A carbon tax is a fee charged on the carbon emissions created when making goods and services. This tax helps show the costs of carbon emissions that society often does not see. It is meant to lower greenhouse gas emissions by raising the cost of fossil fuels. This makes goods and services that produce a lot of emissions less attractive to buy and encourages producers to make them less harmful to the environment. When fossil fuels like coal, oil, or natural gas are burned, most of their carbon becomes carbon dioxide (CO2). Greenhouse gas emissions are linked to climate change. This problem, called a negative externality, can be reduced by taxing carbon at any stage of a product's life.
A carbon tax, along with carbon emission trading, is part of the carbon pricing idea. Other common ways to address emissions include using tradable permits with carbon credits and offering financial support. At its simplest, a carbon tax only targets CO2 emissions. However, it can also include other greenhouse gases, like methane or nitrous oxide, by using their CO2-equivalent global warming potential to set the tax rate. Studies show that carbon taxes often help reduce emissions. Many economists believe carbon taxes are the most effective way to fight climate change with the least cost. As of 2019, 25 countries had already started using carbon taxes or planned to do so. In total, 46 countries had placed some kind of price on carbon, either through taxes or emission trading systems.
Some experts say a carbon tax might harm public welfare, especially affecting low- and middle-income families the most by increasing the cost of necessities like gasoline and electricity. A carbon tax might also have limited success if it only slightly reduces emissions. To make carbon taxes fairer, leaders can use the money collected from the tax to help low-income groups through policies like carbon fee and dividend programs. This approach shares the tax revenue with the public instead of keeping it as a regular tax.
Purpose
Carbon dioxide is a type of heat-trapping gas. Other examples include methane and water vapor. These gases are released because of human activities. Scientists agree that the main cause of climate change is the release of greenhouse gases from human activities. Among these gases, carbon dioxide is the most significant one caused by humans. Each year, human activities produce 27 billion tonnes of carbon dioxide worldwide. The effect of CO2 in the atmosphere can be measured by how it changes the balance of energy in the Earth and atmosphere system, known as radiative forcing. Different greenhouse gases trap heat in different ways. The global warming potential is a standard way to compare how much heat different gases trap, measured in units of tonnes of carbon dioxide equivalent. Carbon taxes aim to lower greenhouse gas emissions by raising the cost of fossil fuels that release these gases when burned. This reduces the need for products and services that create a lot of emissions and encourages making them less harmful to the environment.
Economic theory
A carbon tax is a type of pollution tax. David Gordon Wilson first suggested this tax in 1973. Unlike rules that set strict limits on how much pollution each company can produce, a carbon tax lets the market decide the best way to reduce pollution. A carbon tax is an indirect tax, which means it is placed on a transaction, such as buying fuel, instead of directly taxing income. Carbon taxes are price-based tools because they set a cost for pollution rather than setting a specific limit on emissions.
A carbon tax encourages people to save energy and helps renewable energy sources like wind, solar, and geothermal power compete better with fossil fuels. In economics, pollution is called a negative externality, which means it harms people who are not directly involved in the activity that causes the pollution. This is a type of market failure. To address this, economist Arthur Pigou proposed taxing goods that cause pollution, such as fuels that produce carbon dioxide, to ensure their true cost to society is included in their price. A tax on a negative externality is called a Pigovian tax, and it should match the cost of the harm caused.
In Pigou’s ideas, changes are considered small and unlikely to harm the economy. However, climate change is seen as causing major, long-term harm. "Non-marginal" means the effects are large enough to significantly reduce income and well-being. How much money should be spent on reducing carbon emissions is debated. Policies to cut emissions might have large effects, but they are not said to cause total disaster.
Designing a carbon tax depends on two main factors: the tax amount and how the money is used. The tax amount is based on the social cost of carbon (SCC), which tries to calculate how much carbon pollution harms society. Experts disagree on the exact number. Some say the cost is over $200 per ton of carbon, while others estimate it is about $50.
How the tax money is used is also debated. A government might use the money for general spending or to fix budget problems. However, this could make the tax unfair to people with lower incomes, as energy costs might rise. To make the tax more popular, a government might return the tax money to people as a dividend or lower income taxes by the same amount.
