Emissions taxes

Leslie Nielson, Economics Section


The Garnaut Climate Change Review favoured the establishment of a broadly applied carbon tax in preference to a heavily compromised emissions trading scheme. Further, it proposed the introduction of a carbon tax as an interim measure pending the establishment of an effective emissions trading scheme. The Australian Greens in particular support this approach.

What are emissions taxes?

The Organisation for Economic Co-operation and Development (OECD) defines environmentally related taxes as any compulsory, unrequited payment to government, levied on tax-bases deemed to be of particular environmental relevance. The relevant tax-bases include energy products, motor vehicles, waste, measured or estimated emissions, and natural resources. For example, a surcharge may be placed on every litre of petrol sold. Taxes are unrequited in the sense that benefits provided by government to taxpayers are not normally in proportion to the tax payments. In theory, environmentally related taxes should be set at a level equal to the ‘external’ environmental cost of a particular product or activity such as air or noise pollution.

Where are they used?

Such taxes are extensively used in Europe, mainly in the transport and energy sectors. They are suitable for situations where direct emissions are difficult to monitor, or administrative simplicity is a highly desirable policy feature (say where the administrative capacity of a government is very low in relation to an economy as a whole or in relation to a particular sector). The Nordic countries are the most consistent users of environmental taxes.


Environmental taxes have been argued to have the following advantages:

  • they are predictable in their costs. Relatively stable price signals can help business and consumers plan energy spending and provide greater certainty for investments in energy efficiency that have large initial costs
  • they create a permanent and stable incentive to adopt a least-cost way of reducing emissions and continued technical innovation
  • their effect is not susceptible to ‘strategic’ behavior by firms and non-government organisations that could potentially distort an emissions trading market
  • they put a limit on the costs of emissions reduction
  • they can be implemented relatively quickly and are comparatively simple to administer
  • they are efficient in that they are transparent, simple and can have a wide coverage and
  • they are a revenue source. To ensure that the introduction of an emissions tax remains revenue-neutral other taxes can be reduced, or the proceeds of the carbon tax redirected to those most affected.


Emissions taxes as a means of controlling greenhouse gas emissions also have some disadvantages:

  • while emissions taxes work well in conditions of certainty, they are less effective in conditions where the response to a tax on emissions is unknown, which leads to a lack of certainty over the amount of emissions reduction
  • there are no guarantees that emissions will decline if consumption of the goods and services that produce emissions remains relatively unresponsive to price increases (that is, price-inelastic)
  • the level at which the tax is set to produce the best outcomes cannot be known in advance. Thus the tax may have to go through several changes before having the desired effect. This makes it politically vulnerable, restricting the capacity for the best tax level to be found
  • if the tax is set at too high a level, activities that are particularly sensitive to it may relocate to a location that does not have such imposts
  • depending on how the tax is applied, it may lock a firm into one particular emissions reduction method simply to reduce the tax imposed, rather than the environmental harm occurring. For example, a tax on firms that do not use smokestack scrubbers may only lead to the increased use of such devices. It will not lead to fuel substitution or better combustion processes
  • effective emissions reductions require effective international action. The reality of widely differing and volatile exchange rates and differing administrative capacities makes a co-ordinated and effective set of emissions taxes on an international scale a difficult objective to achieve. To date emissions taxes have not received much support as the internationally preferred method of controlling greenhouse gas emissions. The international community appears to prefer the cap-and-trade approach
  • they are potentially regressive. The impact of a flat carbon tax will be highest on the lowest income households. This effect is offset to some degree by the higher consumption of wealthier households and
  • they are a tax, and therefore are politically unpopular by their very nature.

The nature of climate change impacts and long-term effectiveness

Emissions taxes should be set at a level equal to the external cost of the good or service provided. Not only is this hard to calculate accurately, but there is the significant possibility that this cost might rapidly increase. The progression of expected climate change impacts is not linear; rather, impacts may become increasingly severe. This means that the external cost of greenhouse gas emissions will increase. This rate of increase may well be at a faster rate than any tax can be adjusted to match.

Library publications and key documents

L Nielson, Emissions control: your policy choices, Background note, Parliamentary Library, Canberra,
10 May 2010, http://www.aph.gov.au/library/pubs/BN/eco/EmisisonsControl.pdf