Negative Externalities

• Negative externalities are social costs created by the consumption of a good. For example, smoking cigarettes causes health dangers to others due to second-hand smoke. Driving a car creates emissions, which harms the environment.
  
  

Function

• Corrective taxes are designed to decrease consumption of a good to its socially optimum level. The amount of the tax should therefore equal the cost of the negative externality. For example, if each pack of cigarettes smoked costs society $10, the cigarette tax should measure $10 per pack.
  
  

Examples

• Tobacco and alcohol taxes represent common corrective taxes. Corrective taxes have also been applied to soda and activities that cause pollution.
  
  

Considerations

• If corrective taxes are too high, black market activity or smuggling may result and counteract attempts at mitigating the negative externalities.