How Does a Carbon Tax Work?

A carbon tax is where a government sets a price that businesses have to pay, dependent on the amount of greenhouse gases that they emit. It is a financial incentive for corporations and consumers alike to reduce their emissions to avoid paying the carbon tax. 

Australia introduced a carbon tax in 2011. However, it was repealed in 2014. Today, about 40 countries and 20 cities, states and provinces worldwide use carbon pricing mechanisms. Plenty of others are planning their implementation. Collectively, these schemes cover about 13 per cent of annual global greenhouse gas emissions.

Why are carbon emissions some of the worst greenhouse gas emissions?

Carbon dioxide (CO2) emissions are the most common type of greenhouse gas. They are responsible for about three-quarters of all global warming. Humans have increased the atmospheric concentration of CO2 by 50 per cent since the Industrial Revolution by burning fossil fuels. Subsequently, there are now 419 carbon dioxide molecules for every million molecules of air. This is the highest level of CO2 in the atmosphere for over 4.5 million years.

Like all greenhouse gases, CO2 contributes to global warming by preventing heat from escaping the Earth into space. It exists in the atmosphere for a very long time. It can take 300 to 1,000 years for CO2 to break down. Therefore, CO2 greenhouse gas emissions from burning coal in Victorian factories can still contribute to global warming today. 

Equally, the emissions we cause now will impact the planet for centuries. Collectively, human-caused emissions are responsible for a global surface temperature increase of 1.07°C since the 19th century. We cannot hope to prevent global warming whilst continuing to use coal, oil and natural gas and increasing the amount of CO2 in the atmosphere.

Why are some countries imposing a carbon tax?

Climate change is having severe effects on nations around the world. Between 2016 and 2018, climate-related disasters cost the world USD $650 billion, according to Morgan Stanley. But, this is only the beginning. The Economist Intelligence Unit’s (EIU’s) Climate Change Resilience Index predicts that global warming could directly cost the world economy USD $7.9 trillion by 2050. As more severe droughts, floods, and crop failures hamper growth and threaten infrastructure, three per cent of global GDP will be spent on climate change.

A carbon tax is a way to recoup the economic cost of climate change and discourage additional emissions. Many governments create their own carbon tax based on the financial burden that carbon emissions cause. For example, they can link it to the damage it is causing crops and property and the health care costs it incurs due to droughts, flooding, rising sea levels and heatwaves. 

As the World Bank explains, “A price on carbon helps shift the burden for the damage back to those who are responsible for it, and who can reduce it.” It is the simplest way to achieve the environmental goal of reducing emissions. There is no need for complicated calculations of who is polluting, how much they are polluting and where they can reduce their pollution. Instead, a carbon tax is a low-cost way to put the onus on reducing emissions back on the biggest emitters themselves.

The two types of carbon pricing

Emissions trading systems (ETS)

An ETS is also known as a cap-and-trade system. It limits the total level of greenhouse gas emissions. This permits industries and businesses with lower emissions to sell their spare allowances to larger emitters. In practice, it creates a market price for emissions. The cap helps to ensure that the countries’ emitters stay within their pre-allocated carbon budget.

A carbon tax

A carbon tax defines a tax rate on either greenhouse gas emissions or the carbon content of fossil fuels. It, therefore, sets a direct price on carbon. As a result, the emissions reduction outcome is not clear from the outset. 

How do we determine carbon pricing?

Each country or jurisdiction that implements a carbon tax must decide how to determine carbon pricing. The rate that is set affects the impact on emissions levels and the revenue that the tax will raise. Some carbon taxes increase over time to help companies to adapt to the tax and seek lower emissions alternatives.

Sweden’s successful carbon tax 

A common criticism of a carbon tax is that it will be detrimental to the economy. However, this assertion has been disputed multiple times. Sweden is an example of how a carbon tax does not inhibit economic growth.

Sweden implemented a carbon tax in 1991. It was the second country in the world to do so after Finland. They levy the highest rate in the world, charging USD $126 per tonne of CO2. Consequently, their greenhouse gas emissions decreased by 27 per cent between 1990 and 2018. Simultaneously, Sweden has been maintaining solid GDP growth. GDP per capita increased by more than 50 per cent in real terms between 1990 and 2019.

Does Australia have a carbon tax?

Australia currently does not tax carbon. As mentioned, the Oceania country introduced a carbon tax that came into effect in July 2012. It levied a tax of AUD $23 per tonne of CO2. The intention was to transition it to an ETS or cap-and-trading system after three years. This would link Australia to international carbon markets. It would also cut pollution and support the economy by providing money for low and middle-income households. 

But, the transition never went ahead. Instead, the opposition Liberal-National coalition won an election with a campaign to ‘axe the tax’. Subsequently, they repealed the carbon price in July 2014. Australia has lacked a carbon tax ever since. It is currently ranked last out of more than 170 countries by the UN for its action on climate change.

Was it successful?

Nevertheless, during its short lifespan, Australia’s carbon tax successfully reduced emissions. In fact, they fell immediately after it was introduced, as businesses began using technologies with fewer emissions. The country’s greenhouse gas emissions were reduced by 1.4 per cent in the second year of Australia’s carbon tax. In 2013, the scheme slashed carbon emissions by around 17 million tonnes. This was the largest annual reduction in 24 years of record keeping. 

However, the carbon tax also increased electricity costs for both households and industry. The cost of electricity leapt by 10 per cent for the average Australian family. This was because many of the roughly 75,000 businesses that paid the carbon tax passed on part or all of this cost to their consumers, smaller businesses and households. It, therefore, increased the cost of living for households by about AUD $9.90 per week.

Right-wing Labour party leader Tony Abbott manipulated this hike in electricity prices to his advantage. He said removing the carbon tax would save Australians AUD $550 per year. Although this figure was widely disputed, the tax was repealed, and electricity and gas prices fell by an estimated seven and five per cent, respectively. However, Australia’s emissions immediately rose again.

Will Australia impose a carbon tax?

The Australian government opposes any form of a carbon tax. In October 2021, the government announced a commitment to net zero emissions by 2050. However, the accompanying plan is light on detail and relies on unproven technologies. On top of this, the government has not included a tax on fossil fuel emissions. This is down to political manoeuvring. A poll taken when the Australian carbon tax was repealed found that almost two-thirds of Australians believe that there should be pricing for big emitters.

Ultimately, Australia is falling behind the rest of the world with its climate change policies. It has the 14th highest emissions per capita in the world at 15.5 tonnes. The country contains just 0.3 per cent of the world’s population, yet it produces 1.8 per cent of all greenhouse gases. It is time for Australia to face up to its climate responsibilities and tax those most responsible for causing the worsening climate catastrophe.