A Pigovian tax is a tax levied on goods or services that generate negative externalities, which are costs that affect society as a whole but are not reflected in the market price of the good or service. The purpose of a Pigovian tax is to discourage consumption of goods or services that create negative externalities and to internalize those costs into the market price.
For example, consider a factory that emits pollution into the air. The pollution has negative effects on the environment and public health, but those costs are not reflected in the price of the goods produced by the factory. A Pigovian tax would impose a tax on the factory’s emissions, increasing the cost of production and reducing the quantity of pollution emitted.
In this way, a Pigovian tax can help align the private costs and benefits of a good or service with its social costs and benefits, leading to more efficient and sustainable outcomes.