By Andrew Z. (Coll)
Carbon taxes directly increase the cost of emitting greenhouse gases by imposing a fee on carbon-intensive fuels and activities. This creates a price signal that incentivises businesses and consumers to shift toward cleaner energy sources and adopt energy-efficient practices. Unlike subsidies, which primarily support the development and adoption of specific technologies, carbon taxes encourage a broad range of emissions-reducing behaviours, allowing market forces to determine the most cost-effective solutions.
Some would argue that the most efficient way of reducing emissions whilst also prompting innovation in its economic activity is through carbon taxes. (Miron, 2024) This would typically raise the price of products that produce a lot of carbon: this might have the effect of decreasing the popularity of the government because of the rising oil, heating and other goods’ prices. This is one of the main incentives for governments to move away from the typical carbon taxes and now focus on subsidies for cleaner alternatives.
Carbon pricing globally poses challenges as it requires entire countries to pay a certain amount for producing a certain number of emissions. However, there is often great inequality when this happens as some countries are more able to afford the costs, while others might not. There are a few metrical faults that lie in trying to measure carbon emissions as well: if one calculates using total emissions then the results will be much different from emissions per capita (the Chinese total emissions is 3 times larger than the United States but they don’t have a number close to the number they have per capita). (Worldometer, 2022) It also follows that many of the richest countries are the ones with more emissions per capita. An argument that is often put forward is that carbon pricing punishes the countries or companies that produce the most emissions accordingly. Another argument that is also often suggested is the benefit of including carbon pricing costs to electrical prices, which is important to keep consumers satisfied. This argument, however, assumes that retail prices are otherwise set efficiently, so that incorporating GHG emissions into electricity prices would improve the efficiency of retail pricing. (Borenstein, 2022) Importantly, carbon pricing cannot be relied upon to drive economic growth; instead, it can sometimes lead to reductions in output for some industries.
However, border carbon adjustments (BCAs) involve imposing tariffs on imports from countries without carbon taxes or equivalent climate policies. BCAs address the competitive disadvantage faced by domestic industries and help prevent carbon leakage by balancing the deficit. They also incentivise other countries to adopt similar carbon pricing mechanisms to avoid trade penalties. It reduces the impact that is derived from carbon leakages (the process of businesses moving their location). (Sanam Rasool, 2024) Moreover, it encourages global adoption of carbon pricing as it negatively impacts their total exports if they don’t meet the environmental goals.
Subsidies
Subsidies and carbon taxes differ in revenue generation: carbon taxes are also used to generate revenue for governments, whereas subsidies for renewable energy involves government expenditures that can potentially strain budgets. Some cleaner energy sectors may also have drawbacks such as electric vehicles, which have batteries that are often charged by unclean energy. (Miron, 2024) Subsidies are a better policy in scenarios in which renewable energy development domestically might be necessary: it lowers the barrier of entry as companies are helped with high upfront costs. Targeted subsidies for renewable energy projects can also create jobs in manufacturing, installation, and maintenance of green technologies. This can stimulate local economies, particularly in regions with high renewable energy potential. Subsidies carry a certain opportunity cost that governments have totake on as a result of spending and potentially creating more national debt. Governments would be wiser to spur growth in an industry whilst keeping emissions low, by using subsidies. Research and development of technology could then be used to offset any opportunity costs occurring from the use of subsidies as opposed to using it balance out the equity imbalance of a carbon tax.
(Jamil Khan, 2022)
Carbon taxes and subsidies for renewable energy are not mutually exclusive; they can complement each other to maximise effectiveness. There may be carbon taxes put in place and the spare revenue that is collected could be reinvested into renewable energy or carbon sequestration. A combination of two guarantees both the demand-side reductions in fossil fuels but also the supply-side growth in cleaner energy, which can ensure a balanced and sustainable transition to a low-carbon economy. However, this combination of the two may be difficult to calibrate and avoid over-subsidisation or under-pricing of carbon.
A comparative advantage may be created if a government only puts carbon taxes on its own companies—making it cheaper to import goods from countries without such taxes. (Sexton, 2013) This lack of competitiveness in global markets will force companies to relocate their production sites to countries without carbon taxes, a phenomenon known as “carbon leakage.” This shift not only undermines the environmental goals of the carbon tax by potentially increasing global emissions but also results in economic losses for the taxing country. These losses include reduced domestic production, job displacement, and a decline in government revenue, which could have been reinvested in sustainable development initiatives.
Furthermore, the relocation of industries may concentrate emissions in countries with weaker environmental regulations, worsening global environmental challenges. To address this, complementary measures such as border carbon adjustments or international agreements on carbon pricing are essential to the and ensure the effectiveness and impartiality of carbon taxation policies.
The effectiveness of carbon taxes relies on the assumption that higher costs will deter emissions. However, for wealthy enterprises or high-income individuals, the tax may be insufficient to incentivise meaningful behavioural change. This is particularly true if the tax is too low to reflect the true social cost of carbon emissions. More efficient firms can still operate with the emissions penalty but many smaller firms will potentially be pushed out as well because of the strain it has on the production costs: it may have unintended consequences on competitiveness in certain industries.
Alternatives
A large effect of carbon pricing and taxation is brought on consumers as energy prices generally rise and there are more equity concerns domestically. Revenue recycling enables governments to reinvest the revenue from carbon taxation into social benefits or reducing other taxes and making the policy revenue neutral. This will not only mitigate economic burden on vulnerable groups but also increase public support for carbon taxes – contrary to the lack of political support that rises in energy prices has. There are many geopolitical issues that arise with the introduction with a global carbon tax: any regulations that have passed through before have merely been agreements similar to the goal of reaching net zero by 2050.
Cap and trade, which has been implemented in many countries, guarantees emissions reductions through setting a limit on the total emissions companies are allowed to produce. The use of permits also gives it an element of flexibility and cost efficiency. This method differs from the typical command economies in which the government dictates the choices of the producers. It allows the market to determine a price on carbon and that price drives investment choices and market innovation. (C2ES, 2024) Cap and trade policies may find difficulties in regulating the caps and ensuring there is not as much price volatility in permit markets. In many countries, cap and trade has been attempted such as South Korea, 2015, when a mandatory cap-and-trade program has been implemented. (C2ES, 2024)
Conclusion
In conclusion, it is clear that the solution to the current carbon crisis cannot be reached through simply one method. Rather, a combination of carbon taxes and renewable energy subsidies should be implemented to double the effectiveness of these policies. Furthermore, cap and trade taxes could be useful in the future; however, for this policy to happen, there must be international cooperation. These two policies, when combined, could create a balanced strategy that addresses both the demand-side reduction in fossil fuel consumption and the supply-side growth in renewable energy production. Additionally, border carbon adjustments (BCAs) and cap-and-trade systems provide complementary frameworks to ensure global competitiveness and emissions reductions. BCAs can prevent carbon leakage by equalizing costs between domestic and foreign producers, while cap-and-trade policies offer flexibility and cost efficiency by allowing the market to set a price on carbon.
