxation on carbon with rebates. However, it proved to be unpopular and contributed to the Liberal Party's defeat, earning the lowest vote share since Confederation. The Conservative party won the election by promising to "develop and implement a North American-wide cap-and-trade system for greenhouse gases and air pollution, with implementation to occur between 2012 and 2015".
In 2018, Canada enacted a revenue-neutral carbon levy starting in 2019, fulfilling Prime Minister Justin Trudeau's campaign pledge. The Greenhouse Gas Pollution Pricing Act applies only to provinces without provincial adequate carbon pricing.
As of September 2020, seven of thirteen Canadian provinces and territories use the federal carbon tax while three have developed their own carbon tax programs.
In December 2020, the Federal Government released an updated plan with a CA$15 per tonne per year increase in the carbon pricing, reaching CA$95 per tonne in 2025 and CA$170 per tonne in 2030.
Quebec became the first province to introduce a carbon tax. The tax was to be imposed on energy producers starting 1 October 2007, with revenue collected used for energy-efficiency programs. The tax rate for gasoline is $CDN0.008 per liter, or about CA$3.50 per tonne of CO 2 equivalent.
A national carbon tax in the U.S. has been repeatedly proposed, but never enacted. For instance, on 23 July 2018, Representative Carlos Curbelo (R-FL) introduced H.R. 6463, the "MARKET CHOICE Act", a proposal for a carbon tax in which revenue is used to bolster American infrastructure and environmental solutions. The bill was introduced in the House of Representatives, but did not become law.
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