The carbon fee is based on the economic principle that if you want less of something you increase the price.
Putting a steadily rising price on all CO2 pollution places equal economic pressure on every ton. As a market based mechanism this incentivises the economy to remove the most cost effective ton first. As the price rises this process continues until all possible CO2 emissions are removed.
The fee starts low as to avoid a shock to the economy and rises in a steady and predictable way. This enables business and industry to make informed decisions related to energy, such as energy efficiency, long term investments and innovation. The economy gets an initial nudge and a clear signal for the future. All actors in the economy (industry, business, public sector, families & individuals) are motivated to adopt cleaner approaches based on financial benefits.
The most cost efficient place to charge the fee is up-stream as soon as the fossil fuel enters the economy, at the point of extraction or port of entry. This is because there are relatively few points to monitor with in-place processes and resources to charge the fee. The effects of the increased up-stream cost will propagate through the economy, impacting all activity that relies, directly or indirectly, on fossil fuels.
Economic instruments like carbon taxes are attractive because of their simplicity and broad scope covering all technologies and fuels and thus evoking the cost-minimizing combination of changes to inputs in production and technologies to changing behaviour as manifested in consumption choices and lifestyles. This is the reason they have the potential to be more efficient than directly regulating technology, products, or behaviour. To minimize administrative costs, a carbon tax can be levied ‘upstream’ (at the points of production or entry into the country). Finally,(…), a tax can piggyback off existing revenue collection systems. (IPCC, 2015)