Carbon pricing is the practice of attaching a dollar cost to greenhouse gas emissions so that the businesses producing pollution pay for damages that would otherwise fall on the public. It takes several forms: a carbon tax that fixes the price per ton, a cap-and-trade system that fixes the total tonnage and lets the market price the allowances, offsets that pay for reductions elsewhere, and border fees that equalize costs on imports. About 80 such programs operate worldwide as of 2026. The United States has no federal carbon tax and no nationwide trading system, though regional programs cover parts of the country and several proposals sit in Congress.
How a Carbon Tax Works
A carbon tax sets a fixed price on every metric ton of carbon dioxide, or its equivalent in other greenhouse gases, that a covered entity emits. The government picks the number, and anyone producing or importing carbon-intensive fuels owes that amount. The mechanics resemble the federal excise taxes already applied to gasoline and diesel: the charge attaches at a specific point in the supply chain and flows through to end users as a higher price.1Office of the Law Revision Counsel. 26 USC 4081 – Imposition of Tax
Where the tax lands in the supply chain shapes how it works. An upstream tax hits producers and importers of fossil fuels, so coal mines, natural gas processors, and petroleum refineries pay, and the cost ripples through every product that burns those fuels. A downstream tax targets the entity actually burning the fuel: a factory, a power plant, a fleet operator. Upstream collection is simpler because it covers fewer taxpayers. Downstream gives regulators more precision.
The advantage of a carbon tax is cost certainty. A company facing $50 per ton can project its liability from its expected fuel use. The tradeoff: a fixed price does not guarantee any particular level of emission reductions. That depends on how each company responds. Some invest in cleaner equipment. Others absorb the tax and keep running as before.
No federal carbon tax exists in the United States. Multiple proposals were introduced in the 119th Congress, with prices ranging from $40 to $75 per metric ton of CO₂ equivalent. The MARKET CHOICE Act (H.R. 3338) would repeal existing federal fuel excise taxes and replace them with a carbon tax starting at $40 per ton in 2027. The America’s Clean Future Fund Act (S. 2712) would start at $75 per ton that same year. None had been enacted as of mid-2026.
How Cap-and-Trade Works
Cap-and-trade takes the opposite approach. Instead of fixing the price and letting emissions float, it fixes the total volume of allowed emissions and lets the market determine the price. The government sets a cap on the maximum tonnage that regulated industries can collectively emit, then divides that cap into individual permits called allowances. Each allowance represents the right to emit one metric ton of CO₂ equivalent.
Allowances are typically distributed through government auctions, or in some designs given away based on historical emission levels. Either way, they are tradable. A company that can cut emissions cheaply will do so and sell its extra allowances at a profit. A company facing expensive upgrades may find it cheaper to buy allowances than to retrofit. This is what makes cap-and-trade economically efficient: reductions happen where they cost the least.
The cap tightens over time. As permits become scarcer, their price rises, and the financial incentive to reduce emissions grows. The Regional Greenhouse Gas Initiative (RGGI) shows the model in practice. RGGI is a cooperative program among several northeastern states that caps CO₂ emissions from the power sector, runs quarterly allowance auctions, and lets regulated sources in any participating state use allowances purchased from any other participating state.2RGGI, Inc. Elements of RGGI
Compliance Penalties
At the end of each compliance period, regulated facilities must surrender enough allowances to cover their actual emissions. Falling short is expensive. Under RGGI’s model rule, a source with excess emissions must forfeit three allowances for every ton it exceeded, and offset credits cannot be used to close that gap. Beyond the forfeiture, each excess ton is a separate legal violation, and each day of the compliance period can count as a separate day of violation, so potential fines compound quickly.3RGGI, Inc. Model Rule Part XX CO2 Budget Trading Program
Carbon Border Adjustments
A carbon border adjustment charges fees on imports from countries that do not price carbon at comparable levels. Without one, domestic carbon pricing can push manufacturers to move production to jurisdictions with weaker rules, a problem known as carbon leakage. The domestic industry loses competitiveness, and global emissions do not fall.
The European Union’s Carbon Border Adjustment Mechanism (CBAM) entered its definitive operational period on January 1, 2026, covering imports of cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen.4European Commission. Carbon Border Adjustment Mechanism Importers into the EU now buy certificates reflecting the carbon embedded in these goods, equalizing the carbon cost between EU producers (who pay under the EU Emissions Trading System) and their foreign competitors.
The United States has no border adjustment in place. Five proposals were introduced in the 119th Congress during 2025. They take different approaches. The Foreign Pollution Fee Act (S. 1325) would impose an import fee based on pollution intensity compared to a U.S. baseline, without creating a domestic carbon price at all. The America’s Clean Future Fund Act (S. 2712) would pair a border fee starting at $75 per ton with a domestic carbon tax. The Clean Competition Act (S. 3523) sets an emissions performance standard under which both domestic producers and importers pay based on how much their carbon intensity exceeds an industry baseline.
Carbon Offsets and Their Limits
Carbon offsets let a business or individual compensate for their own emissions by paying for reductions somewhere else: funding reforestation, capturing methane from a landfill, or backing renewable energy in a developing country. Each offset credit is meant to represent one metric ton of CO₂ removed or avoided. The integrity problem is that not all offsets deliver what they promise, and weak verification has dogged the market for years.
