What is a Pigouvian Tax?

Definition: A Pigouvian tax is an additional tax obligation imposed to certain activities that produce a negative external impact on society. Simply put, it is a special tariff charged at business activities that have a harmful impact that is not being fully acknowledged by them.

What Does Pigouvian Tax Mean?

This concept was introduced by the economist Arthur Pigou, in his book “The economics of Welfare”. The main purpose of this tax is to compensate the consequences that some business activities have on society. By charging an additional tax to these endeavors the State establishes a balance for the cost of these externalities. This concept is wide enough to include any external consequence that the company is not fully compensating by itself even if they are not “dangerous” per se.

These charges often push companies to develop more social-conscious ways to manufacture their goods or, in some cases, to promote marketing campaigns that increase society’s awareness of the previously mentioned “harmful” consequences of their activities. Nonetheless, there are some negative effects that come from imposing these charges to companies. For example, business activities of these sectors are sometimes crucial to society and these taxes might dissuade new ventures because of unsustainable profit margins or low return on investments.

Here’s an example.

Example

All Glue Co. is a company that produces different types of glues for retail consumers. The company has a small factory but given the type of raw material that the company handles there’s a lot of heavy-weight transport coming in and out of the factory. The company is located at a industrial zone and the constant traffic seems to be damaging the roads. How can a Pigouvian Tax help the municipality to reduce the social impact of this situation?

As we previously defined, a Pigouvian tax is an additional tariff imposed to certain activities that produce a negative external impact on society. By imposing let’s say a $400 a month special fee for road’s maintenance the municipality can reduce the overall impact of this external consequence produced by the regular business operations of All Glue Co.