Corrective Taxation versus Liability

Since the writing of A. C. Pigou (1932), taxes have been emphasized as a means of control of activities that generate harm, especially in the domain of pollution, yet their use is in fact limited (Robert N. Stavins 2003). In contrast, liability has great importance in reducing harm. Much of the vast terrain of accidents—from oil spills, to crane mishaps, to car collisions—is subject to liability but not to taxation. I here compare corrective taxation to liability in two versions of a model, with a view toward shedding light on the difference in their application. In the first version, the danger from an injurer’s activity depends on factors that vary among injurers. For example, the probability and seriousness of an oil spill due to an oil tanker accident will depend on the strength of the tanker’s hull and the vulnerability of fishing activity and tourism to a spill; and the expected harm from a crane accident will depend on characteristics of the crane and the exposure to risk of nearby buildings and passersby. I assume that it is impractical for the tax to be based on many such variables and for simplicity that the tax is a function only of an injurer’s level of activity (amount of oil transported, number of uses of a crane). Hence, the tax will not induce injurers to choose their levels of activity optimally.