Government Intervention - What is a Pigouvian Tax?

A Pigouvian tax is a type of tax that is designed to correct for negative externalities, which are the external costs that are experienced by a third party as a result of an economic transaction. The goal of a Pigouvian tax is to internalise the externality and align the private costs of a good or service with the social costs.

A Pigouvian tax is named after economist Arthur Pigou, who developed the concept in the early 20th century.

Pigou argued that when the production or consumption of a good or service generates externalities, the market will fail to allocate resources efficiently.

To correct this market failure, Pigou proposed the use of taxes or subsidies to bring the private costs and benefits of a good or service into alignment with the social costs and benefits.

Some examples of Pigouvian taxes might include:

• A carbon tax, which is designed to internalize the negative externality of carbon emissions and encourage the use of cleaner energy sources
• A sin tax, which is designed to internalise the negative externalities of harmful or unhealthy products, such as tobacco or alcohol
• A congestion tax or charge, which is designed to internalize the negative externalities of traffic congestion and encourage the use of alternative modes of transportation