The Incidence of a U.S. Carbon Tax

Economists have long argued that market based instruments are more efficient than regulations as a means of addressing the social damages arising from polluting activities. By market-based instruments we mean policies that force firms to “internalize” the cost of polluting activities. In the context of climate change arising from greenhouse gas emissions, the polluting activity is the release of carbon dioxide and other greenhouse gases. Carbon taxes and cap and trade systems are two examples of market based instruments that create a cost to emissions. A carbon tax does this directly by taxing the carbon content of fuels while a cap and trade system imposes a cost by requiring the surrender of valuable permits in proportion to the carbon content of fossil fuels.

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