Carbon Taxes vs Carbon Credits: What’s the Difference?

Carbon Taxes vs Carbon Credits: What’s the Difference?

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Grace Smoot

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Many agree that putting a price on carbon emissions could help mitigate climate change and lead to a more sustainable planet for future generations. Carbon taxes and carbon credits are two of the highly debated methods to do this, but they vary in their methodology. So, we had to ask: What’s the difference between carbon taxes and carbon credits?

Carbon taxes are a price tag put on fossil fuel emissions to disincentivize their use and promote a switch to green energy. Carbon credits are tradable certificates or permits that set a maximum level of carbon emissions for industries, companies, or countries.

In the fight against climate change, how can we tell the difference between carbon taxes and carbon credits? Below we will define both terms, identify the key advantages and differences of each, explore how they operate and what impact they have on carbon emissions, and discuss why they are important in the fight against climate change.

How Are Carbon Taxes and Carbon Credits Defined

Carbon taxes and carbon credits are two sustainability tools that can help individuals and organizations lower their carbon footprints. But although they are often used in the same conversation, they actually target different facets of emission reduction. 

What Does the Dictionary Say About Carbon Taxes and Carbon Credits

Carbon emissions already have a price tag attached to them, but it is our environment that pays the price, not the emitters. Carbon taxes, a form of carbon pricing, seek to resolve this issue and make the emitters pay for their carbon emissions. 

Carbon Tax: a tax on the use of fuels that produce gasses that harm the atmosphere”

Cambridge Dictionary

A carbon tax is a fee placed directly on the burning of fossil fuels (i.e., coal, oil, and natural gas). And it is the only way to make users of fossil fuels pay for the social, economic, and environmental damage caused when carbon is released into the atmosphere. Placing the tax on the fuel itself creates a monetary disincentive that promotes the switch to greener energy by making it more economically rewarding to use non-fossil fuels. 

Finland was the first country to implement a carbon tax back in 1990, and now there are 64 carbon pricing policies (carbon taxes and cap-and-trade policies) in operation worldwide. 35 of these are carbon tax programs. As of 2021, Sweden had the highest and Poland the lowest carbon tax at $137 and <$1 per metric ton of CO2 equivalent, respectively. The United States and Australia are currently the only two developed countries without some form of carbon pricing.

But carbon taxes are not the only available tool. Carbon credits are another option to reduce carbon emissions. 

Carbon Credit: a unit used in carbon trading that represents the right of a business, factory, etc. to release 1000 kilograms of carbon dioxide into the environment”

Cambridge Dictionary

Carbon credits are tradable certificates or permits that give companies, industries, or countries the right to emit 1 tonne (1,000kg) of CO2 or the equivalent amount of a different greenhouse gas (GHG). They are a form of climate currency, meaning they are subject to supply and demand and can be bought and sold through a cap-and-trade market. This market limits how much total CO2 can be emitted. 

Cap-and-trade markets became established after the Kyoto Protocol, an international treaty, set a maximum amount of GHG emissions that could be released into the atmosphere, both globally and nationally. Each entity operating under a cap-and-trade program is issued a certain number of carbon credits each year. They can purchase more if their emissions exceed what was issued, and they can sell unused credits to other entities if their emissions are less than what was issued. 

What Are the Differences Between and Advantages of Carbon Taxes and Carbon Credits

Both carbon taxes and carbon credits represent ways in which we can mitigate carbon emissions and global warming. But they are also different methods of climate action with different environmental impacts, making it important to understand their differences.

The main difference between carbon taxes and carbon credits involves the price of emissions and the total amount of emissions reduction. The price of emissions is pre-determined with carbon taxes, but the total amount of emission reduction is not. The reverse is true of carbon credits. The amount of total emissions reduction is predetermined with carbon credits, but the price of the emissions is not. 

The following are key advantages of carbon taxes:

  • They generate revenue for governments to develop green energy
  • Different fossil fuels can be taxed at different rates
  • They provide social, economic, and environmental benefits

The following are key advantages of carbon credits:

  • Caps on carbon emissions can be set strictly 
  • Unused carbon credits can be traded to other companies
  • Incentivizes companies to invest in greener technologies

How Do Carbon Taxes and Carbon Credits Impact Your Carbon Footprint

Knowing the similarities and differences between carbon taxes and carbon credits is important when making a decision of which one to use. 

Carbon Taxes Carbon Credits
How are carbon emissions reduced A fee is placed on fossil fuels, which creates a monetary incentive to switch to greener forms of energy.  Carbon credits cap how much CO2 can be emitted by an entity. This cap on emissions can be gradually reduced over time, leading to less and less overall emissions.
Impact on own carbon emissions Carbon taxes do not directly reduce your carbon footprint.  Carbon credits do not directly reduce your carbon footprint. 
Impact on global carbon emissions Carbon taxes work at the core issue of reducing overall CO2 emissions. Carbon credits mitigate the problem, but they do not work at the core issue of reducing overall CO2 emissions.
Environmental benefits Carbon taxes facilitate the switch to greener energy sources and promote energy independence.  Carbon credits facilitate the switch to greener energy sources and promote energy independence. 
Overall effectiveness in reducing carbon emissions Carbon taxes are effective if they are complemented by programs that ensure people are not made worse off from increases in fossil fuel costs. Improper reporting and discrepancies in maximum GHG levels between countries limits carbon credit effectiveness on a global scale. 

