Financial Glossary: Pigovian Tax


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Pigovian Tax

Pigovian Tax

A special Tax that is often levied on companies that pollute the environment or create excess social costs, called negative externalities, through business practices.

In a true market economy, a Pigovian Tax is the most efficient and effective way to correct negative externalities. Pigovian taxes are named after economist Arthur Pigou (1877-1959), who also developed the concept of economic externalities. A type of a Pigovian Tax is a "sin Tax", which is a special Tax on tobacco products and alcohol. A Pigovian Tax is considered one of the "traditional" means of bringing a modicum of market forces, and thus better market efficiency, to economic situations where externality problems exist.

This Tax is applicable only because market economies often fail to provide a proper incentive to reduce negative externalities. For instance, a coal-powered plant may be polluting a nearby river by disposing its harmful byproducts in the river instead of shipping the byproducts to a special facility. A sufficient Pigovian Tax would punish this firm economically when it chooses to dispose of the harmful byproducts in the river, creating an incentive to use more environmentally friendly methods of disposal.

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