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

Many economics texts cover the economics of controlling negative production externalities. Most authors introduce their analysis by examining a tax on the output of polluting firms, sometimes called a "simple Pigovian tax." They then often point out that taxing pollution directly is more efficient than taxing output and proceed to discuss an emission fee as an alternative. But they do not show how and why an emission fee is more efficient than an output tax. This note presents a simple numerical example that allows straightforward comparison of the welfare effects of the two approaches. It also allows students to see easily why a government policy of ordering firms to reduce the pollution intensity of their output would be less efficient than the emission fee