Carbon Tax: Understanding Its Impact and How It Works

‍^‍At its core, climate change is an economic problem. Greenhouse gas emissions from burning fossil fuels (gas, coal, oil) warm the atmosphere, which destabilizes the climate and leads to a host of consequences for the environment, the biosphere, and human societies.

These consequences—these “damages”—represent a cost borne by society as a whole. In a way, society is subsidizing the cost of the climate damage caused by greenhouse gas emissions. This is known as a negative externality.

Reducing emissions largely involves shifting this cost from society, back to the initial emitters. In other words, we must internalize the externality. To do so, we need to put a price on greenhouse gas emissions. Only then can we truly accelerate the energy transition.

There are two main approaches to do this at scale: a market-based mechanism or a fiscal mechanism—i.e., a tax. Both aim to internalize the cost of emissions for emitting industries. Of course, the strength of the incentive depends on the price placed on emissions. Too low, and it has no effect. Too high, and it may hurt companies' competitiveness or cripple them faster than they can adapt. Setting the right level is one of the ongoing challenges in emission pricing systems.

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In this article, we focus on one of these two solutions: the carbon tax.

What is a Carbon Tax?

A carbon tax is a fiscal instrument whose primary objective is to reduce greenhouse gas (GHG) emissions by putting a price on carbon emissions. It follows the polluter-pays principle: the more an individual or company emits, the more they pay. The idea is to encourage economic actors to adopt more sustainable behaviors, under the pressure of carbon taxation. For example, by reducing their consumption of fossil fuels like gasoline, or investing in clean technologies.

At Homaio, we believe that pricing emissions is the most effective way to reduce them because it aligns economic interest with environmental interest. It also reintroduces a sense of economic justice: those who cause damage should pay for it. That’s why we opened the EU Emissions Trading System (EU ETS) to retail investors—to make it even more effective.

Definition and Objectives of a Carbon Tax

A carbon tax is defined as a legally imposed tax applied to the amount of CO₂ emitted by certain sectors. It can apply to companies and/or households. The main goals of this tax are:

1. To reduce greenhouse gas emissions and combat climate disruption;
2. To stimulate technological innovation in favor of renewable energy;
3. To generate revenue for the state, which can be reinvested in ecological initiatives.

Why Are Carbon Taxes Introduced?

Carbon taxes are implemented for several reasons.

Mainly, they aim to correct a market failure by internalizing the environmental costs of CO₂ emissions. They also encourage companies and consumers to adopt more sustainable practices by making fossil energy sources more expensive. Additionally, the revenues generated can fund renewable energy or energy transition projects.

It’s also a fiscal system—making it relatively simple to understand, implement, and manage.

How is the Carbon Tax Calculated?

Calculation and Implementation Mechanism

The mechanism is relatively straightforward: it’s based on the amount of CO₂ emitted, measured in tons. Tax authorities set a price per ton of carbon, which is then applied to individuals or companies based on their emissions. For example, if the price is set at €50 per ton of CO₂ and a company emits 1,000 tons, it would owe the state €50,000 in carbon tax. This system creates an incentive for companies to reduce emissions to cut costs.

In France, the carbon tax—called the “climate-energy contribution” (CCE)—is set at €44.60 per ton of CO₂. Annual revenues from this tax in France are around €100 billion.

For comparison, the European Union Emissions Trading System (EU ETS)—now accessible to retail investors thanks to Homaio—currently prices allowances at around €70 per ton.

Sectors Affected by the Carbon Tax

The carbon tax mainly targets high-emitting sectors like energy, industry, transportation, and agriculture.

In France, it applies to the combustion of fossil fuels (fuel oil, gasoline, natural gas, coal, etc.) in transportation, residential, and non-EU ETS industrial sectors. That’s because sectors covered by the EU ETS are already subject to a market mechanism—unlike the carbon tax, which relies on fiscal policy.

Implementation of Carbon Taxes Around the World

Looking at a few examples, the first carbon taxes were implemented in the early 1990s—primarily in Northern Europe, where climate action enjoys stronger political support. Tax levels vary widely from one country to another, ranging from less than €1 per ton in Argentina to nearly €130 in Sweden or Switzerland.

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Economic and Environmental Impacts of a Carbon Tax

Impact on Climate and Emission Reduction

One of the main effects of a carbon tax is a decrease in greenhouse gas emissions. Studies show that carbon taxes have contributed to lowering CO₂ emissions in countries where they were adopted. For example, Sweden introduced a carbon tax in 1991 and has since cut emissions by 25%—while growing its economy by 75% over the same period. The incentive was particularly strong due to the high tax level.

