A carbon tax is a tax charged on greenhouse gas emissions, most often on the carbon dioxide released when coal, oil and natural gas are burned. It is usually set as a fixed price per tonne of carbon dioxide or its equivalent and collected upstream, from fuel producers, importers or large emitters, who pass much of the cost on through prices, as tax incidence analysis predicts. Its purpose is to make activities that cause climate change more expensive, so that households and firms shift toward cleaner choices.
A carbon tax is the best-known example of a Pigouvian tax, a levy meant to correct an externality: emitters do not pay for the damage their emissions cause to others, a classic market failure. It is one of two main forms of carbon pricing; the other is an emissions trading system, or cap-and-trade, in which a government caps total emissions and lets firms trade permits. Carbon taxes are set by national or regional governments and support commitments under the Paris Agreement.
Carbon tax in plain terms
Imagine a neighbourhood where some people burn rubbish in their gardens. The smoke drifts over everyone, much like the tragedy of the commons, but only the burners save money by not paying for collection. A carbon tax is like a charge on every bag burned: it does not ban burning, but it makes people think twice and makes the cleaner alternative look cheaper.
Because the charge is built into the price of petrol, heating fuel and electricity made from fossil fuels, people respond in many small ways, from driving less to insulating homes, while companies look for cleaner ways to make things. The government also collects money it can return to people or spend.
How a carbon tax is calculated
For a fuel, the tax per unit is the carbon price multiplied by how much carbon dioxide that unit releases when burned:
The emission factor is the tonnes of carbon dioxide released per unit of fuel. Burning a litre of petrol releases roughly 2.3 kilograms, or 0.0023 tonnes, of carbon dioxide. At a carbon price of $50 per tonne, the tax is , or about 11.5 cents per litre. A car using 1,000 litres a year would pay about $115 in carbon tax.
How strongly people respond depends on the price elasticity of energy demand. In the short run demand for fuel is fairly inelastic, since people cannot quickly change cars or boilers, so emissions fall slowly at first and more over time as equipment is replaced.
Carbon taxes and emissions trading
A tax fixes the price of carbon and lets the quantity of emissions adjust. Cap-and-trade fixes the quantity and lets the price adjust. Economists debate which is better: a tax gives businesses predictable costs and is simpler to run, while a cap gives more certainty about emissions. In practice the two often coexist. The European Union Emissions Trading System, launched in 2005, is the largest carbon market, and from 1 January 2026 the EU's Carbon Border Adjustment Mechanism began charging importers of goods such as steel, cement and aluminium for their embedded emissions, to stop production moving to countries with weaker rules, which is known as carbon leakage. Critics abroad describe it as a disguised tariff.
According to the World Bank's 2026 report on carbon pricing, 87 carbon taxes and trading systems were in operation, covering about 29% of global greenhouse gas emissions, and they raised more than $107 billion for public budgets in 2025.
Carbon taxes in practice
- Nordic pioneers. Finland introduced the first carbon tax in 1990 and Sweden followed in 1991. Sweden's rate, which started at SEK 250 per tonne, is SEK 1,520 (about €138) per tonne in 2026, among the highest in the world.
- Canada. British Columbia introduced a revenue-neutral carbon tax in 2008, and a national system followed in 2019, with most revenue returned to households as rebates. The consumer fuel charge was set to zero from 1 April 2025 after it became politically contentious, while pricing for large industrial emitters continued.
- Asia and Africa. Singapore's carbon tax, introduced in 2019, rose to S$25 per tonne in 2024 and is scheduled to reach S$45 in 2026. South Africa introduced a carbon tax in 2019 with generous allowances for industry.
Arguments for and against
Many economists favour carbon taxes as the lowest-cost way to cut emissions, because they let every emitter find its own cheapest reductions rather than relying on regulations or subsidies that pick technologies. Supporters also note that revenue can cut other taxes, fund rebates or support green investment, while companies buying clean power can also use instruments such as a renewable energy certificate. In the United States, proposals for a "carbon fee and dividend" would return all revenue to households in equal payments.
Critics raise several concerns. Energy costs take a larger share of poorer households' budgets, so a carbon tax can be a regressive tax unless revenue is returned. Firms in trade-exposed industries fear losing out to foreign rivals. Some environmental groups argue that prices have been set too low to meet climate targets and prefer stricter caps and regulation, while some on the right object to new taxes or doubt the case for strong climate policy. Estimating the right price relies on the "social cost of carbon", which uses cost-benefit analysis and contested assumptions about discount rates. Earmarking revenue for green projects, a hypothecated tax approach, is popular with voters but reduces flexibility, and the global nature of the problem creates a free-rider problem between countries.