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Societies implement corrective taxes to address negative externalities. Externalities represent the effect of an individual's decision on society as a whole. Some activities, like immunizations and technology research, have a positive externality because they benefit society as much as or more than they benefit the individual. In contrast, negative externalities are activities that have a harmful impact on society. Cigarettes, alcohol, pollution and auto exhaust are all examples of negative externalities.
Corrective Taxes as a Solution
Negative externalities occur because the cost of the activity to the individual isn't as large as the cost to society. In 1920, English economist Arthur Cecil Pigou introduced the concept of corrective taxes to address this issue by charging the offending individuals or businesses for undesirable activity. For example, say that a company pollutes a river because it is less costly than finding an environmentally friendly solution. The government could enact a pollution tax to increase the company's cost to pollute, incentivizing the company to find a better solution.
Corrective Taxes in Society
The most widespread corrective taxes in the U.S. are on cigarettes and alcohol. These corrective taxes come in a variety of forms and at a
variety of rates depending on state and local regulations. For example, businesses in Minnesota that don't pay state taxes aren't allowed to sell liquor. In New York City, citizens pay both a state excise tax and a city tax on beer and liquor above 24 percent alcohol by volume. The federal government currently levies a cigarette tax of $1.01 per pack.
Alternatives to Corrective Taxes
Not everyone is sold on the concept of a corrective tax. It's difficult for economists to accurately measure the cost of an externality, so it's equally difficult to ensure a corrective tax is set at an ideal rate. If the rate is too low, it won't be enough incentive to stop the behavior. If the rate is too high, it may cause too much underproduction. For example, too high of a tax on fast-food could cause restaurants to stop selling fast food completely, which would raise the price of similar food products or drastically reduce options for consumers. In addition, harsh sin taxes on practices like pollution aren't as effective when a company can easily leave the country and produce offshore. Alternatives to corrective taxes include corrective subsidies, government industrial policies, or simply banning detrimental products and practices.