Carbon leakage happens when reducing emissions in one place causes emissions to increase elsewhere, where rules are weaker. This can have both positive and negative effects. Negative leakage, which is helpful, is called "spill-over." For example, if developed countries reduce coal use, it might lower fuel prices, allowing developing countries to switch from coal to cleaner fuels like oil or gas, reducing emissions. However, if cleaner technologies are delayed, this change might not help the environment in the long run. Carbon leakage is important for climate policies, such as the 2030 Energy and Climate Framework and the European Union’s review of carbon leakage rules.
A carbon tariff or border carbon adjustment (BCA) is a tax on goods that have high carbon emissions. The goal is to stop pollution from moving to countries without carbon taxes. Examples of high-carbon imports include electricity from coal power plants, iron and steel made in blast furnaces, and fertilizer from the Haber process.
Currently, only California uses a BCA for electricity. The European Union and the United Kingdom will start using BCAs in 2026 and 2027, respectively. Other countries are also considering these measures.
Impacts
Research shows that carbon taxes help reduce greenhouse gas emissions. Most economists say carbon taxes are the best and most efficient way to reduce climate change with the least negative effect on the economy. One study found that Sweden’s carbon tax reduced carbon dioxide emissions from transportation by 11%. A 2015 study in British Columbia found that carbon taxes reduced greenhouse gas emissions by 5–15% and had very small effects on the economy. A 2017 study in British Columbia found that industries overall benefited from the tax and saw small but meaningful increases in employment each year. However, industries that produce a lot of carbon or are sensitive to trade faced challenges. A 2020 study of carbon taxes in wealthy democracies showed that these taxes did not slow economic growth. In Europe, carbon taxes do not seem to harm employment or GDP growth. Their economic effects range from no change to small positive changes.
Many studies show that without increases in social benefits or tax credits, carbon taxes may affect poor households more than rich households. Gilbert E. Metcalf disagreed that carbon taxes would be regressive in the United States. Carbon taxes can increase electricity prices. Some people debate how carbon pricing (like carbon taxes or emission trading) relates to climate justice. Carbon pricing can follow ideas from climate justice, such as making polluters pay. Many supporters of climate justice oppose carbon pricing. To address differences between these ideas, carbon pricing could set limits on emissions, reduce pollution in underserved communities, and fairly share the money collected.
Support and opposition
Carbon taxation has been discussed by many economists as a way to reduce CO₂ pollution. Some experts say it is a better method than current rules that directly control pollution. They also believe it is simple because it uses market principles. This approach is described as the most effective way to influence the choices of businesses and individuals, since carbon emissions cause harmful effects on Earth's climate that are not fully accounted for in their costs.
Since 2019, more than 3,500 U.S. economists have signed The Economists' Statement on Carbon Dividends. This document explains the advantages of a U.S. carbon tax and suggests ways to implement it. One idea is to give the money collected from the tax back to the public. The statement was first signed by 45 Nobel Prize-winning economists, former leaders of the Federal Reserve, former heads of the Council of Economic Advisers, and former Treasury secretaries. It is considered a major example of agreement among economists. Ben Ho, an economics professor at Vassar College, has stated that "carbon taxes are part of the best set of policies to fight climate change, but they are not the most important part."
Many people have opposed carbon taxes. These taxes have been rejected in some elections and changed in response to growing opposition. One way to gain public support has been to give carbon tax money directly to the public. The Citizens' Climate Lobby is an international group with more than 500 chapters. It works to pass carbon tax laws that return tax money to people in a fair way. NASA climatologist James E. Hansen has also supported a carbon tax that returns revenue to the public.
How carbon tax money is used can influence public support. Spending tax money on climate projects and helping low-income housing has been popular. However, in countries that have already used carbon taxes, sharing details about how money is spent has not always increased public support. A 2021 survey by GlobeScan across 31 countries and territories found that 62% of people, on average, support a carbon tax, while 33% oppose it. In 28 of the 31 countries and territories surveyed, more than half of the population supports a carbon tax.
