A carbon tax is a government levy charged per tonne of carbon dioxide (or CO2-equivalent) emitted, putting an explicit, predictable price on greenhouse-gas pollution so that emitters internalise the climate damage their activities cause. Unlike an emissions trading scheme, which caps the quantity of emissions and lets the price float, a carbon tax fixes the price and lets emitted quantities adjust; examples include Sweden’s levy of over 100 euros per tonne and carbon taxes in Canada, Singapore and South Africa.
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Definition
A carbon tax is the price instrument of Climate Policy: a per-tonne charge on CO₂ (or CO₂-equivalent greenhouse gases) levied on fossil fuels in proportion to their carbon content, usually collected upstream from fuel suppliers or large emitters. Its economic rationale is Pigouvian — greenhouse-gas emissions impose damages on third parties that market prices ignore, and taxing each tonne at (ideally) the social cost of carbon makes polluters internalise that externality. Once carbon carries a price, every actor in the economy faces a continuous, decentralised incentive to abate wherever abatement is cheapest: switching fuels, improving efficiency, electrifying processes or redesigning products, without regulators needing to prescribe how.
The instrument’s defining contrast is with the Emissions Trading Scheme (cap-and-trade): a tax fixes the carbon price and leaves the resulting emission quantity uncertain, whilst a cap fixes quantity and leaves the price uncertain — Weitzman’s classic “prices vs quantities” analysis frames the choice under uncertainty. Taxes offer price predictability for investment decisions, administrative simplicity (they piggyback on existing fuel-excise machinery) and revenue stability; caps offer certainty of environmental outcome and generate tradeable allowances and Carbon Credits. Hybrids blur the line: price floors and ceilings inside trading schemes, and tax rates that escalate on legislated schedules, each borrowing the other’s virtues. Revenue use is politically decisive — options include “fee and dividend” rebates to households (British Columbia’s model, later Canada’s federal backstop), cutting other taxes, or funding green investment — and poorly designed schemes can be regressive or provoke backlash, as France’s gilets jaunes protests demonstrated in 2018.
Current Landscape
According to the World Bank’s annual State and Trends of Carbon Pricing, around a quarter of global emissions are now covered by some carbon price, split between roughly three dozen carbon taxes and a similar number of trading schemes within the world’s Carbon Markets. Sweden’s tax, introduced in 1991 and now exceeding €100 per tonne, is the long-run exemplar, with national taxes also operating in Norway, Switzerland, Canada, Singapore, South Africa, Uruguay and elsewhere; the UK applies a Carbon Price Support tax alongside its emissions trading scheme rather than a standalone economy-wide tax. Most observed rates remain well below estimates of the social cost of carbon, and coverage gaps persist in agriculture and international transport. The frontier issue is carbon leakage: border carbon adjustments — led by the EU’s Carbon Border Adjustment Mechanism, phasing in charges on embodied carbon in imports from 2026 — extend domestic carbon prices to traded goods and pressure trading partners in the Compliance Carbon Market world to price carbon themselves.