Pigovian taxes aim to internalize externalities from "summary" of Public Finance by Harvey S. Rosen
Pigovian taxes are designed to correct market failures that arise from externalities. An externality occurs when the actions of one individual affect the well-being of another individual, without compensation. For example, pollution from a factory imposes costs on nearby residents, who must breathe polluted air or drink contaminated water. Because the polluting firm does not bear these costs, it has no incentive to reduce pollution to the socially optimal level. Pigovian taxes aim to address this problem by taxing activities that generate negative externalities, such as pollution.
By levying a tax on the polluting firm equal to the cost of the external harm it causes, the government can internalize the externality. The tax increases the firm's costs,...
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