Registered Environmental Manager (REM) Practice Exam

What is the purpose of a Pigouvian tax?

1. To increase government revenue through public services

2. To encourage consumption of public goods

3. To mitigate the effects of negative externalities

4. To subsidize environmental sustainability initiatives

The correct answer is: To mitigate the effects of negative externalities

A Pigouvian tax is specifically designed to address and mitigate the effects of negative externalities, which are costs incurred by third parties not directly involved in a transaction. For instance, when a factory emits pollutants into the air, it negatively impacts nearby residents who may suffer from health issues or decreased property values. This scenario does not reflect the true cost of production, compelling the factory to continue harmful practices without financial repercussions. By imposing a Pigouvian tax on the factory, it becomes financially accountable for the negative impact it causes, thereby incentivizing it to reduce pollution or adopt cleaner technologies. The intent behind this taxation is to adjust behavior in a way that leads to better societal outcomes, reflecting the true environmental and social costs associated with certain activities. This approach promotes more responsible behavior or alternative actions that are less harmful to society, ultimately benefitting public health and the environment.