Alternatives
Carbon emission trading, also called cap and trade, is a method used to control emissions. A limit is set on how much carbon can be emitted, and permits are given to companies to allow them to emit within this limit. These permits can be given through government auctions or based on past emissions. Auctions help raise money that can be used to lower other taxes or fund government programs. Some systems set minimum or maximum prices for permits. A carbon tax can be used along with trading. A cap with permits based on past emissions may be more efficient because it applies to all industries. Cap and trade gives all producers the same reason to reduce emissions, which is an advantage over a tax that may give lower rates to certain industries.
Both carbon taxes and trading systems aim to reduce emissions by making it costly to release carbon dioxide. If there is no uncertainty about the cost of emissions, both systems can lead to the same level of emissions and price for carbon. However, if it is hard to calculate the exact cost of emissions, a permit system may be better. If it is unclear how much it costs to reduce emissions, a tax may be more useful. Permit systems control the total amount of emissions. In practice, limits have sometimes been set too high, making permit prices very low. For example, in the first phase of the European Union Emissions Trading System, companies reduced emissions without buying extra permits, which caused permit prices to drop to nearly zero and led to changes in the system.
When hybrid systems are used, the difference between taxes and permits can become unclear. A hybrid system may allow prices to change within limits, which can reduce the strictness of a cap. If prices get too high, more permits may be issued at that price. If emissions drop so much that permits are not needed, a minimum price may not be met. Economist Gilbert Metcalf suggested a system called the Emissions Assurance Mechanism, and the idea has been supported by the Climate Leadership Council. James E. Hansen argued in 2009 that emissions trading could benefit financial institutions but might not reduce emissions from major industries.
A carbon credit is a tradable certificate that shows a company has reduced greenhouse gas emissions or helped remove them from the atmosphere. One carbon credit represents the reduction of one metric ton of carbon dioxide or its equivalent.
Carbon offsetting is when companies use carbon credits to balance out their own emissions, as required by reporting programs or goals. Carbon credit systems let project developers sell credits to buyers who use them to claim they have offset their emissions. Credits used in regulated markets, like the European Union Emissions Trading Scheme, help companies meet legal requirements. Credits can also help reach global goals to reduce emissions. How a buyer uses or "retires" a credit is up to them.
Two related taxes are emissions taxes and energy taxes. An emissions tax charges companies for each ton of greenhouse gas they release, while an energy tax is applied to fuels themselves. A carbon tax is not the same as an emissions tax. For example, a carbon tax encourages using less fuel but does not directly support methods like carbon capture. Energy taxes raise fuel prices regardless of emissions.
An ad valorem energy tax is based on the energy content of a fuel or its value, which may not match the amount of greenhouse gases released or their impact on global warming. Studies show that ad valorem taxes may cost more to reduce emissions than carbon taxes. However, energy taxes might help reduce other problems, like air pollution, which carbon taxes do not address. Combining carbon and energy taxes could be more effective at reducing air pollution.
Taxes can be paired with rebates, where money collected is given back to people or businesses. This helps penalize heavy emitters and support those who emit less. Carbon taxes only target carbon dioxide, not other gases like methane, which are more harmful.
Many countries tax fuel directly, such as the UK, which taxes vehicle fuels like petrol and diesel. While direct taxes clearly signal costs to consumers, they may not be very effective at changing behavior. Reasons include delays in replacing old vehicles, political resistance to raising taxes, and limited influence of fuel prices on consumer choices. Other methods, like fuel efficiency standards, may be more effective. Fuel taxes are often used for general government spending because fuel demand is not very sensitive to price changes.
Vehicle fuel taxes may help reduce the "rebound effect," where improved vehicle efficiency leads to more driving or buying larger vehicles, which cancels out efficiency gains.
A 2018 survey of economists found that 58% believed carbon taxes are better for climate policy than cap-and-trade, while 31% had no opinion or were unsure, and none disagreed.
A 1996 study found it was unclear whether an international cap system or a global carbon tax was better. A 2012 study compared a carbon tax, emissions trading, and strict regulations, concluding that market-based methods like trading or taxes would be more effective at reducing emissions without harming industry production.
