Business & Policy Environmental Policy What Is a Carbon Tax? Learn what a carbon tax is and how it works. By Larry West Larry West Writer University of Washington Larry West is an award-winning environmental journalist and writer. He won the Edward J. Meeman Award for Environmental Reporting. Learn about our editorial process Updated August 22, 2022 Share Twitter Pinterest Email AVTG/E+/Getty Images Business & Policy Corporate Responsibility Environmental Policy Economics Food Issues Simply put, a carbon tax is a fee levied by a government on the production, distribution, or use of fossil fuels such as oil, coal, and methane (natural gas). Typically, the more carbon dioxide pollution a factory, power plant, or other user of fuel emits, the more tax it will pay. Carbon taxes are a way to disincentivize the use of highly polluting fuels that contribute to climate change. How Does a Carbon Tax Work? A carbon tax—also known as a price on carbon—is a tax on pollution: the more a company pollutes, the more tax it pays. It is based on the economic principle of negative externalities. In the language of economics, externalities are costs or benefits created by the production of goods and services, so negative externalities are unpaid costs. When utilities, businesses, or homeowners use fossil fuels, they generate greenhouse gases and other types of pollution that carries with it a cost for society, because pollution affects everyone. Pollution affects people in different ways, including health effects, degradation of natural resources, down to less obvious effects like depressed property value. The cost we bear for carbon emissions is an increase in atmospheric greenhouse gas concentration, and as a consequence, global climate change. A carbon tax factors the societal cost of greenhouse gas emissions into the price of the fossil fuels that create them—so the people or companies who cause the pollution have to pay for it. To simplify the application of a carbon tax, the fees can be applied to the fossil fuel directly, for example as an extra tax on gasoline. How Does a Carbon Tax Promote Renewable Energy? By making dirty fuels like oil, methane, and coal more expensive, a carbon tax encourages utilities, businesses, and individuals to reduce energy consumption and increase energy efficiency. A carbon tax also makes clean, renewable energy from sources such as wind and solar more cost-competitive with fossil fuels, favoring investments in those technologies. How Can a Carbon Tax Reduce Global Warming? A carbon tax is a market-based strategy—another is cap and trade—aimed at reducing greenhouse gas emissions and slowing global warming. The carbon dioxide created by burning fossil fuels gets trapped in the Earth's atmosphere, where it absorbs heat and creates a greenhouse effect that leads to global warming and climate change. Climate change leads to all kinds of extreme weather, like more severe droughts, increased flooding, and more intense wildfires. In order to slow climate change and reduce global warming, we need to dramatically lower the amount of carbon dioxide and other greenhouse gases that are emitted each year. Carbon taxes and other systems of putting a price on carbon have been shown to be an effective way of reducing greenhouse gas emissions. When governments implement a carbon tax, companies switch to cleaner energy sources, and cut the amount of pollution they generate. Some governments may choose to use the money collected from the carbon tax to invest in carbon-free or renewable technology, which could further help reduce emissions. Carbon Taxes Are Being Adopted Worldwide A number of countries have instituted a carbon tax. In Asia, Japan has had a carbon tax since 2012, South Korea since 2015. Australia introduced a carbon tax in 2012, but it was then repealed by a conservative federal government in 2014. A number of European countries have established carbon taxation systems, each with different characteristics. Edited by Frederic Beaudry Sources and Further Reading Harrison, Kathryn. "The Comparative Politics of Carbon Taxation." Annual Review of Law and Social Science 6.1 (2010): 507–29. Print. Lin, Boqiang, and Xuehui Li. "The Effect of Carbon Tax on Per Capita CO." Energy Policy 39.9 (2011): 5137–46. Print.2 Emissions Metcalf, Gilbert E. "Designing a Carbon Tax to Reduce U.S. Greenhouse Gas Emissions." Review of Environmental Economics and Policy 3.1 (2008): 63–83. Print.