The move, announced by Australian Climate Change Minister Greg Combet, comes less than two months after Australia's carbon pricing scheme took effect.
Under the plan businesses that emit 25,000 tons of carbon dioxide or the equivalent in other greenhouse gases are charged $24 per ton. In 2015 it was to convert to an emissions trading scheme with a floating price starting at a floor of $15.
Now the government will scrap the floor price and link its plan with the European Union's.
The European Union's emissions trading scheme stands at about $10 a ton.
At first, the link will be one way, allowing Australian businesses to buy permits from the EU scheme. Two-way trade is to begin in 2018.
"Linking the Australian and European Union system reaffirms that carbon markets are the prime vehicle for tackling climate change and the most efficient means of achieving emissions reductions," Combet said.
"The EU carbon market with which we will link is the largest carbon market in the world and the EU collectively is the third largest greenhouse gas emitter internationally."
"This is a very good move for our economy and a very good move for our environment."
Combet said the arrangement would pave the way for similar agreements with other economies in the Asia-Pacific.
The Climate Institute cautiously welcomed the announcement.
"While our preference is for a longer-term price floor, linking with the world's biggest carbon market is welcomed so long as it is combined with strong policies for clean energy and energy efficiency," Erwin Jackson, Climate Institute deputy chief executive, said in a statement.
Frank Jotzo, director of the Center for Climate Economics and Policy at the Australian National University in a report in "The Conversation," said the EU link is the biggest drawback of the policy change.
Jotzo questioned whether it was a good idea for Australia to enter a market dominated by a larger partner, with a combined price "that is much more influenced by policy decisions made in Brussels, Berlin and London than in Canberra."
Greens leader Christine Milne welcomed the move and said it means that Australia's scheme will be linked with 500 million people in the European Union.
"It advances the cause of global emissions trading which is ultimately what we have all been hoping for and ultimately it means actually improving the scheme that we legislated," Milne told the Australian Broadcasting Corp.
Opposition leader Tony Abbott has pledged to abolish the tax if elected prime minister in 2013.