The United Nations recently issued yet another dire reminder of the need to ramp up efforts to combat climate change, warning that we are on track to pass a critical temperature threshold by the early 2030s. Many countries have used regulatory pressure to help lower greenhouse gas emissions, but as the situation becomes increasingly dire and the time to act grows shorter, governments are looking to carbon taxes as a way to force necessary change.

Tax credits and other preferential treatment, which are also part of the 2022 U.S. Inflation Reduction Act, have had some success in encouraging a reduction in harmful emissions. However, that approach has also proven to have limits. Shell, for example, recently refused to set targets to reduce oil and gas use at the consumer level (“Scope 3” emissions), stating that “would be against the financial interests of [their] shareholders.”

Faced with these limitations, governments have introduced more stringent carbon taxes, hoping that the potential impact on profits  will be a stronger inducement for companies to cut emissions.

So What Are Carbon Taxes?

Carbon taxes are basically a way to put a concrete price on a company’s carbon emissions. This cost is intended to encourage companies to transition to greener business practices by making it more cost-effective for them to do so, or if a company refuses, to generate tax revenue that can then be put into government programs to address climate change. Unlike methods like cap-and-trade, carbon taxes have the advantage of being easier to administer and more predictable for companies, allowing them to more easily divert the money they might spend on taxes into green technology.

Differing Approaches to Carbon Taxes

New Zealand farmers will pay for their methane, carbon dioxide and nitrous oxide emissions beginning in 2025. Agriculture is a significant portion of the New Zealand economy and the country is the world’s biggest dairy exporter, with farming accounting for roughly half of the country’s total greenhouse gas emissions. These fees will allow New Zealand to reach its target of reducing methane emissions to 10% below 2017 levels by 2030. The revenue generated by the tax will in part be used for incentive payments designed to encourage farmers to implement mitigation strategies, like methane inhibitors, which will in turn decrease their bills.

Carbon taxes also allow governments to put pressure on businesses outside their borders to reduce their emissions. The European Union recently agreed to a groundbreaking carbon tax that would impose import tariffs on goods from countries that have not taken steps to curb their greenhouse gas emissions. Called the Carbon Border Adjustment Mechanism, the law serves a dual purpose of supporting EU companies that are subject to stricter regulations, and thus higher costs, and encouraging other countries to adopt more stringent emissions.

The Rule of Unintended Consequences

These taxes are not without potential consequences, however. There is concern that regulations like the EU’s import carbon tax could end up hampering the ability of developing countries to further industrialize, many already disproportionately impacted by climate change while responsible for only a fraction of carbon emissions. There is also the risk of the countries affected by the import tax taking their own steps to attempt to counteract the cost of the taxes, such as India’s proposed tariffs on European goods in response. In the case of the New Zealand farm tax, farm groups have expressed concern that the costs will lead to farmers leaving their land, particularly those who run smaller farms that have already been under pressure by agribusiness corporations.

Carbon Taxes Can Help Drive Development

However, it would be unfair to characterize the issue as purely business versus the environment. In 2019, Singapore enacted the Carbon Pricing Act. Consulting with both business groups and environmentalists, the Singapore government decided to begin with a moderate tax before increasing to their eventual goal for the tax level, giving companies time to make changes to reduce their potential tax liability. The tax is currently 5 Singapore dollars per ton of carbon, will increase to 25 dollars per ton in 2024, and the government hopes to raise it to 50-80 dollars per ton by the end of the decade. This commitment to carbon reduction has made the country an appealing location for the expanding green energy industry. In 2022, Spanish renewable energy company EDP Renewables noted Singapore’s “ecosystem of clean energy” as a contributing factor in their decision to establish their Asia-Pacific headquarters there.