What Is Carbon Taxation?

• Author: Ian Parry
• Position: Principal environmental fiscal policy expert in the IMF's Fiscal Affairs Department
• Pages: 54-55

54 FINANCE & DEVELOPMENT | June 2019

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ART: ISTOCK / RASTUDIO

What Is Carbon Taxation?

Carbon taxes have a central role in reducing greenhouse gases

Ian Parry

DETERRING THE BURNING of fossil fuels is crucia l

to reducing the accumulation of heat-trapping

greenhouse gases i n the earth’s atmosphere. A carbon

tax could disc ourage the use of fossil f uels and

encourage a shift to less-polluting fuels, thereby

limiting the carbon dioxide (CO2) emissions that

are by far the most prevalent green house gas.

According to the World Meteorological

Organization, without measu res to reduce green-

house gases, global temperatures are projected to

rise by about 4°C above preindustrial levels by

the end of the century (temperatures have al ready

increased by 1°C), with rising and irreversible

risks of collapsing ice sheets, disruption of ocean

circulatory system s, inundation of low-lying isla nd

states, and extreme weat her events.

The case for carbon taxes

Carbon taxes, le vied on coal, oil products, and

natural ga s in proportion to their carbon content,

can be collected from f uel suppliers. ey in turn

will pass on the ta x in the form of higher prices

for electricity, gasoline, heating oil, and so on, as

well as for the products and ser vices that depend

on them. is provides incentives for producers

and consumers ali ke to reduce energy use and shift

to lower-carbon fuels or renewable energy sources

through investment or behavior.

While addressing climate change by reducing

greenhouse gases, carbon taxes c an also generate

more immediate environmental and hea lth benef‌its,

particula rly by reducing deaths that result from local

air pollution. ey can a lso raise signif‌icant revenue

for governments, revenue they can use to counteract

economic harm caused by hig her fuel prices. For

example, governments could use ca rbon tax reve-

nue to ease the burden of taxation on workers by

lowering personal income and payroll ta xes. Carbon

tax revenue could also f und productive investments

to help achieve the United Nations Sustainable

Development Goals, including reducing hunger,

poverty, inequality, and environmental degradation.

Other policies are less ef‌fect ive than carbon taxes.

For example, incentives for renewable power gener-

ation do not promote switching from coal to gas or

from these fuels to nuclear, do not reduce electricity

demand, and, not least, do not promote emission

reductions beyond the power-generation sector.

International appeal

Carbon taxes a re generally straightforward to

administer because they can be piggybacked on

existing fuel taxes, which most countries already

collect with ease. It is a lso possible to integrate

carbon taxes i nto the royalties paid by coal mining

and oil and gas dri lling industries. In fact, the f‌i scal

and administrative case for carbon ta xes may be

especially appealing in developing economies, where

large informal sectors of the economy constrain

revenue that can be collected f rom broader taxes

on income and prof‌its. With the establishment of

emission-monitoring capacity, variants of carbon

taxes can b e applied to other sources of greenhouse

gases, such as em issions from forestry, international

transportation, cement manufa cturing, and mining

and drilling activities.

Carbon taxes c an play a key role in achieving

countries’ pledges under the 2015 Paris Agreement,