Carbon Tax: What is it and How Does it Work?

In the midst of a post-pandemic world, production is booming in every sense of the word – people are socializing, traveling more, and many businesses are ready to take advantage of the fact that people have pent-up energy from saving their money these past couple of years.

However, with all of that demand comes a need for supply – something that also results in excessive emissions that the world needs to start avoiding if it’s to successfully combat climate change.

How can carbon tax be implemented to successfully incentivize people and businesses to reduce their energy consumption and overall emissions?

Think of carbon tax as similar to a driving ticket. What is going to stop someone from turning right at a stop sign or running a red light? If no police are present, these dangerous driving tactics will continue – that’s why so many streets are now dedicated to placing hidden cameras to catch drivers in the act and issue hefty fines for speeding or other misconduct on the road. Eventually, most drivers will become more cautious when driving as they don’t want to pay an expensive driving ticket.

Carbon tax works in the exact same way, as it tries to encourage companies to mitigate the use of these substances from the start.

In a supply chain, “upstream” refers to all activities that engage the company’s suppliers – such as their tier 1, tier 2, or tier 3 suppliers. On the other hand, “downstream” refers to the actions and activities of the product after the raw materials have been provided, up until the product is distributed into the hands of the customer.

“Upstream” is often referred to as supply, whereas “downstream” is often referred to as demand. 

This fee is imposed in order to give both consumers and producers a financial incentive to reduce their own carbon footprints, become more sustainable, and protect the environment. However, carbon tax cannot mitigate all emissions by itself, as some carbon that is already integrated into products like plastic water bottles aren’t subject to carbon tax.

The production and consumption of plastic creates excessive greenhouse gasses and carbon emissions, but even the most widely used culprits of these emissions won’t be subject to carbon tax. In addition to this, carbon dioxide that is emitted into the atmosphere but later captured and sequestered by a carbon capture and storage system will not be subject to carbon tax.

If not all detrimental items or substances are subject to carbon tax, then why is it important? 

Carbon tax is important for the same reasons as introduced with the driving ticket example explained above. If there are no driving tickets, how will people stop driving recklessly? The same goes for households and businesses that emit too much carbon dioxide or greenhouse gasses – money serves as the ultimate motivation to get people to do the things they want to do the least.

However, the problem with carbon tax is that many governments and policymakers are hesitant to go through the grueling process of establishing carbon taxes in their vicinity – out of fear of creating unsuitable financial circumstances for low-income households.

Carbon tax is meant to encourage households and businesses to make the switch to low-carbon sources to power their activities, such as through the use of renewable energy. The problem is, many will find these sustainable alternatives more expensive than a carbon tax itself – and will ultimately resort to continuing their excessive use of the very substances carbon tax is trying to mitigate people from using.  

This might raise the question if carbon tax is effective, and how frequently it is used around the world.

Several countries around the world make use of carbon tax, or something similar to carbon taxes in order to deter companies and households from contributing to climate change. 

As of 2021, there are 35 different carbon tax programs around the world. Some examples include British Columbia, South Africa, and Boulder, Colorado in the United States. Overtime, the interest in developing a nation-wide carbon tax across the U.S. has been increasing. Therefore, while carbon tax is still not as effective as it could be – the premise has been successful in achieving support in the future of carbon tax. 

In October 2021, the Senate Committee on Finance is finally reviewing the pros and cons of imposing carbon tax as a means to pay for other political responsibilities – such as the creation of a reconciliation package. There are several ways that the Senate Committee on Finance could implement this, one being to create a carbon tax contingent to be calculated per-ton of emissions created from the substance, such as fossil fuels, over time. 

The use of carbon tax is established, but policymakers are still working on making it more prominent and a new-norm.

What do policymakers need to consider as they venture into the journey of implementing carbon taxes?

The process of developing carbon tax is multifaceted and often contingent on locale, but what are some of the general areas that all policy makers involved in the creation of carbon tax need to pay attention to?

