The higher cost of the polluting activity that results from the environmental tax makes the activity less
attractive to consumers and businesses. In contrast to regulations or subsidies, however, a tax leaves
consumers and businesses full flexibility to decide how to change their behaviour and reduce the harmful
activity. This allows market forces to determine the least-cost way to reduce environmental damage.
For example, many countries impose significant taxes on motor fuels like petrol and diesel because
their use contributes to global warming and local air pollution. The resulting increase in the cost of driving a
vehicle is an incentive to reduce emissions that could be achieved in a number of ways, in both the short-term
and the long-term:
Drive a smaller or otherwise more fuel-efficient vehicle.
Drive a vehicle that uses a lower-emission power source, such as a hybrid-electric vehicle.
Drive less, perhaps by greater use of low- or no-emission alternatives like public transit, cycling,
walking, living closer to the place of work, or otherwise changing habits to reduce the need to
travel.
The environmental tax provides a greater range of abatement options than instruments such as a
regulation requiring a minimum fuel efficiency level for vehicles or a subsidy that privileges electric vehicles,
which target only some solutions. Of course, if regulations are tough enough and strictly enforced, they can
have significant effects. However, this achievement may be bought at the expense of unnecessarily high costs