• Category
  • >Financial Analytics
  • >Science & Technology

What is Carbon Tax and How does it Work?

  • Soumyaa Rawat
  • Oct 08, 2021
What is Carbon Tax and How does it Work? title banner

Carbon Tax 


Fossil fuels are present across Earth in a limited quantity. Used for many purposes like energy production, running steam machines, and industrial pursuits across the globe, fossil fuels are exhaustible natural resources. 


The burning of fossil fuels leads to the emission of carbon which is harmful to the atmosphere. However, there are more carbon emissions causes prevalent in the contemporary scenario. 


Even though there are many uses of fossil fuels, they are still harmful to the atmosphere in the long run. 


In light of the emerging climate change protocols and treaties to substantially decrease global warming, carbon emission has also been perceived as one of the major target factors that need to be reduced. 


A penalty fee for burning fossil fuels, the carbon tax was invented by David Gordon in 1973. As a response to the emerging climate change crisis, Gordon was the first one to propose the concept of the carbon tax. 


However, it was only in the mid-1990s that the first carbon tax was implemented. This time too, it was implemented in addition to an energy tax. Defined as a fee that governments impose on companies or organizations, a carbon tax is required to be paid by companies or organizations that burn fossil fuels. 


Some of the widely known fossil fuels under this tax are gasoline, natural gas, coal, and oil. Since the burning of fossil fuels leads to the emission of greenhouse gases, it deteriorates the environmental quality and perhaps damages the global atmosphere. 


Often, a carbon tax is imposed on a very high level in order to discourage the burning and extensive use of fossil fuels. 


(Similar reading: What is Active Solar Energy?)


How does it work?


Until the time carbon tax was imposed, carbon emissions were freely allowed and went unchecked. 


Yet, as soon as international summits gathered and discovered that the world had entered the phase of global warming, they rolled out the mandate of the carbon tax in order to keep a check on the carbon emissions. 


In a way, carbon tax came in as a system of checks and balances that has not only discouraged companies and organizations to burn fewer fossil fuels but has also created awareness pertaining to the adverse effects it can have on the atmosphere.  


"The purpose of a carbon tax is to reflect the true cost of burning carbon. Those costs are borne by those who suffer from the effects, such as homeowners, farmers, and ultimately the government." Significance of Carbon Tax 


For high-end industrial procedures, carbon emissions can go unnoticed on the part of organizations. However, the ones who inhabit in proximity to these industrial plants, are the ones who ultimately bear the harsh consequences of carbon emissions. 


Usually, these carbon taxes are hefty amounts that discourage companies from burning fossil fuels. Moreover, such a tax also encourages innovative alternatives to be established. 


For instance, the production of coal energy has been substantially reduced as governments have now discovered other sources of energy (thermal and wind energy source). 


Simply put, a carbon tax is an incentive for organizations to reduce the commercial usage of fossil fuels and implement environment-friendly practices to preserve Earth from the harmful consequences of carbon emissions. 


In order to charge an organization or a company for carbon emission, a government must first determine the cost of each ton of carbon released. One of the biggest advantages of the carbon tax is that it motivates consumers to seek cleaner sources of energy. 


(Also read: What is Renewable Energy?)


Pros of Carbon Tax


  1. Primarily, a carbon tax acts as an incentive in discouraging people from using fossil fuels that lead to environmental damage. 


By making fossil fuels users pay a substantial amount, governments can indeed bring down carbon emission levels that will help worldwide. 


  1. As soon as companies are charged for using fossil fuels, they will accelerate their respective R&D protocols to innovate newer sources of energy that are against the use of fossil fuels. 


This will lead to environment-friendly practices in the long run. 


  1. Similar to the concept of differentiated responsibilities, a carbon tax is likely to begin charging major defaulters more fees. 


This way, those who damage the environment more, will have to pay more. As a result of this, fairer policies will be put in place. This pro acts as one of the biggest carbon tax benefits to mankind. 



Cons of Carbon Tax 


  1. One of the biggest drawbacks of the carbon tax is that it can encourage countries to shift their manufacturing operations to countries that do not charge carbon tax. In a way, this will only continue to harm the atmosphere.


