Abstract: Although the corrective tax has long been viewed by economists as a theoretically
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 here in theory and
suggest that the conclusions help to explain the observed predominance of liability over
taxation, except in the area of pollution. The following factors are emphasized in the
analysis: inefficiency of incentives under taxes when, as would be typical, it would be
impractical for the state to incorporate into taxes all of the variables that significantly
affect expected harm; efficiency of incentives under strict liability, which requires only
that actual harms be measured; efficiency of incentives to exercise precautions 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
would be unlikely or injurers would not be able to pay fully for harms caused.