Pigovian Tax

There’s a new factory in town, and your neighborhood isn’t happy about it. Nearby residents aren’t looking forward to an increase in local lung cancer rates and a decrease in local housing prices. These are social costs that the factory is putting upon people without paying for them...also called negative externalities.

Yeah, there are positive externalities too...like if the factory emitted not pollution, but pollution-free flower-smells, which raised local housing prices. In that case, the people would owe the firm for the free social benefit it got. Nobody likes giving out free stuff, so positive externalities aren’t too common or much of an issue.

But negative externalities caused by firms onto local residents is a recurring thing. And economists consider this inefficient. And economists don’t like inefficiency.

One way to address unpaid social costs from negative externalities is through a corrective tax...the hero of all taxes. Taxes that are designed to fix negative externalities are called Pigovian taxes (some people spell it “Pigouvian”).
Pigovian taxes are designed to correct market inefficiencies. The tax will equal the measured social cost of the negative externality.

Besides the classic polluting factory Pigovian tax, Pigovian taxes can be used in other areas, like public healthcare costs. For instance, a tax on high-sugar drinks and tobacco discourages use, which in theory lowers public healthcare costs via “preventative care”...basically, drinking less liquid sugar and smoking less tobacco. But hey, YOLO.