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Economic Impact on Businesses and Households

Carbon taxes also have economic impacts beyond climate. Higher fossil fuel costs for businesses can lead to increased prices for consumers. The goal is for companies to avoid these costs by investing in cleaner, more efficient technologies, rather than passing them on to consumers. It's also an opportunity for businesses to invest in the green technologies shaping tomorrow’s economy and gain a competitive edge.

A report by ADEME (the French Agency for Ecological Transition) shows that 78% of French companies believe carbon taxes can drive innovation, although 45% are concerned about the short-term competitiveness impact.

Challenges and Criticism

Solutions for Businesses

The best way for businesses to reduce carbon tax costs is to decarbonize their operations. By improving energy efficiency and adopting cleaner technologies, companies can minimize emissions and reduce their tax exposure. For example, a study by McKinsey & Company found that energy-efficient investments can reduce energy consumption by 15–30%, helping offset carbon tax impacts on operating costs.

Companies can also turn to renewable energy sources, such as solar panels or wind power. Google, for instance, has invested heavily in renewables, reducing its carbon footprint while stabilizing long-term energy costs. In 2020, Google announced that it had reached 100% renewable energy for its global operations.

Solutions for Individuals

Individuals can also reduce their carbon tax burden in various ways. One of the most direct is to optimize household energy consumption by choosing products with lower fossil content or higher energy efficiency. Investing in better home insulation or energy-efficient appliances can reduce energy bills—and carbon tax costs. ADEME estimates that improving insulation can cut heating bills by 20–30%.

Households can also shift to cleaner transport options by avoiding fossil fuels (gasoline, diesel)—opting instead for biking, public transit, or electric vehicles. According to the WHO, countries investing in bike infrastructure and transit systems can cut emissions while offering affordable alternatives to citizens.

Finally, awareness and education play a crucial role. Community initiatives and education programs can help individuals understand the impact of their consumption choices and encourage more sustainable behavior, reducing overall carbon footprints.

Carbon Tax vs. Emissions Trading System (ETS)

It’s essential to understand the differences between carbon taxes and emissions trading systems (ETS). A carbon tax imposes a fixed cost per ton of CO₂ emitted, whereas an ETS allows companies to buy and sell emission permits, with prices set by the market.

On one hand, we have a tax-based tool. On the other, a market-based tool. Both aim to put a price on greenhouse gas emissions. At Homaio, we focus on market-based mechanisms. While the carbon tax is… well, a tax, emission allowances are financial instruments.

Comparing Emission Pricing Mechanisms

Simplicity and Transparency

• Carbon Tax: Easy to understand—fixed cost per ton. For example, France set its tax at €44.60 per ton in 2021.
• ETS: More complex—permit prices fluctuate with supply and demand. For example, EU ETS prices have ranged between €5 and €100 over the past decade.
  
  

Flexibility

• Carbon Tax: Less flexible—rates set by law and hard to adjust quickly, raising concerns over competitiveness and effectiveness.
• ETS: More flexible—companies can buy or sell allowances based on their needs, though changes depend on regulatory processes.
  
  

Economic Impact

• Carbon Tax: Generates tax revenue for green projects but can harm businesses if not paired with support measures.
• ETS: Revenue from permit auctions also funds climate policy. A market mechanism spreads the decarbonization effort where it’s cheapest and most effective.

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The Future of Carbon Taxes

Carbon taxes are a key tool in the fight against climate change by internalizing the cost of greenhouse gas emissions. By choosing between market or fiscal mechanisms, countries can adapt their environmental policies to support a transition toward a low-carbon economy.

Today, there are 39 carbon taxes and 36 ETS systems worldwide, totaling 75 pricing mechanisms. These cover about 19% of global CO₂ emissions for ETS and 6% for carbon taxes—25% in total. While carbon taxes are more numerous, ETS systems tend to cover a larger volume of emissions.

It’s crucial to find the right balance between the two approaches to maximize impact. A combined system could offer a more robust environmental policy—one that delivers meaningful emission reductions while preserving business competitiveness and social fairness.

In the end, the question isn’t whether a carbon tax is the best solution—but how it can be integrated into a broader climate policy framework. Policymakers, businesses, and citizens must work together to build a sustainable future, where emission pricing drives positive change and innovation.

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