Simply put, a carbon tax is an environmental fee levied by governments on the production, distribution or use of fossil fuels such as oil, coal and natural gas. The amount of the tax depends on how much carbon dioxide each type of fuel emits when it is used to run factories or power plants, provide heat and electricity to homes and businesses, drive vehicles and so on.
How Does a Carbon Tax Work?
Essentially, a carbon tax—also known as a carbon dioxide tax or CO2 tax—is a tax on pollution. 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 pollution that carries with it a cost for society, because the pollution affects everyone.
A carbon tax factors the societal cost of greenhouse gas emissions into the price of the fossil fuels that create them—so the people who cause the pollution have to pay for it.
How Does a Carbon Tax Promote Renewable Energy?
By making dirty fuels like oil 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.
How Can a Carbon Tax Reduce Global Warming?
A carbon tax is one of two market-based strategies—the other 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—which many scientists believe is causing significant climate changes.
As a result of global warming, polar ice caps are melting at an accelerated rate, which contributes to coastal flooding worldwide and threatens habitat for polar bears and other Arctic species. Global warming also leads to more severe droughts, increased flooding, and more intense wildfires. In addition, global warming reduces the availability of fresh waterfor people and animals who live in dry or desert areas. By reducing the release of carbon dioxide into the atmosphere, scientists believe we can slow the rate of global warming.