Simple Pigovian Taxes vs. Emission Fees to Control Negative Externalities: A Pedagogical Note

Many economics texts introduce their analysis of negative externalities by examining a tax on the output of polluting firms, sometimes called a "simple Pigovian tax," often pointing out that taxing pollution directly is superior to taxing output and proceeding to discuss an emission tee as an alternative. They do not show how and why an emission fee is more efficient than an output tax. This note presents a numerical example allowing comparison of the welfare effects of the two approaches, as well as showing why simply reducing the pollution intensity of polluters' output would be inferior to an emission fee.