• Preetika

Carbon tax: a good alternative for the environment?

On the 5th of June every year, World Environment Day is celebrated to create awareness and action for the protection of our environment. This year marked the 47th World Environment Day, which was first celebrated in 1974 with the theme ‘Only one Earth’. From then till now, the idea of the theme is prevalent and still significant enough. With the ever-increasing industrialization, and accompanying globalization, we need to remain focused on the fact that "We have only one Planet, and We need to Protect it!"

While not overtly obvious, the economy and environment are closely related. Any economic system exists within and is encompassed by the natural world. The natural world acts as the provider of raw materials and energy inputs, without which production and consumption would be impossible. Thus, an economic system has an impact on nature, by drawing upon raw materials to keep the system functioning. So, Environmental Economics is the application of principles of economics to the study of how environmental resources are managed. The overwhelming scientific consensus is that human activity is responsible for causing climate change and the only way to avoid catastrophe is to reduce carbon emissions. Carbon emissions are strongly correlated with another incredibly important factor to individual households: air pollution. The environment in emerging economies has deteriorated so much that it is now an urgent public health hazard. We talk about sustainability, but still, none would voluntarily sacrifice anything to affect the lives of unborn people. If the assumption is made that people have well-defined preferences, and they do not care about the damage to other people, an ideal environmental policy, in that case, would be one that sets a price for damaging the environment. From this, comes the idea of a carbon tax.

A carbon tax is a fee that the government imposes on any company that burns fossil fuels like coal, oil, gasoline, and natural gas. The purpose of this tax is to reflect the actual cost of burning carbon, which would be borne by those who suffer from the effects. It makes sure that companies and consumers pay for the external costs that they impose on society. To implement a Carbon-Tax, the government needs to determine the external cost for each ton of greenhouse gas emission. The U.S. Interagency Working Group estimated $40 per metric ton. A recent report from the Organization of Economic Co-operation and Development found that average carbon prices across 42 major countries were $35 per ton in 2018. The advantage due to Carbon Tax is that it does reduce emissions by motivating companies to switch to clean energy. Also, it increases the price of gasoline and electricity that will eventually make the consumer more energy-efficient and aware of saving electricity. It has been stated that a carbon tax can instigate economic growth, as Sweden’s carbon tax has reduced emissions by 26% in the past 27 years, and during that period, their economy grew by 78%. Now whether carbon tax does impact the GDP of a nation is not substantiated much, but there have been studies that state that it does not harm employment or long-term growth, which was otherwise stated by Trump. As always, this policy comes with drawbacks. A carbon tax is regressive, as making fossil fuels more expensive imposes a heavy burden on those with low incomes. So, many believe that a carbon tax must be introduced gradually to work. Raghuram Rajan, the former governor of RBI and Chief Economic Advisor to Government of India, who is currently the Professor of Finance at the University of Chicago, suggests something as Global Carbon Incentive (GCI). According to him, developed industrialized countries such as the US are concerned to work hard on reducing emissions, but the developing countries will keep pumping them out with abandon. He feels that there lies a profound inequity in asking a country that emitted 0.17 tons of CO2, to bear the same cost as that of developed nations which emit much more. He also states of GCI, where every country that emits more than the global average would pay annually into a global incentive fund, with the amount calculated by multiplying the excess emissions per capita by the population and the GCI. The countries below the per capita average would receive a commensurate payout, where the free-rider problem could be done away with. This would also address the fairness problem as the low emitters are often the poorest countries, which are also most vulnerable to climate change.

Thus, there are different opinions regarding the concept of a carbon tax. Though some countries have adopted it and have been successful, there are developing and poorer nations as well, who still need to look upon and take measures accordingly. Going beyond carbon tax, governments could also ‘nudge’ people towards choices better for the environment. The bottom line lies in the importance of awareness and quick measures to address the issue. Abhijit V. Banerjee and Esther Duflo stress the roles of ‘habits’ in our preferences. They argue that what one grows up consuming forms the tastes today. e.g., Migrants continue to eat what they have grown up eating, even if it is expensive in the new country. Habits may be painful in the short run, but they can be changed. So, announcing a future tax hike on goods taking up energy can be an easier way to get used to it.


1. Banerjee, Abhijit. V and Duflo, Esther (2019): “Good Economics for Hard Times” 2. Field, Barry C and Field, Martha. K. (2006): “Environmental Economics: An Introduction” 3. Rajan, Raghuram G. (2021): “A Global Incentive to Reduce Emissions”, Issue: May 31, Project Syndicate.