Carbon Tax – Pros and Cons

The production of carbon dioxide is widely held to contribute to social/environmental problems such as global warming. This carbon pollution is a negative externality. It is a cost imposed on the whole of society and not just the individual who consumes a certain product. e.g. if you drive a car, the external costs are felt by everyone else.

Because certain carbon-intensive industries create negative externalities, the social cost of production is greater than the private cost.

In a free market, these negative externalities encourage in the price leading to overconsumption and social inefficiency. We can say there is a missing market because the external cost of carbon emission is ignored.

Diagram to show welfare loss of a negative externality



SMC = Social Marginal Cost (total cost to society) | PMC = Private Marginal Cost (cost to individual) | PMB = Private Marginal Benefit (benefit to individual)

This diagram shows that in a free market, we get overconsumption of carbon, leading to a welfare loss to society (shown by shaded red triangle)

The Purpose of A Carbon tax

The purpose of a carbon tax is to internalise the externality. What this means is that the final price of the good should include the external cost and not just the private cost. It is similar to the ‘polluter pays principle.‘ This was incorporated into international law at the 1992 Rio Summit. It simply means those who cause environmental costs should be made to pay the full social cost of their actions.

In theory, the tax should equal the external cost. Therefore, the price consumers pay will be the social cost.
Demand will fall and the new equilibrium will be socially efficient because, at this output, the marginal social cost equals the marginal social benefit.

Diagram to Show Carbon Tax


The tax shifts the supply curve from S to S2. With the tax, consumers now face the full social cost (SMC)

Revenue Neutral

In theory a carbon tax should be revenue neutral. This means the tax raised from taxing carbon emissions can be used to reduce other taxes. There should be no overall increase in the tax burden. The aim is to increase social efficiency by making people aware of the full social cost.

Benefits of Carbon Tax

1. Encourages alternatives. A higher price of carbon emissions will encourage firms and consumers to develop more efficient engines or alternatives to consuming carbon emissions. For example, with carbon taxes, it will be more efficient to develop hydrogen engines or solar power.

  • It might encourage more people to cycle or walk to work. This would have health benefits such as lower risk of heart attack.
  • This could make it more feasible to generate electricity from green sources (e.g. solar power). If we develop more green sources it will also make us less reliant on oil.
  • It will help make the transition to a post-oil economy easier.

2. Raises Revenue. The revenue raised from a carbon tax could be used to subsidise alternatives such as green electricity or the revenue raised could be used to repair the damage caused by environmental pollution.

3. Leads to a socially efficient outcome. It makes people pay the social cost and overcomes the excess consumption.

Problems of Carbon Tax

  • Production may shift to countries with no or lower carbon taxes. (so-called ‘pollution havens’)
  • The cost of administrating the tax may be quite expensive reducing its efficiency.
  • Difficult to know the level of external cost and how much the tax should be.
  • Possibility of tax evasion. Higher taxes may encourage firms to hide carbon emissions.
  • If demand is price inelastic, the tax may have to be very high to reduce demand significantly. In the short term, firms may not feel they have many alternatives. Though other time, demand will become more elastic as more alternatives are generated.
  • Consumers dislike new taxes and often don’t believe that they will be ‘revenue neutral’. This is not an economic argument, but it is a political reality and explains why it is often difficult to implement.
  • A global carbon tax may curtail economic activity in the poor developing world because they can’t afford the small increase in energy costs, but the developed world may simply be able to pay. There may be a need for a carbon tax to reflect different abilities to pay.

Carbon Tax vs Cap and Trade

See: Carbon Trading


53 thoughts on “Carbon Tax – Pros and Cons

  1. In 1973 I was told by lecturer at LaTrobe University that CO2 was warming up the globe. We are currently having a normal cold and wet winter. Four weeks ago Ms Gillard told Parliament that at present there is the greatest concetration of CO2 in the atmosphere for the last million years. Really, when is the globe going to start to warming up?

  2. I think everyone should stop blaming CO2 on global warming and carbon tax WON’T encourage us to walk because the tax isn’t on us!!

  3. After reading the article along with its many comments i conclude that no one really knows how this trial and error ‘solution’ will pan out, (assuming that there is a problem in the first place). For instance how will the consumers of Australia really react to this proposed tax if it goes ahead?… we don’t know. This is why it is of such controversial nature, people are worried about the implications it will have on them, with such high costs of living i certainly wouldn’t want to start forking out money for a questionable purpose, however this is just one of the many assumptions that we are plagued with in this time of uncertainty.

