The Australian government has announced plans to introduce a carbon tax from July 2012. It is not clear whether it will boost carbon trading and encourage companies to reduce their emissions or it will simply add to the state coffers.  

Traditionally the idea of a carbon tax has been viewed as a knee-jerk reaction of the political classes to force companies to reduce emissions, versus the more progressive cap-and-trade approach which generates significant funding for renewables projects in the developing world. However both can work together if the revenue raised from the carbon tax is used to fund emission reduction projects. There is a big question mark of course as to how this can be implemented in practice.

A carbon tax can only achieve emission reductions if it's sufficiently high to make an impact on a company's turnover. In other words the carbon price per metric tonne emitted must be such that the total carbon tax bill for an average emitter amounts to a significant percentage of the turnover, otherwise there would be no real incentive to make a serious effort to curb emissions (which can be costly to implement). The downside of a high carbon tax is that there can be implications for the end consumer of goods and services in higher prices and a decrease in competitiveness.

Effectively emissions reductions can be very costly and take a long period of time to implement because in most manufacturing processes changes require a timescale of years. Without a clear plan of how the carbon tax revenue will be allocated to drive the low-carbon economy and clean energy investment, it remains simply yet another tax.

When economists sit down and scratch their heads to find a solution for a problem, the first word that comes to mind is “tax”.  So it’s no wonder that many leading economists of the world think that a carbon tax will solve global warming.  

Unless a carbon tax is used as a form of revenue for environmental purposes and to fund decarbonisation, it’d be a hard sell. In ordinary circumstances there is no appetite for new taxes, and in the current climate to sell the idea of a carbon tax is nearly impossible.  

Usually the idea of a carbon tax is discussed versus cap-and-trade as though they’re mutually exclusive. There is no objective reason why this should be so. A carbon tax can be introduced in developed countries as a form of value added tax to reflect the carbon footprint of goods and services and to incentivise decarbonisation.

In this way, when products follow a strict code of carbon disclosure, they can be taxed according to their environmental cost (and this could include toxicity and level of sustainability, not just GHG emissions). This tax could then be reclaimed by businesses who offset their emissions or fund projects to remedy their environmental impact.   

The revenue collected will then be used to give grants to those businesses who take measures to reduce their impact.  In effect this form of carbon tax creates three tiers where those businesses who minimise their environmental impact receive the greatest financial incentive.  

A uniform carbon price or carbon tax worldwide would be completely unrealistic because of the huge wealth gap between developed and developing nations.  

Cap and trade has got a bad reputation because in the EU it has miserably failed to deliver emission cuts. CDM is also widely criticised for delivering carbon credits of questionable additionality, creating a bloated market of carbon assets to the service of financial interests but not necessarily the best formula for climate change mitigation. This can and should change in future.  

Potentially carbon trading could deliver the economic benefits that developing countries require to fund decarbonisation. Public money alone will not be sufficient to fund a technology transfer that developing countries need to grow and curb their GHG emissions at the same time. At the moment, developing countries are taking positions to show up at Copenhagen and demand around $500bn per year for “technology transfer” whilst developed nations are only prepared to commit $100bn per year (and even that might be tricky to pull off).   

It is probably too late now to expect that Copenhagen will give us a global emissions trading mechanism that will effectively make up the shortfall but this should be articulated sometime in the next year, as it is our best chance to fund decarbonisation, rather than through a carbon tax.