A
Pigovian tax (also spelled
Pigouvian tax) is a
tax levied on any market activity that generates negative
externalities (costs not internalized in the market price). The tax is intended to correct an inefficient
market outcome, and does so by being set equal to the social cost of the negative externalities. 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. An often-cited example of such an externality is environmental pollution.