Tuesday, 27 March 2012

Pigouvian Tax

Pigovian tax (also spelled Pigouvian tax) is a tax levied on 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 tends to 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.1

The 'Fat Tax' introduced in Denmark, in 2011, is an example of a Pigouvian taxation. Denmark has imposed a 'fat tax' on foods such as butter and oil to curb unhealthy eating habits. It is believed to be the first in the world to tax fatty foods.

In economics, an externality, or transaction spillover, is a cost or benefit not transmitted through prices [1] that is incurred by a party who did not agree to the action causing the cost or benefit. The cost of an externality is a negative externality, or external cost, while the benefit of an externality is a positive externality, or external benefit.2

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