Abstract:Taxation and liability are compared here as means of controlling harmful
externalities. It is emphasized that liability has an advantage over taxation: inefficiency
of incentives arises under taxation when, as would be typical, it would be impractical for
a tax to reflect all variables that significantly affect expected harm, whereas efficiency of
incentives under liability does not require the state to determine expected harm – it
requires only that injurers pay for harm that occurs. However, taxation enjoys an
advantage over liability: incentives under liability are diluted to the degree that injurers
might escape suit. The optimal joint use of taxation and liability is also examined, and it
is shown that liability should be employed fully because liability creates more efficient
incentives than taxation; a tax should be used only to take up the slack due to the
possibility that suit for harm would not be brought.