Economics of the EU Revision - Carbon Taxes

Revision notes on carbon taxation in an EU context

A carbon tax is a tax on the consumption or production of goods and services, which cause carbon emissions

The case for a carbon tax:
• A tax creates specific price on carbon – with less uncertainty than emissions-trading
• It is a classic way of internalizing externalities (i.e. making the polluter pay) - the tax would raise the marginal cost of the cO2-emitting activities, up to the point that the marginal social cost of abatement activities is equated to the marginal social benefit from these activities
• Provides an incentive for firms to lower emissions and for consumer behaviour to change
• The tax can be phased in and can be revenue neutral (i.e. other taxes can be cut)
• Revenue generated can be “ring-fenced” and then recycled – i.e. spent on environmental initiatives

Counter arguments:
• Issues of who to tax and how much to tax when emissions are difficult to measure / quantify
• Potentially high costs of compliance (administration) and the risk of tax evasion
• Possible regressive effects on low-income families (when carbon taxes are passed on in prices)
• Less certainty about the effect on quantity of emissions than a trading scheme
• Non EU-countries may free ride i.e. enjoy a reduction in emissions without imposing their own tax
• Would potentially damage competitiveness and jobs of EU countries
• Would politicians be prepared to raise the carbon tax sufficiently high to reduce emissions?