The Federal Trade Commission’s Green Guides set the baseline legal rules for marketing carbon offsets to U.S. consumers. Sellers must have competent and reliable scientific evidence for their claims. They must use accounting methods that prevent the same reduction from being sold twice. They must disclose if the reduction will not happen for at least two years. And they cannot claim credit for an activity that was already required by law: if a power plant was going to close anyway due to regulation, selling offsets based on that closure is deceptive.5Federal Trade Commission. Environmental Claims: Summary of the Green Guides
Within cap-and-trade systems, offsets play a limited role. Regulated entities can use offset credits to satisfy part of their compliance obligation instead of buying allowances, but only a small part. This quantitative usage limit stops companies from buying their way out of actual reductions entirely. Verification generally involves third-party registries that audit projects against established protocols and track credits from issuance to retirement to prevent double-counting.
For buyers evaluating offsets outside a regulated program, the strongest indicator of legitimacy is independent third-party verification under recognized standards. Offsets that lack transparent methodology, measurable baselines, and proof of additionality (that the reduction would not have happened without the offset funding) are the ones most likely to amount to greenwashing.
What Governments Do With the Revenue
Carbon pricing generates substantial revenue. Globally, carbon pricing instruments brought in over $100 billion for public budgets in 2025. What governments do with the money is often the most politically consequential design choice, and the approach falls into two broad camps.
Revenue-neutral programs return the money to households. The carbon price raises energy costs across the economy, so the government sends the revenue back as a dividend or tax rebate. Several U.S. proposals follow this model, some as a monthly per-person payment and others as an annual credit. Low- and middle-income households, which spend a larger share of income on energy, tend to come out ahead under dividend designs because they receive the same payment as wealthier households while generating less carbon tax liability.
Revenue-positive programs direct funds toward public investments. Proposals in Congress have allocated carbon revenue to highway infrastructure, renewable energy development, climate resilience, reforestation, worker transition programs for displaced fossil fuel employees, and weatherization assistance. The MARKET CHOICE Act would send 70% of its trust fund allocation to the Federal Highway Trust Fund, with smaller shares going to state grants for low-income households, flood mitigation, and displaced energy workers.
Most proposals blend the two approaches, returning a majority of revenue to households while earmarking a share for targeted investments. The legal structure matters: statutes generally have to specify whether funds flow through a dedicated trust fund or the general treasury, because without that protection, carbon revenue can be diverted to unrelated spending. Regular public reporting and independent audits of revenue flows are standard features in well-constructed programs.
Reporting and Enforcement in the United States
Every carbon pricing system depends on accurate, verifiable emissions data. The EPA’s mandatory Greenhouse Gas Reporting Rule (40 CFR Part 98) requires owners and operators of facilities that meet certain thresholds to calculate and report annual greenhouse gas emissions following specific methodologies for each source category. The EPA reviews these reports and conducts audits to verify accuracy.6eCFR. 40 CFR Part 98 – Mandatory Greenhouse Gas Reporting
Enforcement teeth are real. Failing to report, misreporting, or failing to monitor emissions properly all count as Clean Air Act violations, and each day of noncompliance is a separate violation.7eCFR. 40 CFR 98.8 – Compliance and Enforcement Provisions The Clean Air Act authorizes civil penalties per day per violation, with amounts adjusted annually for inflation, and the EPA can pursue enforcement through administrative orders or federal court action.8Office of the Law Revision Counsel. 42 USC 7413 – Federal Enforcement For a facility that underreports for months, the cumulative exposure adds up fast.
For entities subject to excise taxes on fossil fuels and related environmental taxes, reporting happens through the IRS on a quarterly basis using Form 720, with environmental-specific taxes calculated on Form 6627.9Internal Revenue Service. Instructions for Form 720 (Rev. March 2026) Underpayment or failure to file carries the standard federal tax penalties (interest, late-payment charges, and potential fraud prosecution) layered on top of any environmental enforcement. If a federal carbon tax is eventually enacted as an excise tax, this dual structure (EPA for emissions data, IRS for tax payments) would apply at once.
The Social Cost of Carbon in 2026
One term that shows up often in carbon pricing debates is the Social Cost of Carbon (SCC), an economic estimate of the long-term damage caused by emitting one additional metric ton of CO₂ in a given year. Federal agencies have historically used SCC figures when writing regulations, weighing the cost of a rule against the value of avoided climate damage. Using EPA’s 2023 estimates for the year 2026, the SCC ranged from roughly $128 per metric ton at a 2.5% discount rate to $353 per ton at a 1.5% rate, measured in 2020 dollars.10Environmental Protection Agency. EPA Report on the Social Cost of Greenhouse Gases
The metric’s federal role has shifted. Executive Order 14154, signed in early 2025, disbanded the Interagency Working Group on Social Cost of Greenhouse Gases and withdrew the guidance, recommendations, and documents the working group had issued. Under the implementing memorandum (M-25-27), it is no longer federal policy to maintain a uniform estimate of the monetized impacts of greenhouse gas emissions. Agencies are told to limit consideration of greenhouse gas emissions to what their statutes plainly require, and not to monetize those emissions even when consideration is required.11The White House. M-25-27 Guidance Implementing Section 6 of Executive Order 14154
The EPA’s 2023 estimates remain available as a document, but the SCC has no active role in federal rulemaking under the current administration. It still matters in ongoing litigation and in state-level proceedings where state agencies use their own climate damage estimates.