It is a tax levied on output producing which is alleged to generate negative externalities. Generally, we want the production of widgets to increase as long as their marginal benefits exceed the marginal costs. But the externality has a “social cost” to some group of strangers superadded onto the cost of the widget to the producer yet not taken into consideration by him. By taxing the widgets, the government reduces output and makes the marginal benefit equal to the combined marginal individual + social cost.
It’s hard to believe that economists were so easily misled by this prospect of power to optimize production. There are 3 devastating problems with Pigovian taxes.
First, one can engage in calculation of costs and benefits only within the market. The externality is by its nature external to the market. As a result, the proper amount of the tax can only be politically determined. For example, the people can only register their preferences regarding the production / pollution trade-off in their capacity as voters not as consumers. It is true that an economist can come up with some function that links pollution and production. But then the choice would be between politician A who promises to cut pollution by 10% and production by 8%; B, by 20% and 18%; and C who would practice laissez-faire. How much pollution to allow is a political decision in this sense.
Second, there are millions of existing products out there. Each product may be accused of generating some negative externalities. Yet the tax on each product for the sake of improving economic efficiency has to be unique and proper to that product: say, 10% on bacon; 12% on wine; 4% on aluminum; and so on. We can see that no politician can aggregate these values into a platform on which to run for office.
Third, no entrepreneur would be free to introduce a new product to the market, as it could conceivably turn out to be produced “inefficiently.” Any such product would have to be submitted to the government Externalities Bureau for evaluation of the correct tax to be imposed on it. Not only would an epic amount of money have to be given to this bureau to do its work, but this would effectively shut down all economic progress.
Pigovian taxes are a nonsensical attempt to recruit the government into improving economic outcomes. To the extent that there are unhappy externalities (such as on community B when residents of nearby community A dispose of their garbage by throwing it out the windows), they have to be addressed by other means.