A carbon tax is a fee assessed on the carbon content of fuels. Because of the strict proportionality between fuels’ carbon content and their carbon dioxide emissions when burned, a carbon tax is effectively a tax on the carbon dioxide emissions from burning fossil fuels. Thus, carbon tax is shorthand for carbon dioxide tax or CO₂ tax — or, one could say, for a carbon pollution tax.

The carbon content of every form of fossil fuel, from anthracite to lignite coal, from residual oil to natural gas, is precisely known. This makes a carbon tax simple to document and measure. Utilizing existing tax collection mechanisms, the carbon tax is paid “upstream,” i.e., at the point where fuels are extracted from the Earth and put into the stream of commerce, or imported into the U.S. Fuel suppliers and processors would pass along the cost of the tax to the extent that market conditions allow.Generally, a Btu from coal produces 30% more carbon dioxide than a Btu from oil, and 80% more than from natural gas (methane). A carbon tax would obey these proportions, taxing coal somewhat more heavily than petroleum products, and much more than natural gas.

A revenue-neutral carbon tax preserves the tax’s price-incentive to reduce emissions but avoids the “income” effects that might drag down economic activity.Revenue-neutral means that government retains little if any of the tax revenues raised by taxing carbon emissions. The vast majority of the revenues are returned to the public; with, perhaps, small amounts utilized to assist communities dependent on fossil-fuel extraction and processing to adapt and convert to low- or non-carbon economies.

There are two primary approaches to returning or recycling the tax revenues.

1. One approach returns revenues directly through regular (e.g., monthly) “dividends” to all U.S. households or residents. Every resident or household receives an equal, identical slice of the total carbon revenue “pie.” In this approach each individual’s carbon tax is proportional to his or her fossil fuel use, creating an incentive to reduce; but everyone’s dividend is equal and independent of his or her usage, preserving the conservation incentive. Alaska’s dividend program has provided residents with annual allotments from the state’s North Slope oil royalties for three-and-a-half decades.

2. In the other revenue return method, each dollar of carbon tax revenue triggers a dollar’s worth of reduction in existing taxes such as the federal payroll tax or corporate income tax — or, on the state level, sales taxes. As carbon-tax revenues are phased in (with the tax rates rising steadily but not too steeply, to allow a smooth transition), existing taxes are phased out. While this “tax-shift” is less direct than the dividend method, it too ensures that the carbon tax is revenue-neutral. It offers other important benefits, as well; for example, reducing payroll taxes could stimulate employment.