A Pigovian tax (also spelled Pigouvian tax) is a tax applied to a market activity that generates negative externalities. The tax is intended to correct the market outcome. In the presence of negative externalities, the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. A Pigovian tax equal to the negative externality is thought to correct the market outcome back to efficiency.
In the presence of positive externalities, i.e., public benefits from a market activity, those who receive the benefit do not pay for it and the market may under-supply the product. Similar logic suggests the creation of Pigovian subsidies to make the users pay for the extra benefit and spur more production.
Pigovian taxes are named after economist Arthur Pigou who also developed the concept of economic externalities. William Baumol was instrumental in framing Pigou's work in modern economics.
Read more about Pigovian Tax: Arthur C. Pigou's Original Argument, Working of The Pigovian Tax, Lump-sum Tax Subsidy, Double Dividend Hypothesis, Pigouvian Tax and Distortionary Taxation, Criticisms
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