Carbon Tax Meaning, Principle, Effect, Comparison and Examples

A carbon tax is a levy allocated to firms and institutions for the carbon dioxide which they produce.

This article discusses the carbon tax concept based on the following perspectives;

-Carbon Tax Meaning: 8 Ways to Define the Carbon Tax

-How the Carbon Tax Works: Basic Principle

-Carbon Tax Effect on the Gasoline Market

-Carbon Tax and Cap-and-Trade System: A Comparison

-Examples of Carbon Taxes around the World

-Conclusion

Carbon Tax Meaning: 8 Ways to Define the Carbon Tax

A carbon tax is a tax which is levied on atmospheric carbon emissions by a company or institution.

It is important to clarify the role of the institutions and companies in carbon emission, when defining the concept of carbon taxes, as this establishes a rationale for the existence of this levy. The following carbon tax meaning portrays this perspective;

Carbon tax is a tax levied on institutions and firms for the carbon dioxide which is produced as a result of their operations in energy production, manufacturing, commerce and administration.

The establishment of carbon tax is in line with the basic concept of sustainable development and sustainability [1]. This is elaborated briefly as follows;

Carbon tax is a tax which is used as an incentive to effectively cut down on carbon emissions in the economic sector, so as to move closer to a sustainable economy.

Within the same context of sustainability, it is possible to outline the carbon tax meaning in terms of policy development;

Carbon tax is a policy which implements the social cost of atmospheric carbon, so as to limit the emission of this gas by industrial, institutional and commercial entities [2].

As the above definitions imply, carbon taxes are premised on environmental protection and conservation. This is further portrayed in the following definition;

Carbon tax is a government tax policy which is implemented to address environmental degradation in the form of climate change, greenhouse emission and global warming, by allocating levies to institutions and corporations in line with the amount of carbon which they emit into the atmosphere.

To further clarify the link between carbon taxes and emissions, the concept can be defined based on the practice of emissions trading, as follows;

Carbon tax is an emissions-trading tool which is designed to reduce atmospheric carbon by taxing producers of goods and services for their carbon emissions, on a per-ton basis.

Another perspective from which carbon taxes can be viewed, is that of addressing environmental problems related to the excessive dependence on fossil fuels as a source of energy;

Carbon tax is a social policy system that assigns a price per-ton of carbon emission, as a means of addressing environmental problems associated with fossil fuel dependence, and accelerating the transition to renewable energy, energy efficiency and conservation.

Lastly, carbon tax meaning can be understood based on its potential role in addressing greenhouse emissions in general;

Carbon tax is a levy allocated to carbon emissions by companies, to reduce atmospheric carbon dioxide, as well as other greenhouse emissions produced from similar processes, like nitrous oxide and methane.

How the Carbon Tax Works: Basic Principle

Carbon tax works based on three steps; which are emission-valuation, price-allocation and policy-implementation.

These steps are individually elaborated below;

1). Emission-Valuation

Emission-valuation is the process of determining the actual cost implication of greenhouse emissions.

In the case of carbon taxes, emission-valuation has to do with estimating the cost which can be imposed as a result of carbon dioxide emission into the atmosphere.

To achieve this valuation, several factors must be considered. These factors are the potential side-effects of carbon emission and include the cost of environmental remediation, health care, soil conservation, and measures to tackle food insecurity that may result from atmospheric emissions.

After these factors have been assessed, a cumulative cost of carbon emission is derived. This cost is then resolved to represent one ton of carbon dioxide. It is important to note that the cost per-ton of carbon emission may vary for different regions.

2). Price-Allocation

This is the second step in the carbon levy process or working principle.

Price-allocation occurs when a definite value has been calculated and assigned to carbon emissions. This value then becomes the working price per-ton of atmospheric carbon.

Carbon taxes are calculated as follows;

Carbon tax($/ton)= (Potential cost of carbon capture and storage + environmental remediation +emission-related healthcare/amenities)$/ (Volume of emissions) ton

The value derived from this calculation is resolved to one ton of carbon emission, to derive the cost per-ton.

3). (Carbon Tax) Policy-Implementation

Policy-implementation is the final step in the carbon levy creation-process.

After the carbon value or price has been determined and allocated, a carbon policy is established, which legalizes the implementation and enforcement of carbon taxes.

Carbon Tax Effect on the Gasoline Market

In general, the effect of carbon taxes on the gasoline market is an increase in price and a corresponding decrease in demand.

