Fireworks, Pigou, and You

Did you know many states include a sales tax on fireworks as a “Pigouvian tax.”? Pigouvian taxes are placed on businesses or private individuals who engage in activities that lead to adverse effects in society, such as environmental pollution, strains on public healthcare through the sale of goods and activity deemed to negatively impact society. 

An article from The Tax Foundation explains why: “Wildfires can spread rapidly across property and even state lines, and can begin with just a few sparks. Therefore, it is no surprise that many states dedicate funds from fireworks taxes and license fees towards firefighting and fireman training. This is a textbook example of what is called a “Pigouvian tax.” Named after the English economist Arthur Pigou who first articulated the idea, Pigouvian taxes are intended to raise the cost of goods that damage third parties when they are consumed. Revenues from Pigouvian taxes are then used to compensate the people who were damaged.”

Pigouvian taxes play a vital part in society today. Another popular Pigovian tax is the rising carbon emissions tax. A carbon emissions tax is imposed by governments on any company that burns fossil fuels. When burned, fossil fuels emit one of the main causes of global warming, greenhouse gases. This tax aims to factor in the cost of burning fossil fuels and the societal effect. What is the end goal? To ensure that producers of carbon products are the ones incurring cost and maximizing economic efficiency. 

There are also other sales tax considerations for business owners selling fireworks, including outright bans, extra insurance, high annual permit and licensing fees, and other regulatory barriers, as well as “distribution licensing fees ranging from minimal costs to cover necessary paperwork to up to $5,000 a year in some cases.” 

When calculating the proper tax rate, governments use a Pigouvian Tax Formula to determine the precise amount of externality cost imposed by the producer, as well as the correct price for the specific market. If lawmakers overestimate the external costs involved, Pigovian taxes cause more harm than good.

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