A carbon tax is a tax on the carbon content of fuels. When hydrocarbon fuels like gasoline or natural gas are burned, they produce carbon dioxide (CO2). Carbon dioxide is a greenhouse gas—it accumulates in the atmosphere, warming the planet, and destabilizing the climate. Making hydrocarbon fuels more expensive reduces the demand for them, and thereby reduces harmful CO2 emissions.
Carbon taxes are intended to correct a market failure. When people burn hydrocarbon fuels and emit greenhouse gases, they get to enjoy the benefits, while the costs that come from destabilizing the climate are transferred to others. Economists call this a negative externality. Carbon taxes put a cost on greenhouse gas pollution, because pollution has negative consequences for everyone.
There are different ways to implement a carbon tax. Governments can use the revenue to pay for programs that promote the transition away from fossil fuels, redistribute it to individuals and businesses through rebates or tax cuts—or some combination of both. But governments need to take into account the disproportionate impact that a carbon tax can have on low-income people, and prevent the tax from becoming regressive.
Carbon taxes help incentivize the development of low-carbon technologies, by making them cost-competitive with their carbon-emitting counterparts. Low-carbon technologies include things like electric cars and solar power, as well as systems that can capture carbon emissions from industrial processes—or out of the air.
Carbon taxes are a form of carbon pricing, which includes a broader set of market-based mechanisms for putting a price on greenhouse gas emissions. Another approach to carbon pricing is an emissions trading system, in which polluters are required to obtain tradable credits to cover their emissions.
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