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It states on Wikipedia:

A Pigovian tax (also called Pigouvian tax, after economist Arthur C. Pigou) is a tax imposed that is equal in value to the negative externality. The result is that the market outcome would be reduced to the efficient amount. A side effect is that revenue is raised for the government, reducing the amount of distortionary taxes that the government must impose elsewhere. Governments justify the use of Pigovian taxes saying that these taxes help the market reach an efficient outcome because this tax bridges the gap between marginal social costs and marginal private costs.

Q: When it says, "A side effect is that revenue is raised for the government, reducing the amount of distortionary taxes that the government must impose elsewhere", what does that even mean?

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2 Answers 2

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The Pigovian taxes are non-distortionary. For example imagine situation where government optimal spending is 100e and before Pigovian tax all 100e was raised through income tax which creates distortions on Labour market. Let’s say that after imposing Pigovian tax government gets additional 30e. Now since government needs only 100e for its optimal spending it can either choose to run 30e surplus or choose to reduce the distortionary income tax by 30e. The Wikipedia sentence refers to this second option where government chooses to reduce some other distortionary tax thanks to the revenue from Pigovian tax.

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    $\begingroup$ +1 for completeness let me just mention that this feature is called the double dividend hypothesis and that whether or not it actually occurs is debatable (at least in a general equilibrium framework) $\endgroup$ Jan 22, 2020 at 15:26
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    $\begingroup$ Whether or not it actually occurs is more of a policy decision than a debate. See, e.g., nber.org/papers/w6199 $\endgroup$
    – heh
    Jan 22, 2020 at 16:09
  • $\begingroup$ Yes these are all good points +1 to both of your comments $\endgroup$
    – 1muflon1
    Jan 22, 2020 at 16:20
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Pigouvian taxes correct an externality. Non-Pigouvian taxes cause market distortions that cause deadweight losses - inefficiencies that reduce the number of profitable trades that can take place in the market. Externalities also cause these kinds of deadweight losses, however a Pigouvian tax can correct for the externality and reduce or eliminate those deadweight losses.

People often say (as 1muflon1 did in his answer) that "Pigouvian taxes are non-distortionary". This is not the case. What is going on is that Pigouvian taxes distort the market in the opposite direction to an externality that's causing an existing market distortion.

The phrase talking about reducing distortionary taxes is kind of an irrelevant aside that says more about the writer's biases than anything about Pigouvian taxes. Pigouvian taxes are good because they correct the externality and reduce the associated deadweight losses. Most taxes are not good by comparison because they cause deadweight losses. All that phrase is saying is that lowering non-Pigouvian taxes also reduces deadweight losses.

I write in more depth about Pigouvian taxes here.

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