Carbon Tax Basics Examples

Carbon Tax Basics Examples

Carbon Tax Basics: A carbon tax is levied on the carbon content of fossil fuels. The term can also refer to taxing other types of greenhouse gas emissions, such as methane. A carbon tax puts a price on those emissions to encourage consumers, businesses, and governments to produce less of them.

What’s a carbon tax?

A carbon tax is a way — the only way. Really — to have users of carbon fuels pay for the climate damage caused by releasing carbon dioxide into the atmosphere. If set high enough, it becomes a powerful monetary disincentive that motivates switches to clean energy across the economy. Simply by making it more economically rewarding to move to non-carbon fuels and energy efficiency.

Carbon chemistry is potent but also simple. The amount of CO2 released in burning any fossil fuel is strictly proportional to the fuel’s carbon content. This allows the carbon tax to be levi “upstream” on the fuel itself when it is extract from the ground or import into the U.S., which vastly simplifies its administration.

The energy essence of every fossil fuel is its carbon and hydrogen atoms. Oxidizing (combusting) those atoms releases their heat energy but also converts carbon to carbon dioxide. Natural gas, with a high ratio of hydrogen to carbon, is the least carbon-intensive fuel, while coal is the most. The CO2 released from burning these fuels rises into the upper atmosphere and remains resident there — typically for around a century — trapping heat re-radiated from Earth’s surface and causing global warming and other harmful climate change.

The carbon content of every fossil fuel. From anthracite or lignite coal to heating oil and natural gas, is precisely know. A carbon tax obeys these proportions, taxing coal more heavily than petroleum products, and much more than natural gas. This makes a carbon tax simple to document and measure.

How is a carbon tax implement?

Utilizing existing tax collection mechanisms, a carbon tax is paid “upstream,” at the point where fuels are extract from the Earth and put into the stream of commerce, or import into the U.S. Fuel suppliers and processors are free to pass along the cost of the tax to the extent that market conditions allow. Placing a tax on carbon gives consumers and producers a monetary incentive to reduce their carbon dioxide emissions.

Carbon that is chemically bound into manufactured products such as plastics but is not burned will not be taxed. Similarly, any CO2 from energy production that is permanently sequester rather than release into the atmosphere won’t be taxed (or will receive an offsetting tax credit). Additionally, some carbon tax proposals include exemptions for export-dependent businesses to help them remain competitive in global markets.

Carbon Taxes in Action

A number of countries, territories, and local governments around the world have carbon taxes or similar such as energy taxes related to carbon content. South Africa became the first African country to implement a carbon tax in 2019. In 2006, the city of Boulder, Colorado, became the first US city with direct voter approval of a carbon tax. And other cities are exploring the idea.

In the United States, interest in a carbon tax across the economy has grown gradually. Debates often center on how to use the income generated by taxes. One idea is to use income to reduce taxes on productive activities, such as payroll or corporate taxes.

So far in the 117th Congress (2021–2022), five carbon pricing proposals have been introduced. Additionally, carbon tax proposals have been introduced in Congress for several years without success. But proponents hope that the need for new revenues to pay for tax or infrastructure reforms will make them more politically attractive.

As of October 2021, the Senate Finance Committee is considering carbon emission costs as one way to help pay for a budget reconciliation package. The most effective approach being considerE is a cost per tonne of emissions from fossil fuels that starts at a modest rate and increases over time. When paired with border tax measures. Such carbon costs will soon become the single most important policy for reducing US emissions and increasing US competitiveness in the global economy.

Key Design Elements

Policymakers must consider a range of design choices, including:


The scope of the carbon tax depends on substances covered. For instance, a carbon tax could be levied on the carbon dioxide content of fossil fuels.

Point of Taxation ­

A carbon tax can be levied at any point in the energy supply chain. The simplest approach, administratively, is to levy the tax “upstream”. Where the fewest entities would be subject to it (for instance, suppliers of coal, natural gas processing facilities, and oil refineries). Alternatively, the tax could be levied “midstream” (electric utilities) or downstream (energy-using industries, households, or vehicles).

Tax and Escalation Rates ­

Economic theory suggest a carbon tax should be set equal to the social cost of carbon. Which is the present value of estimat environmental damages over time caused by an additional ton of carbon dioxide emitt today. The tax rate should also rise over time to reflect the growing damage expected from climate change. An increasing price over time also provides a signal to emitters that they will need to do more and that their investments in more aggressive technologies will be economically justified. One of the challenges of a carbon tax is forecasting the resulting level of emissions reduction from a specific tax rate. Building in review and opportunity for adjustment can help. But also reduces the one of the values of a carbon price price certainty.

Distributional Impacts ­

Lower-income households spend a larger share of their income on energy than higher-income households. As a result, a price on carbon that increases energy costs can have a greater impact on lower-income individuals. Directing a certain percentage of revenue from a carbon tax toward low income households to compensate for increased energy costs can help ensure that the tax does not disproportionately affect the poor.


Without provisions protecting local production, a carbon price could put domestic energy-intensive, trade-exposed industries (EITEs), such as chemicals, cement/concrete, and steel. At a competitive disadvantage against international competitors that do not face an equivalent price. A shift in demand to those countries could result in “emissions leakage” from one country to another reducing the climate benefit of a carbon price. All existing carbon pricing programs include mechanisms to address competitiveness concerns. These include allocations based on historical emissions, output-based allocations, exemptions for select sectors, and rebates. There is growing interest in a carbon border adjustment as a preferred approach to address emissions leakage and incentivize emission reductions.

Revenues ­

A carbon tax can raise significant revenue. How that revenue is use will ultimately be a political choice. Some or all of it could be return to consumers in the form of a dividend. Alternatively, it could be reinvest in climate purposes, such as advancing low-carbon technologies or building resilience. Economic research suggests that using the revenues to reduce existing taxes on labor and capital also known as a tax swap can minimize the economic costs and may result in net economic benefits.