    For this tax to have any credibility certain questions and statements must be answered, am i the only one that thinks this a ‘stab in the dark’ attempt of fixing the ‘problem’, i say ‘problem’ because carbon emmisions are in itself a highly debateable topic, there is yet to be factual solid evidence that co2 emmisions are a direct cause of global warming.

    For the people of Australia and indeed the greater world, how will this impact you? will the tax on major producers be handed down to consumers? Will both producers and consumers change their ways in order to make room for an environmentally sustainable world…. can they? Does Australia have the proper policies and guidlines in place to support such a tax proposal?

    Everyone is entitled to their own oppinion on the subject, and as such no one person is correct, all i ask is that you do your homework before making a decision, to truly solve this issue (providing there is one) we need to come together as a whole and unite to negotiate for a fairer more stable and secure outcome that will benefit everyone as well as the environment.

    Thankyou for your time.


  4. Pingback: Why choose between the environment and the economy: Carbon Tax and Income Tax Reduction
  5. its really all about a changing of the guard ie., cultural & class

    overturning of the paradigm so to speak.

    Carbon Tax is more about politics rather than the environment ultimately.

    polution has nothing or little to do with it all.

  6. What’s all this talk on global ‘warming’? The winters are getting extremely cold too – there is no warming, the weather’s going totally extreme.
    Not sure what a tax will do about that…

    But thankyou for the pros and cons and other info about carbon tax. It was really helpful. Its good to be educated on these things.

  7. Hey you guys are idiots, the carbon tax is great… learn to respect the planet who cares about where the money goes its more important that we save the planet it will reduce carbon emission by a little bit, and every little bit counts.. im in grade 1

    1. You’re an idiot! The carbon tax is a con. It is a Labour initiative to get the country back into surplus by 2013 in any way shape or form it can. It is also a “greens” tax. Remember The “Greens” are running this country now. If Gillard backed down on Carbon Tax now she would lose the “Greens” support and therefore the Coalition would romp in. The carbon tax is the way for Labour to hang on to its jobs. Talk about self interest. What about the country?

  8. Clearly life won’t be worth living after July 2012, so I’ve entered into a suicide pact with my family. The Labor government listening to scientists and economists instead of experts like John Du Bois on this page. They seem hell bent on depriving me of my god given right to degrade the planet.

  9. It’s not global warming. Its climate change, meaning not that our globe is beginning to warm, but also that we’re experiencing extreme temperatures from cold to warm. And not only that but also that it’s causing disruptions in ocean currents, and wind currents. You may not think this is serious but it’s changing the way the world even functions. Furthermore, climate change is causing the molecular formula of the ocean to change and become more acidic which is then causing reefs and aquatic life to deteriorate. Climate change is also causing the rising sea level, and thousands of species to be lost because they have to migrate to the poles where it’s cooler. You can choose to believe that climate change isn’t happening, but it is, and faster than anyone could have ever predicted.

    Greenhouse gases create a barrier around the ozone layer. Normally the the sun’s says are able to mostly bounce off the clouds and go back into space. However, these greenhouse gases create this barrier and instead of allowing the sun’s rays to escape they are bounced back into the earth once again. One of the most significant greenhouse gases is carbon dioxide because it has increased so much. Yes, the world needs carbon dioxide to function, but you don’t want too much of a good thing. Our human influence on the earth is causing the carbon dioxide amounts to increase. People who believe that most of the carbon dioxide is naturally made, you should check you stats because I’m pretty sure that’s impossible with the increase in industrial factories all around the world. Are you aware of just how much carbon dioxide is released from the industrial world? How can you say we’re not impacting our world?

    Now, I’m not saying I completely agree with the carbon tax. I believe it is a good idea because big companies are moved by money. Therefore if they’re losing a lot of revenue because of this carbon tax they will find a way to produce power without producing so much carbon. However, I don’t believe this will be effective unless countries all around the world make this decisions together. It won’t be effective if Canada introduces this tax but the United States doesn’t when they’re neighboring countries. In conclusion, I believe that the carbon tax could be very impactful if many countries band together.

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