This article looks into Pigouvian taxes and explores how they could change the world. Pigouvian taxes are named after English economist Arthur Pigou (1877–1959) who also developed the concept of economic externalities.


In lay man’s terms, a Pigouvian tax is a government cost on activities that create socially harmful externalities. An externality is an activity that creates a negative effect on others in a society but not necessarily the person who does that activity.

A Pigouvian tax, aims to correct an undesirable or inefficient market outcome. It does this by being set equal to the social cost of the negative externalities.

For those of you who like graphs there is a very helpful graph below that shows how it achieves this.


Pigou’s recommendation was for taxes to be placed on the offending producer, proportional to the damage that they inflict. This could be applied equally well to both social and environmental problems.

Hopefully you can see where I am going with this, as there is a lot of similarity to the polluter pays principle, which I was writing about recently. You can find a link to this article below.


What you don’t want is blanket taxation that punishes people who are not responsible for negative social end economic outcomes as much as those who are responsible for them.

Pigouvian taxes are also important for their focus on making amends for the externalities that are caused, but not necessarily going any further into punishment territory. The aim of a Pigouvian tax is to cost the producer an amount equivalent to the harm they caused others.

This makes them a more politically acceptable form of taxation. After all, who could be against holding those responsible for externalities accountable for their actions?

A great example is beginning to emerge of clean air zones in urban areas, where drivers are charged for bringing the most polluting vehicles into urban areas. This has developed very quickly into an important phenomenon. But the driver behind these zones is principally poor air quality as opposed to the climate change impact of these vehicles.

An altogether different approach would be to apply Pigouvian taxation to the problem of climate change. This would come in the form of a carbon tax.

We have briefly discussed the idea for this before in my article on Elon Musk’s perspective on climate change. You can find a link to this article below.


Elon’s suggestion is for a non-partisan revenue neutral carbon tax. This would mean that only those using a high level of carbon would pay an increased level of taxation.

Carbon taxes have been implemented in the past. However, the lack of success in past schemes is more to do with the low-price set for carbon. These schemes could not be described as Pigouvian as they were not set at an equal rate to the externality of climate change.

If properly applied to the problem of climate change, Pigouvian taxation could be the missing link that drives carbon emissions down in the timeframe that we need this to happen by.

What you need to know

This article looked into Pigouvian taxation and how it could change the world.

A Pigouvian tax is a tax that is applied to a negative activity in proportion to the damage that it occurs.

If applied to the problem of climate change, it could be revolutionary in making those responsible for carbon emissions, responsible for paying for the damage done.

Thank you for reading,

By Barnaby Nash

Please share your thoughts in the comments section below, or reach out to me on social media. What do you think about the potential of Pigouvian taxes?

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I can be reached on LinkedIn and on Twitter @FollowBarnaby

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