Carbon Tax

Non-Technical Option | Generic Example
Climate | Energy

View All


The aim of a carbon tax is to reduce carbon emissions. A carbon tax seeks to incorporate the cost of the environmental damage caused by carbon into the price of fossil fuels and other energy activities such that an incentive emerges for consumers to reduce consumption, increase energy efficiency and switch to lower carbon content products/fuel types and services. Generally a carbon tax will focus on certain fuel and activity types that result in the generation of CO2 emissions.


The basic theory of a carbon tax is that taxation would be levied according to the carbon content of certain fuel and activity types with the tax generally focusing on energy related CO2 emissions. In theory a carbon tax would be applied across all sectors of the economy. The carbon tax is closely associated with the polluter pays principle which requires that environmental costs are internalised and reflected in the prices of the goods and services that cause pollution as a result of their production and consumption.

The price signal that emerges from the carbon tax indicates that the assimilative capacity of the environment is scarce and valuable and that money can be saved by reducing ones consumption/use of goods/services that have associated carbon emissions.

One of the main arguments put forward in favour of using environmental taxes is the potential to take advantage of the so-called ‘double dividend’ effect. In addition to the environment benefiting from a tax because it discourages environmentally damaging activities, the revenue generated by such a tax can be used to reduce distortions elsewhere in the economy, thereby further improving performance, yielding the second or ‘double’ dividend.

The imposition of a carbon tax is likely to lead to an increase in the price of consumer products. The increase in the price of consumer goods is related to the carbon content of that product and results in a fall in real income for all households. How carbon tax revenues are recycled is crucial to the overall effect of the tax on the economy. Political support for a carbon tax will be greatly enhanced if the revenue generated from the carbon tax is recycled in an equitable manner.


Beyond the expected imapct on behaviour and an associated reduction in carbon emissions, there are a number of other impacts to consider:

Compensating low income groups and reducing fuel poverty

The increase in the price of carbon related products as a result of a carbon tax is often seen as regressive because the price increase places a relatively greater burden on lower-income households than on higher-income households. This is the case because lower income households have a greater propensity to spend a larger share of their income compared with higher income families, with a larger percentage of income traditionally spent on carbon intensive energy products (i.e. gasoline, electricity, and fuel for heating and cooking). As a result it is often argued that low income families should be compensated from the carbon tax revenue pool to at least partially offset the impact of the tax.

Reducing labour tax and improving competitiveness

One of the most frequent suggestions regarding the use of carbon tax revenue involves reducing existing distortions such as labour tax. This would have the effect of reducing the cost of the carbon tax throughout the economy while at the same time increasing national competitiveness.  In addition carbon tax revenue could be used to reduce social insurance contributions or increase welfare payments. This is particularly relevant in a move towards taxing less of what we earn and more of what we burn. A policy which would promote a more stable and sustainble tax base and offer a means of blancing the load on the workforce in regard to supporting the retired population. In a tax system based on consumption nor earnings, the burden is balanced to a more manageable level.

Investing in further greenhouse gas emissions savings activities

Given that the ultimate aim of a carbon tax is to induce emissions reductions it seems appropriate to suggest that part of the tax revenue be invested in public good activities to further reduce greenhouse gas emissions. Such activities should include investment in developing alternative energy sources, such as renewable energies, and energy efficiency schemes to reduce the burden of the carbon levy in the long run and create new industry and employment, increasing investment in energy R&D, and establishing centres of expertise on energy efficiency and other emissions mitigation and adaption activities for particular sectoral groups.

Costs & Benefits


  • Direct administrative costs of levying the carbon tax and collecting the revenue
  • Increase in the price of carbon related products


  • Societal benefits – reduced carbon (and other) emission levels
  • Recycling of carbon tax revenue
  • Improvement in domestic and consumer energy efficiency

Evidence & Reference

  • The Carbon Tax Centre: Carbon Tax Centre
  • Agostini, P., Botteon, M., Carraro, C., 1996. A carbon tax to reduce CO2 emissions in Europe. Energy Economics, Volume 14, Issue 4, pp. 279 – 290.
  • Schlegelmilch, K., Dutzler, H., Jurrat, S., Luhmann, H.-J., Niemann, S., 1999. Energy taxation in the EU and some member states: looking for opportunities ahead. Wuppertal Institute for Climate, Environment and Energy on behalf of the Heinrich-Böll-Foundation, February 1999.
  • European Environment Agency (EEA), 2000. Environmental Taxes., EEA Draft Report, Copenhagen.
  • European Environment Agency (EEA), 1996. Environmental Taxes: Implementation and Environmental Effectiveness. Environmental issues Series No.1. Copenhagen.

Modelling this Measure

Within a given modelling framework the effects/impacts of a carbon tax can be captured through their impact on a number of key modelling parameters:

  • Activities­– the degree to which the implementation of a carbon tax reduces energy consumption across the economy. One would expect that the introduction of a carbon tax will result in a reduction in energy consumption as consumers seek to improve energy efficiency  and switch  to lower carbon content products/fuel types and services to avoid payment of the tax.
  • Technology Change– the degree to which a carbon tax induces technology change – notably greater use of energy efficient and lower carbon content products.  
  • Costs– the financial costs associated with the application of the carbon tax.
  • Benefits– with a carbon tax expected to lead to a reduction in energy consumption as people reduce their consumption of CO2 intensive goods and services or shift to consuming more CO2 efficient products there will be an associated change in emission levels with associated benefits.
  • Utility– the degree to which a carbon tax impacts on a household’s financial well-being as a result of the increase in the price of carbon related goods and services.

Site Entry Created by J A Kelly on May 09, 2010

Reference This Source (2019). Carbon Tax. Available: Last accessed: 24th April 2019

Reader Comments

There are no comments for this measure yet.

Add your Comment or Rate this Measure

Only registered users can comment on and rate material within the policy measures database.

Login using the form below or click here to register on the site.

Auto-login on future visits

Forgot your password?

Rate this Measure