OECD (2006) identified 375 environmentally related taxes in OECD countries in addition to about 250 environmentally-related fees and charges. All these change the prices that individuals face in an attempt to ‘internalize’ (i.e., properly account for) the external effects. Corrective taxes are often called Pigovian taxes since they were introduced by Pigou (1920). In a partial-equilibrium analysis, and assuming that the externality cost is known, a Pigovian tax (i.e., a correction to market prices by incorporating the value of the externality) is all that is needed to restore the optimality properties of decentralized decision-making. There is a large amount of work providing the theoretical basis for environmental taxes (Baumol, 1972; Baumol and Oates, 1971, 1988).

In practice, things are more complicated. First, it may not be administratively feasible to impose corrective (Pigovian) taxes for some goods and activities. Second, as it has been mentioned, there is the issue of ascertaining the value of the externality—an issue addressed with the shadow price. Third, once we take a general-equilibrium perspective and acknowledge that other distortions, beyond the externality that is the focus of attention, are present, then the theory of the second-best must be brought into the analysis. The theory of the Second Best (Lipsey and Lancaster, 1956) implies several counter-intuitive results relevant for corrective taxation:

- If there is a distortion in a particular sector, then it is no longer generally desirable to apply firstbest optimality conditions in the remaining sectors.

- If there are _n_ distortions, we cannot generally claim that the competitive equilibrium with _n_ - 1 distortions (i.e., when we remove one distortion) is Pareto better than the competitive equilibrium with all _n_ distortions.

Consequently, _the theory of the Second Best implies that nudging a particular price towards its social value is not always necessarily a good thing._ An example is useful to illustrate why this result holds. Railroads often enjoy a public subsidy, but removing such a subsidy will divert traffic to a typically more highly subsidized substitute: roads. The resulting increase in congestion and pollution leads to a worse social outcome. The lesson to be taken is that reflection must be made on how all the external effects work out, and what are going to be the general-equilibrium effects to the policy.

Similar considerations arise in relation to the double-dividend argument on taking into account the whole economic system. The double-dividend proponents argue that environmental taxation, in addition to the environmental dividend obtained by reducing socially damaging activities; there would be a second dividend by reducing other distortionary taxes (Oates, 1995). However, for the double dividend to exist, the taxes that substituted for the environmental tax need to be more distortionary. Thus, in the absence of environmental concerns, the tax reform would in any case be welfare improving. This second dividend is often unlikely because environmental taxes over narrow bases interacting with pre-existing distortions often lead to higher not lower welfare losses (i.e., the excess burden of taxation). Note however, even when the second dividend does not materialize, that the environmental tax still may well justified and welfare improving as long as the environmental gains overweigh the increased excess burden of the tax system. (Goulder, 1995; Parry 1995) A general-equilibrium approach is thus needed; but that does not always imply a high level of micro detail. For instance, Parry and Small (2005) consider a revenue-neutral tax reform, and they examine the 19