World Resources Institute WRI

The bottom line series: Carbon taxes

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Courtesy of World Resources Institute WRI

Climate policy debates often feature discussions about the role of a carbon tax, either as an alternative or a supplement to a cap-and-trade program. This fact sheet describes the similarities and differences between the two policy approaches and answers other common questions about a tax on carbon.

What is a carbon tax?

A carbon tax is a fee imposed on fossil fuels, and other primary products (e.g., refrigerants), based on the amount of greenhouse gases (GHG) they emit. A carbon tax places a fee on coal, for example, based on the amount of carbon dioxide (CO2) that is released when coal is burned. The tax creates a cost for emitting GHGs into the atmosphere (for example, $25/metric ton of CO2-equivalent) and in doing so provides a financial incentive for reducing GHG emissions. A carbon tax policy may also include tax credits for activities that remove GHGs from the atmosphere.

How is a carbon tax different from a cap-and-trade program?

A carbon tax and a cap-and-trade program are similar in that both policy approaches are market-based and create a carbon price that provides the financial incentive to reduce GHG emissions. The fundamental difference between the two approaches is how they establish this price and reduce emissions. A carbon tax imposes a direct fee (the carbon price) on fuels based on the amount of GHGs they emit, but does not set a limit on GHG emissions. A cap-and-trade program establishes a limit, or “cap,” on GHG emissions, but the price for emission allowances (the carbon price) is determined by the supply and demand for allowances in the emissions trading market.

Who has to pay a carbon tax?

Point of regulation for a carbon tax policy can vary, but a tax would likely be imposed on the sale of fuel from “upstream” producers, such as coal mines or natural gas and oil wells. Depending on the ability of the initial consumers (e.g., electric utilities, oil and gas refineries, and fuel transporters) to pass along costs to their own customers, the carbon tax raises prices that “downstream” consumers (i.e., businesses and households) ultimately pay for carbon-intensive goods and services.

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