A carbon tax is a tax on greenhouse gas emissions, designed to account for the social cost of those emissions. It can be levied on all emissions or companies can receive a cap and pay a tax on emissions above that level. A major disadvantage is that it is a national measure trying to solve an international problem. An alternative is a capitalization and trade scheme.
A carbon tax is a tax on the emission of greenhouse gases, usually carbon dioxide. The tax is conceived as a financial means of controlling and limiting these emissions. It is based on the scientific theory that excessive levels of these gases are trapped in the earth’s atmosphere, which can lead to an unwanted increase in temperature.
From a purely economic basis, a carbon tax is designed to account for the social cost of those emissions. This social cost is an attempt to establish a financial figure that reflects the harm suffered by society that is not accounted for when companies set the prices of their goods and services. In practice, this figure may only be an estimate, while setting tax levels must also include political concerns.
In some cases, a carbon tax is levied on all emissions. In others, companies receive a cap and then pay a tax on all emissions above this level. These limits can be gradually reduced each year so that companies have more time to change their production techniques.
As with other taxes designed to influence behaviour, a carbon tax cannot be relied upon as a revenue-enhancing measure. At first blush it may seem logical to argue that a carbon tax is doubly effective, as it can reduce emissions and at the same time raise money for spending on environmental projects. In practice, this cannot work both ways: if the tax meets its stated goal of reducing emissions, the amount of revenue generated will decrease or even reach zero.
One major disadvantage of a carbon tax system is that it is imposed as a national measure that attempts to solve an international problem. There is a risk that companies that run the risk of paying higher taxes will move to other countries that have lower taxes or even no environmental taxes. In this situation, a national government can impose tariffs on imports from that country to make up the deficit.
The most common alternative to a carbon tax is a capitalization and trade scheme. Under this system, companies are assigned a designated level of emissions they can produce each year. Those with emission levels below their target earn credits. They can then sell these credits to other firms, which is the only way those firms are legally allowed to exceed their target levels. The idea is that the system requires that the “cost” of emissions be integrated into the production process.
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