Pigovian

Pigovian refers to the economic ideas associated with Arthur Cecil Pigou (1877–1959), a British economist who formalized the concept of externalities and policy tools to address them. Externalities occur when a person’s or firm’s actions affect others who are not party to the market transaction. Pigou argued that markets may fail to achieve social efficiency when external costs or benefits are not reflected in prices.

Central to Pigovian economics is the Pigouvian tax or subsidy. A Pigouvian tax is a per-unit tax equal to the marginal external cost of the activity, intended to align private incentives with social costs and move output toward the social optimum. Conversely, a Pigouvian subsidy rewards activities that generate positive externalities. The approach relies on government intervention to correct market failures rather than leaving private bargaining alone.

Examples include pollution taxes and carbon taxes; taxes on cigarette smoking may internalize health costs; subsidies for education, vaccination, or research with positive spillovers. The idea contrasts with the Coase theorem, which holds that private bargaining could solve externalities given low transaction costs; Pigou emphasized corrective taxes when bargaining is costly or incomplete.

Critics note difficulties in estimating the marginal external cost, administrative costs, spillover dynamics, and potential deadweight losses from tax design. In practice, Pigovian taxes aim to set a tax equal to the marginal external damage at the socially optimal output, but determining that level is challenging and often contested. Still, the concept underpins a large class of environmental and public health policies.