Fossil fuel prices tend to increase when carbon policies are enforced, although this effect may not be very effective in the long run [6]. This is the case for all non-renewable, carbon-emitting energy sources like coal, diesel, natural gas, and gasoline.

The reason for this increase, is the cumulative effect of carbon prices on the price of gasoline (fossil fuel) itself. When carbon policies are implemented, it implies that companies and consumers are to pay for both fossil fuels and gaseous emissions. With higher rates of taxes, fossil fuel prices will increase.

Correspondingly, carbon taxes reduce the demand for gasoline [5].

This occurs because of the increased overall cost of fossil fuel dependence at all levels including exploration, processing, and marketing.

As the demand for gasoline and other fossil fuel derivatives reduces, alternative sources of energy will grow more relevant for electricity generation, agriculture and other purposes. One of the objectives of carbon policy implementation is to accelerate the transition to solar, wind, geothermal, hydro-power and other forms of renewable energy.

Carbon policies are capable of making zero-carbon energy technologies to become more competitive, while stabilizing the fossil fuel market.

Carbon Tax and Cap-and-Trade System: A Comparison

The main difference between carbon tax and cap-and-trade is that the former is price-oriented while the latter is volume-oriented.

Carbon taxes are created by assigning a price to carbon emissions, so as to control the rate at which these emissions are produced. Cap-and-trade system works by setting a volume-limit on emissions, as a means of controlling them and protecting the environment.

Both systems are aimed toward environmental protection. Cap-and-trade system sets a ‘cap’ or maximum limit on the amount of gaseous emission produced [4]. By imposing this limit, it reduces environmental degradation by excessive greenhouse emission.

Carbon taxes achieve the same purpose by imposing a price on emissions. The effectiveness of both methods is similar, and both can be categorized as Emissions Trading Schemes (ETS).

It is important to note that carbon levy is usually imposed on large entities like energy and manufacturing companies, rather than on individuals.

The following table summarizes the differences between carbon tax and cap-and-trade system;

Examples of Carbon Taxes around the World

The value of carbon taxes may vary in different parts of the world. Below is a summary of carbon taxes for various countries in 2021;

Other countries which are soon to implement carbon taxes include Indonesia, Brazil, Pakistan, Brunei, Thailand, Russia, Vietnam, Turkey and Serbia [3].

Conclusion

Carbon tax is a levy imposed on companies and institutions for their carbon emissions.

The working principle of carbon taxation is a three-step process including;

1. Emission-Valuation
2. Price-Allocation
3. (Carbon Tax) Policy-Implementation

Carbon policy or tax, differs from cap-and-trade system because it is based on price allocation, whereas cap-and-trade is based on volume regulation.

The economy is also affected significantly by carbon tax policy.  If a tax which is proportional to carbon emissions is passed, the market for gasoline will experience an increase in commodity cost and a decrease in demand.

The value of carbon taxes vary in different parts of the world, based on differences in industrial, commercial and environmental factors.

References

1). Ezenagu, A. (2016). “Carbon Taxation as a Tool for Sustainable Development in Africa: Evaluation of Potentials, Paradoxes and Prospects.” Electronic Journal. Available at: https://doi.org/10.2139/ssrn.2748040. (Accessed 6 June 2022).

2). Islam, R. (2022). “What are the advantages and challenges of a carbon tax?” Available at: https://www.weforum.org/agenda/2022/02/what-a-carbon-tax-can-do-and-why-it-cannot-do-it-all/. (Accessed 6 June 2022).

3). Lai, O. (2021). “What Countries Have A Carbon Tax?” Available at: https://earth.org/what-countries-have-a-carbon-tax/. (Accessed 6 June 2022).

4). Mcallister, L. (2012). “Cap and Trade.” Available at: https://www.researchgate.net/publication/256036280_Cap_and_Trade. (Accessed 5 June 2022).

5). Rivers, N.; Schaufele, B. (2012). “Carbon Tax Salience and Gasoline Demand.” Electronic Journal. Available at: https://doi.org/10.2139/ssrn.2131468. (Accessed 6 June 2022).

6). Sterner, T.; Köhlin, G. (2015). “Pricing carbon: The challenges.” Towards a Workable and Effective Climate Regime (pp.251-266) CEPR Press and Ferdi. Available at: https://www.researchgate.net/publication/299494867_Pricing_carbon_The_challenges. (Accessed 6 June 2022).