How can a Corrective tax adjust costs to reflect externalities?
Corrective tax is a tax on the making of goods to internalize negative externalities in production or consumption.
It is mainly subjected to market activities making negative externalities.
If manufacturers pay for the damage they have made, then externalities can be internalized.
Taxes make the prices of manufacturing goods/services go high, making companies produce fewer goods since it is cheaper. This generates an externality, thus providing an incentive to deliver fewer goods/services.
price Marginal social cost
M.P.C +tax
M.P.C
Price =M.R
taxes
New output original output quantity
The above figure shows that corrective tax shifts the marginal private cost curve up, and the producers react by changing the result to the socially optimum level.
To make corrective tax the same as the value of the negative externality is not easy to do in a real sense. However, these taxes provide revenue for the government and increase efficiency.
The cost of a venture is higher than the private cost of an activity in negative externalities.
What effects will a corrective tax have on prices, output, and pollution?
Corrective tax makes prices of goods high because the manufacturer wants to make a profit and at the same time cover for the taxes imposed on his interests.
Corrective tax makes it expensive to produce goods; hence the output of goods/services is low.
If the government inputs taxes on pollution, it increases polluters’ private cost of pollution; therefore, the polluter causes lesser pollution. For example, when the government charges a high amount of money (e.g.500,000$) per ton of pollution, the manufacturers find other favorite ways to get rid of their waste; hence there is lesser pollution.
The private cost of pollution to a polluter is less than the social price.