How Do Carbon Taxes and Carbon Credits Reduce Carbon Emissions

The goal of both carbon taxes and carbon credits is to reduce carbon emissions in order to mitigate climate change.

  • Carbon taxes: Taxes represent indirect emission reductions. A price is placed on emitting fossil fuels, which creates a monetary incentive to switch to greener forms of energy with less carbon emissions.
  • Carbon credits: Credits represent indirect emission reductions. Putting a cap on emissions and decreasing this cap over time reduces carbon emissions over time, preventing CO2 from entering the atmosphere.

When you hear the words “carbon tax”, think about the term “price tag”. Governments set prices that emitters must pay for each metric ton equivalent of carbon they emit. Carbon taxes force emitters to take steps to reduce their emissions in order to avoid paying this tax. The less carbon they emit, the less money they spend, and the less carbon gets released into our atmosphere. 

When you hear the words “carbon credit”, think about the term “allowance”. Carbon credits represent the maximum amount of CO2 an entity is allowed to emit. This cap on CO2 emissions slowly decreases over time, forcing entities to emit less and less CO2 to stay within the boundaries of the cap. Companies with high levels of emissions can continue to operate, but only at an increased cost.

What Impact Do Carbon Taxes and Carbon Credits Have on Your Own Carbon Emissions

One of the best ways we can aid in the fight against global climate change is to reduce our carbon footprint. And to do this we first have to reduce our own carbon emissions. 

  • Carbon taxes: Carbon taxes do not directly reduce your carbon footprint. 
  • Carbon credits: Carbon credits do not directly reduce your carbon footprint.  

Carbon taxes do not directly reduce your own carbon emissions. Putting a price tag on carbon emissions is an indirect method of emissions reduction because people can continue to emit as long as they pay the price. 

Carbon credits do not directly reduce your own carbon emissions. Setting a limit on how much carbon emissions are allowed is an indirect method of emissions reduction because companies can continue to emit as long as they pay the price. 

Coupled with direct measures of emission reductions, such as reducing individual energy usage and consumption, carbon taxes and cap and trade can become more effective. 

What Impact Do Carbon Taxes and Carbon Credits Have on Global Carbon Emissions

Every year we pump over 36 billion tons of CO2 into the atmosphere, fueling climate change. This causes temperature and sea-level rise, melting of sea ice, changing precipitation patterns, and ocean acidification. Carbon taxes and carbon credits aim to reduce global emissions and mitigate these negative environmental effects.

  • Carbon taxes: Carbon taxes work at the core issue of reducing overall CO2 emissions. 
  • Carbon credits: Carbon credits mitigate the problem, but they don’t work at the core issue of reducing overall CO2 emissions. 

Carbon taxes have a significant impact on global carbon emissions. Carbon taxes internalize external costs on the environment by adding them onto the price of fossil fuels. In this way, the producer and consumer pays for the full price of fossil fuels, including external costs to the environment. Higher prices disincentivizes the use of carbon-intensive goods, which leads to a reduction in total carbon emissions. 

Carbon credits do not have a significant impact on global carbon emissions. Although they may incentivize companies to reduce their CO2 emissions, the immediate effect of reducing emissions under the cap-and-trade system is to benefit a company’s bottom line. The direct goal of carbon permits is not to reduce greenhouse emissions or support sustainable energy projects, but rather for companies to make money. 

The COVID-19 pandemic triggered the largest decrease in energy-related carbon emissions since World War II, a decrease of 2 billion tons. However, emissions rebounded quickly at the end of 2020, with levels in December ending 60 million tons higher than those in December 2019. This indicates that the earth is still warming at an accelerated rate, and not enough is being done to implement clean energy practices. 

Illustration of annual CO2 emissions globally
Our World in Data: Annual total CO2 emissions

What Are the Environmental Benefits of Carbon Taxes and Carbon Credits

Using carbon taxes and carbon credits can reduce our consumption of fossil fuels which, in turn, reduces our carbon footprint. But their benefits go beyond reducing your overall carbon emissions to balance off your personal carbon footprint. They also come with various environmental benefits.

Carbon taxes and carbon credits incentivize companies to switch to greener energy sources including solar, wind, hydro, and geothermal energy. They do not emit CO2, nitrogen oxides, sulfur dioxides, or mercury into the atmosphere, soil, or water. And these pollutants are known to contribute to the thinning of the ozone layer, global sea-level rise, and the melting of our world’s glaciers.

Switching from fossil fuels to green energy also promotes energy independence. Being able to produce your electricity without the aid of foreign countries is an important step in becoming more self-sufficient. 

How Effective Are Carbon Taxes and Carbon Credits in Reducing Carbon Emissions

Carbon taxes and carbon credits can be effective at reducing carbon emissions if they are used correctly.

