Explain how a pollution tax is different from a Pigouvian tax. Discuss how incentives for firms differ under the two types of taxes, and what would be required of the government if it were to structure a Pigouvian tax system to mimic the effects of a pollution tax.

Question

What will be an ideal response?

Answer 1

A pollution tax imposes a tax on each unit of pollution that is emitted as a firm produces. A Pigouvian tax is a per-unit tax on the good that is being produced. In a particular market, a pollution tax can be set to result in the same decrease in output as an efficient Pigouvian tax -- but the pollution tax gives an incentive for firms to implement pollution abating technologies in production, whereas the Pigouvian tax gives no such incentive unless the government keeps re-setting the Pigouvian tax each time a firm implements pollution abating technologies.