Tax Design Considerations: Tax Rate

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General economic theory holds that total welfare is maximized when social marginal benefits equal social marginal costs of production. Yet production may continue beyond this point if pollutants or activities generate unrecognized external costs. An optimal tax rate corrects for negative externalities by causing prices to closely approximate marginal social costs.

In the context of a carbon tax, there is an inherent difficulty in quantifying many impacts, and calculations of an optimal tax consequently vary widely. The IPCC estimated a mean calculation of $12 per metric ton of CO2, though estimates ranged from $3 to $97 per ton in their study. The optimal tax rate would equal this social cost of emitting one metric ton of CO2.

An alternative approach is to establish a level of tolerable carbon emissions, and design taxes (e.g. emissions and energy taxes) that would satisfy this target.