  1. Production costs may escalate as companies will have to take longer and more elaborate routes to manufacture goods. That said, consumer costs will also rise and the market will become less affordable for the masses.


  1. Like tax evasion in other areas of the industrial sector, companies might also evade paying carbon taxes by either concealing the true level of carbon emission or simply covering up their carbon emissions as a whole. 


That said, this might not disrupt environmental damage and will only help companies in saving costs. 


Carbon Tax-paying Countries 


When it comes to the origin of the carbon tax, we have already discovered that the concept came in around the mid-1990s. The first-ever country to implement a carbon tax was Finland. 


Even though the concept emerged in the 1970s, it was only in the 1990s that Finland became the first country to introduce this tax.  Later on, several countries followed.


“The list of countries that already practice some method of national carbon pricing includes Argentina, Canada, Chile, China, Colombia, Denmark, the European Union (27 countries), Japan, Kazakhstan, Korea, Mexico, New Zealand, Norway, Singapore, South Africa, Sweden, the UK, and Ukraine. “

Countries with a Carbon Tax Policy 


Other carbon tax countries like Brazil, Brunei, Indonesia, and Russia are considering joining along with the countries that already charge taxes on the emission of carbon. 


While awareness related to carbon emission has been on top of the town, it has only been a handful of years that carbon tax has been talked about in the diplomatic sphere. 


The carbon pricing mechanism for carbon tax has become a necessity as carbon pollution has increased significantly in recent decades. For any company that consumes carbon and leads to public damage, the government prices carbon and its external costs that can be witnessed in public. 


Public damages can either refer to the burning of crops and farm fields or heat waves experienced by the masses residing in that particular locality.


In a way, the goal is to make the defaulter organization pay back for the damage done and compensate the victims in one or the other way. Ultimately, the ultimate goal of the government is achieved.  


(Must read: What is Clean Energy? Sources, Uses and Benefits)


Climate Change and Carbon Emission


Even though a lot of international summits and conferences have addressed the emergent climate change scenario emerging in the world as a consequence of constant carbon emission, there is still a need for the masses to be aware of the connection between climate change and carbon emission. 


Extreme climatic conditions as a climate change effect in the world have indicated that the world is facing a rather massive problem. 


Yet, the principle of common but divided responsibilities has led the developed countries to take active charge in support of climate change, it has somehow been sidelined in pursuit of acing other developmental parameters. 


That said, as of May 2021, a total of 64 countries have carbon pricing policies in place while 3 more nations are lined up for the implementation of the same. Of all the top 20 countries that emit carbon, China tops the list. 


In light of carbon emission, scholars suggest that carbon tax is indeed a suitable way to generate a state of caution among countries and corporations that emit carbon and are perhaps leading to the deterioration of the atmosphere. 


Nonetheless, the responsibility of reducing carbon emissions is to be borne by all countries - developed, developing, and underdeveloped. 


Therefore, the social injustice between these 3 tiers of countries continues to widen as the developed countries are not taking any extraordinary measures in regard to climate change and carbon emission. Here is a pie chart for you to understand the proportion of carbon emissions by the top 20 countries. 

The image is representing 20 largest carbon-emitting countries.

Carbon Emission by Top 20 Countries, Source 

Furthermore, a brief list of carbon tax pros and cons will help you to not only underline the key factors of this concept but will also demarcate the structure of this concept. Let us begin right away.


(Suggested blog: Nuclear Energy- Production, Advantages & Disadvantages)





To conclude, a carbon tax is a far progressive approach to cut down carbon emission levels. What’s more, a carbon tax can also save the world from being further damaged or possibly lower the pace of such damage. 


All in all, it is undoubtedly an innovative and necessary policy that must be implemented by countries as soon as possible, or else countries will continue to pollute the atmosphere as they have done for the past decades. 


The road to Industrial Revolution II is near and the world is preparing for an environmental crisis while knowing what it needs to do. Perhaps carbon tax is the real window for governments to dismantle practices that will otherwise make this planet a living hell for future generations.