Corrective Taxation versus Liability as a Solution to the Problem of Harmful Externalities

Although the corrective tax has long been viewed by economists as a desirable remedy for the problem of harmful externalities, its actual use has been limited, mainly to the domain of pollution. Liability, in contrast, has great importance in controlling harmful externalities. I compare the tax and liability in theory and suggest that the conclusions help explain the observed predominance of liability over taxation, except in the area of pollution. The following factors are emphasized: inefficiency of incentives under taxes when the state cannot practically take into account all variables that significantly affect expected harm; efficiency of incentives under strict liability, which requires only that actual harms be measured; efficiency of incentives under the negligence rule; administrative cost advantages of liability deriving from its being applied only when harm occurs; and dilution of incentives under liability when suit is unlikely or injurers cannot pay fully for harm.