A carbon tax is a tax levied on the carbon content of fuels. It is a form of carbon pricing. Carbon is present in every hydrocarbon fuel (coal, petroleum, and natural gas). Carbon is converted to carbon dioxide (CO2) and other products when hydrocarbon fuel is used. In contrast, non-combustion energy sourcesâ€”wind, sunlight, geothermal, hydropower, and nuclearâ€”do not convert hydrocarbons to CO2. CO2 is a heat-trapping "greenhouse" gas that represents a negative externality on the climate system (see scientific opinion on global warming). Negative externalities are costs not internalized in the market price. Since GHG emissions caused by the combustion of fossil fuels are closely related to the carbon content of the respective fuels, a tax on these emissions can be levied by taxing the carbon content of fossil fuels at any point in the product cycle of the fuel.
Carbon tax offers social and economic benefits. It is a tax that increases revenue without significantly altering the economy while simultaneously promoting the objectives of climate change policy. The objective of a carbon tax is to reduce the harmful and unfavorable levels of carbon dioxide emissions, thereby decelerating climate change and its negative effects on the environment and human health.
Carbon taxes offer a potentially cost-effective means of reducing greenhouse gas emissions. From an economic perspective, carbon taxes are a type of Pigovian tax. They help to address the problem of greenhouse gas emitters that do not not fully face the social cost of their actions.
Opposition to increased environmental regulation such as carbon taxes often centers on concerns that firms might relocate and/or people might lose their jobs. It has been argued, however, that carbon taxes are more efficient than direct regulation and may even lead to higher employment.
A carbon tax is a form of pollution tax. Pollution taxes are often grouped with two other economic policy instruments: tradable pollution permits/credits and subsidies. These three environmental economic policy instruments are built upon a foundation of a command and control regulation. The difference is that classic command-penalty regulations stipulate, through performance or prescriptive standards, what each polluter is required to do to be in compliance with the law.
In economic theory, pollution is considered a negative externality, a negative effect on a party not directly involved in a transaction, which results in a market failure. To confront parties with the issue, the economist Arthur Pigou proposed taxing the goods (in this case hydrocarbon fuels), which were the source of the negative externality (carbon dioxide) so as to accurately reflect the cost of the goods' production on society. The carbon tax would, therefore, internalizing the costs associated with the goods' production.
Prices of hydrocarbon fuels are expected to continue increasing as more countries industrialize and add to the demand on fuel supplies. In addition to creating incentives for energy conservation, a carbon tax would put renewable energy sources such as wind, solar and geothermal on a more competitive footing, stimulating their growth.
Social cost of carbon
The social cost of carbon is the marginal cost of the impacts caused by emitting one extra ton of carbon (as carbon dioxide) at any point in time, inclusive of â€˜non-marketâ€™ impacts on the environment and human health. In economics, comparing impacts over time requires a discount rate. This rate determines the weight placed on impacts occurring at different times.
According to economic theory, if the social cost of carbon estimates were complete and markets perfect, a carbon tax should be set equal to the social cost of carbon. Emission permits would also have a value equal to the social cost of carbon. In reality, however, markets are not perfect, and the estimates on the social cost of carbon are incomplete.
Estimates of the social cost of carbon are highly uncertain; but, estimates of the social cost of carbon for 2005 had an average value of $43 per ton of Carbon, or $12 per ton of Carbon dioxide. Regardless of the current estimate, everyone agrees the true social cost of carbon is expected to increase over time. The rate of increase will very likely be 2 to 4% per year.
The US federal government, based on Executive Order 12866 and the findings of an inter-agency working group, has had an official estimate of the social cost of carbon since 2010. It was $36 per ton of C02 in 2015, which converts to about $132 per ton of Carbon.
One of the more ingenious uses of the carbon tax was proposed by social conservatives. They proposed a Carbon Dividend. The Dividend would be a principal source to fund a Guaranteed Annual Income, or Basic Income.