Implementation
Energy and carbon taxes have been used by many countries to meet goals set by the United Nations Framework Convention on Climate Change. These taxes are often combined with exemptions for certain industries or activities. Indirect carbon prices, like fuel taxes, are more common than direct carbon taxes. In 2021, the OECD reported that 67 out of 71 countries it studied had some type of fuel tax, while 39 had carbon taxes or emissions trading systems. However, the use of carbon taxes is increasing, and several countries, including Singapore, Canada, and South Africa, plan to strengthen their carbon taxes in the future.
Current carbon pricing policies, including carbon taxes, are not yet strong enough to reduce emissions to the levels needed to meet the goals of the Paris Agreement. Experts, such as the International Monetary Fund and the OECD, say that the prices of fossil fuels do not fully account for their environmental harm.
In Europe, many countries have introduced energy taxes that consider the carbon content of fuels. These include Denmark, Finland, Germany, Ireland, Italy, the Netherlands, Norway, Slovenia, Sweden, Switzerland, and the UK. None of these countries have created a single carbon tax that applies to all sectors. Denmark was the first country to include emissions from livestock in its carbon tax system.
In the 1990s, the European Union considered a carbon/energy tax, but it failed because of pressure from industries. In 2010, the European Commission proposed a minimum tax on pollution permits under the EU Emissions Trading Scheme (EU ETS). The suggested tax rate would have been between €4 and €30 per tonne of CO₂.
In 1997, Costa Rica introduced a 3.5% carbon tax on hydrocarbon fuels. Part of the tax revenue supports the "Payment for Environmental Services" (PSA) program, which helps landowners protect forests and practice sustainable development. About 11% of Costa Rica’s land is protected through this program, and it pays approximately $15 million annually to around 8,000 landowners.
In 2008, a Canadian federal election focused on a carbon tax proposal called the Green Shift, introduced by Liberal Party leader Stéphane Dion. The plan would have balanced higher carbon taxes with rebates to citizens. However, the idea was unpopular and contributed to the Liberal Party’s loss in the election. The Conservative Party won by promising a North American-wide cap-and-trade system for greenhouse gases.
In 2018, Canada passed a revenue-neutral carbon tax, which started in 2019. This tax applies only to provinces without strong carbon pricing policies. As of September 2020, seven of Canada’s 13 provinces and territories used the federal tax, while three had their own carbon tax programs. In December 2020, the federal government announced plans to increase the tax rate to CA$95 per tonne of CO₂ by 2025 and CA$170 by 2030. Quebec was the first Canadian province to introduce a carbon tax in 2007, with a rate of about CA$3.50 per tonne of CO₂ equivalent.
The Liberal government claimed that 80% of Canadians received rebates from the carbon tax, but the tax was criticized by many and became a political issue. In 2023, the Official Opposition refused to support a free trade agreement with Ukraine that included a new environmental chapter promoting carbon pricing. Conservative leader Pierre Poilievre called the carbon tax “cruel” and said it unfairly targeted working families.
By late 2024, polls showed the ruling Liberal Party was 20 points behind the Conservative Party, which used the slogan “Axe the Tax.” Many Liberals wanted Prime Minister Justin Trudeau to resign, which he did in January 2025. Mark Carney, the new Prime Minister, ended the consumer carbon tax and rebate program shortly after taking office. He promised to replace the tax with other measures to reduce emissions. Alberta’s Premier, Danielle Smith, warned that future industrial carbon taxes would increase costs for consumers without rebates.
In the United States, carbon taxes have been proposed multiple times but never passed. For example, in 2018, Representative Carlos Curbelo introduced a bill called the “Market Choice Act,” which would have used carbon tax revenue to fund infrastructure and environmental projects. The bill did not become law.
Several organizations now support national carbon tax proposals. To address concerns about government growth and higher living costs, recent plans focus on revenue neutrality, meaning tax money would be returned to citizens. Groups like the Citizens’ Climate Lobby, the Climate Leadership Council, and Americans for Carbon Dividends support a plan called the Baker-Shultz Carbon Dividends Plan. This plan, created by former U.S. leaders James Baker and George Shultz, calls for a gradually increasing carbon tax with equal rebates to citizens. The plan has bipartisan support and is backed by companies such as Microsoft, Exxon Mobil, and General Motors.