  • Carbon taxes: Placing a price directly on fossil fuels is effective at reducing global carbon emissions if there are contingencies in place to ensure increasing costs do not cause unnecessary hardships for people.

Carbon taxes are effective at reducing carbon emissions because they force emitters to pay for fossil fuel emissions. The money generated from a carbon tax could then be used to offset energy costs for low income families, fund green energy technology, help combat climate change, or be given back to citizens as a dividend. But taxes can only be effective if they are complemented by programs that ensure people are not made worse off from increases in fossil fuel costs. Fossil fuels have been powering economies for over 150 years and currently supply approximately 80% of the world’s energy. Increasing the cost of fossil fuels could cause economic hardship for a large percentage of the world.

Carbon credits have faced criticism because most industries lack the technology that monitors and determines their amount of CO2 emissions. This makes it easier for companies to cheat on their emissions reports and say they are emitting less than they actually are. Also, different countries have different standards and caps for CO2 emissions. If the cap is set too high, then companies are not incentivized to reduce emissions. But set the cap too low, and companies will be overly burdened to reduce emissions. And the extra cost will be passed down to consumers as a result.

Why Are Both Carbon Taxes and Carbon Credits Important to Fight Climate Change

Carbon taxes and carbon credits are important to fight climate change because they are both ways to reduce your carbon footprint. Reducing your carbon footprint is important because it mitigates the effects of climate change, which has a positive cascade effect on public health and plant and animal diversity. In addition, this boosts the global economy and leads to innovative, more environmentally-friendly solutions.

However, carbon taxes and carbon credits should not be used as a Panacea for climate change. Relying on carbon taxes won’t be enough because people can still pay the price to emit carbon. And relying on carbon credits solely is impractical because the immediate effect of reducing emissions under the cap-and-trade system is to benefit a company’s bottom line. 

In the long term, direct methods of carbon footprint reduction are much more effective. Reducing your household, travel, and lifestyle carbon footprint can go a long way in the fight against climate change!

What are Better Alternatives to Carbon Taxes and Carbon Credits

If used correctly, carbon taxes and carbon credits can provide environmental, economic, and social benefits that go beyond reducing carbon emissions. They have the potential to instigate meaningful environmental change and begin to reverse some of the effects of climate change. 

However, we can’t let these two methods be a guilt-free way to reduce carbon emissions. Carbon taxes and carbon credits must be used in conjunction with direct carbon reduction measures until the industry has time to invest, develop, and refine more sustainable innovations. 

These reduction measures don’t have to involve drastic changes either. Actions that may seem small can have a big impact because those small changes add up! You can reduce your carbon footprint in three main areas of your life: household, travel, and lifestyle. 

Reduce your household footprint:

Reduce your travel footprint:

  • Walk or bike when possible: The most efficient ways of traveling are walking, bicycling, or taking the train. Using a bike instead of a car can reduce carbon emissions by 75%. These forms of transportation also provide lower levels of air pollution.

Reduce your lifestyle footprint:

  • Switch to Renewable Energy Sources: The six most common types of renewable energy are solar, wind, hydro, tidal, geothermal, and biomass energy. They are a substitute for fossil fuels that can reduce the effects of global warming by limiting global carbon emissions and other pollutants.
  • Recycle: Recycling uses less energy and deposits less waste in landfills. Less manufacturing and transportation energy costs means less carbon emissions generated. Less waste in landfills means less CH4 is generated.
  • Eat less meat and dairy: Meat and dairy account for 14.5% of global greenhouse gas emissions, with beef and lamb being the most carbon-intensive. Globally, we consume much more meat than is considered sustainable, and switching to a vegan or vegetarian diet could reduce emissions. 
  • Take shorter showers: Approximately 1.2 trillion gallons of water are used each year in the United States just for showering purposes, and showering takes up about 17% of residential water usage. The amount of water consumed and the energy cost of that consumption are directly related. The less water we use the less energy we use. And the less energy we use, the less of a negative impact we have on the environment.

Final Thoughts

In short, carbon taxes are not the same thing as carbon credits. Carbon taxes are fees placed directly on the burning of fossil fuels which creates a monetary disincentive for prolonged use and an incentive to switch to greener forms of energy. Carbon credits are tradable certificates or permits that give companies, industries, or countries the right to emit 1 tonne (1,000kg) of CO2.

Both are tools in our sustainability toolbox that can be used to reduce carbon emissions and mitigate climate change. But we should not rely on either or both to be a cure-all for our environmental problems. Direct measures of carbon emission reduction are much more effective in reducing emissions both in the short term and the long term.

Stay impactful,

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Grace Smoot

Grace loves to research and write about all things related to climate action and sustainability. She holds a Bachelor’s of Science degree in Environmental Biology and works as an Environmental Survey Technician. Outside of work, she loves to work out, play soccer, and take her dog for long walks.

Did you know that the internet is a huge polluter of the environment? But fortunately not this site. This site is powered by renewable energy and all hosting-related CO2 emissions are offset by three times as many renewable energy certificates. Find out all about it here.

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