Substances Involved

Carbon tax can not be properly implemented without full knowledge of the substances that will fall under the scope of the carbon tax. For example, carbon tax can be implemented differently depending on the amount of carbon dioxide or greenhouse gas emissions created by an amount of fossil fuels. Policymakers should become familiar with the different substances involved in carbon tax. 

Develop a Reason for Imposing the Carbon Tax 

While carbon tax can be imposed anywhere in the supply chain, policy makers should strive to define the reasoning for the tax – whether it be downstream, upstream, or midstream.  

It is easier for policymakers to place a carbon tax on activities that take place in the “upstream” component of the supply chain, but it can also be done in the middle of the supply chain process – sometimes referred to as, “midstream” and also in the “downstream” phase. For example, policy makers could place a carbon tax on industries or households that use excessive amounts of energy, or the gasoline used to power an automobile.

Determine Viable Carbon Tax Rates ­

Policymakers must strive to follow the guidelines provided by common economic theories and set the carbon taxes accordingly. In general, economic theory claims that a carbon tax should be equivalent to the price of social carbon by creating an estimated value of how much damage the carbon dioxide to be emitted into the atmosphere will cause in the future. Therefore, as climate change continues to worsen, these carbon tax rates should continuously increase – serving as a sign to those subject to the carbon tax that they should alter their business models to mitigate the use of ozone depleting substances immediately for the sake of the planet and their financial revenue. 

The Impact of Imposing Carbon Tax

Policymakers have to be mindful of the financial impact that imposing a carbon tax can have on low-income households. While it can help to serve as motivation for companies and families to reduce their energy consumption, as carbon tax will create more of a financial burden on low-income households than it will on the middle or upper class households. Therefore, it is imperative that policymakers impose the carbon tax in accordance with the income of each household or enterprise. 

Prevent Competition  

Imposing a carbon tax could create unwanted competition between various enterprises that use intensive amounts of domestic energy. Demand from these different entities could increase, and in turn create a volatile rise in emissions from various countries or companies trying to compete with one another. In this sense, carbon tax could completely backfire if it isn’t imposed with this potential consequence in mind. 

Revenue ­

The revenue created from carbon taxes is bound to become substantial, and policymakers must decide how that revenue will be used. It is likely that some of it could be returned to the initial consumers in an annual large sum, but it could also be invested into other areas that will help fight against climate change – such as towards research for developing new technologies or in support of sustainable infrastructure. 

Clearly, there is a lot that policymakers need to consider when implementing carbon tax. If companies strayed away from the need to make use of fossil fuels and other business activities that stimulate the need for carbon taxes in the first place – would the process of imposing carbon tax become easier, or entirely unnecessary? 

The predominant goal of carbon tax to begin with is to deter companies from using substances or suppliers that increase overall global emissions.

If more businesses and households were to operate in conjunction with the measures necessary to mitigate carbon emissions, then the need for carbon tax wouldn’t be as pivotal as it is now. 

Companies can easily avoid carbon tax, and enjoy several other business perks, if they make the effort to switch to a more sustainable business model or commit towards establishing net-zero carbon emission tactics.

There are so many different ways to incorporate the use of renewable energy or new technologies like carbon capture and storage to ultimately reduce emissions and become a more environmentally friendly company.

The cost for many of these carbon emission reducing tactics may seem overwhelming to many at the beginning, but the reality is – it will be more cost effective and beneficial to the environment over time if companies are to bite the bullet and start investing in the measures necessary to reduce carbon emissions. 

What could you have bought if you never had to pay any of your parking tickets? Carbon tax works the same way – and the resources that could become available to those who avoid the need to pay carbon taxes could be exponentially revolutionary in the fight against climate change.

If reading this article about carbon tax and how it works has been impacted by climate change has made you interested in reducing your carbon emissions to further fight against climate change – Greenly can help you!

Greenly can help you make an environmental change for the better, starting with a carbon footprint assessment to know how much carbon emissions your company produces.