pigovian tax definition and example
A Pigovian tax (also spelled Pigouvian tax) is a tax levied on any market activity that generates negative externalities (costs not internalized in the market price). The tax is intended to correct an inefficient market outcome, and does so by being set equal to the social cost of the negative externalities. 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. An often-cited example of such an externality is environmental pollution.
Pollution is often cited as a practical example of the potential of Pigovian taxation. Suppose a steel mill were located in a particular town. During steel production, air and water become heavily polluted, the biodiversity around the mill decreases, and a formerly rural town is impacted by sudden industrialization.