How Can a Fossil Fuel Levy Cut Emissions and Finance Climate Action?

This briefing by the International Institute for Sustainable Development examines the potential for an internationally agreed-upon fossil fuel extraction levy to reduce emissions and fund climate action. It compares four specific proposals—the Windfall Profits Tax, the Climate Damages Tax, the Multilateral Carbon Tax Treaty, and the Wellhead Carbon Tax—analyzing the trade-offs between generating revenue and discouraging production, the challenges of existing fiscal contracts in low-income countries, and mechanisms to incentivize global adoption.

• A levy on fossil fuel extraction offers several advantages over consumption-based taxes, including easier administration due to fewer extracting companies, simpler measurement of carbon content, and broader coverage of emissions including those from extraction, processing, and transport.
• There is an inherent tension between the two primary goals of an extraction levy: raising revenue and discouraging extraction. If a levy successfully reduces extraction, it shrinks the tax base available for climate funding; conversely, reliance on these revenues may create a moral hazard where governments or industries support continued extraction to maintain funding or 'greenwash' expansion.
• Levies based on carbon content are more effective at discouraging production and providing stable revenue than those based on windfall profits, as the latter are subject to volatile oil and gas prices and are easier for companies to avoid.
• Implementing extraction levies faces significant hurdles in low- and middle-income countries due to 'stabilization clauses' in existing contracts that restrict fiscal changes, as well as the potential for governments to secretly compensate companies through subsidies or other tax reductions.
• To incentivize fossil fuel exporters to adopt levies, the Multilateral Carbon Tax Treaty and Wellhead Carbon Tax propose a mechanism where importing governments cannot impose further carbon taxes if the exporting government has already applied an extraction levy, similar to the European Union’s Carbon Border Adjustment Mechanism.

APA

Manley, D., & Parra, P. Y. (2024). How Can a Fossil Fuel Levy Cut Emissions and Finance Climate Action? International Institute for Sustainable Development. https://www.iisd.org/articles/explainer/how-can-fossil-fuel-levy-cut-emissions-finance-climate-action

Chicago

Manley, David, and Paola Yanguas Parra. How Can a Fossil Fuel Levy Cut Emissions and Finance Climate Action? International Institute for Sustainable Development, 2024. https://www.iisd.org/articles/explainer/how-can-fossil-fuel-levy-cut-emissions-finance-climate-action.

Wikipedia

{{cite report |last1=Manley |first1=David |last2=Parra |first2=Paola Yanguas |title=How Can a Fossil Fuel Levy Cut Emissions and Finance Climate Action? |publisher=International Institute for Sustainable Development |date=24 October 2024 |url=https://www.iisd.org/articles/explainer/how-can-fossil-fuel-levy-cut-emissions-finance-climate-action |access-date=17 August 2026 |via=Climate Insights Directory}}

BibTeX

@techreport{manley2024how, author = {Manley, David and Parra, Paola Yanguas}, title = {{How Can a Fossil Fuel Levy Cut Emissions and Finance Climate Action?}}, institution = {International Institute for Sustainable Development}, year = {2024}, month = oct, url = {https://www.iisd.org/articles/explainer/how-can-fossil-fuel-levy-cut-emissions-finance-climate-action}, urldate = {2026-08-17}, note = {Indexed by Climate Insights Directory} }