Gentlemen Prefer Bonds

Via Evan Soltas on Twitter, here is an interesting paper making the case for pollution bonds as a more socially efficient way to tax negative climate externalities than a straight carbon tax.

The regulatory scheme would require emitters to purchase bonds with a face value equal to the highest reasonable estimate of the social cost of emissions. At maturity (30 years, probably), these will pay out the difference between the bonds’ face value and the most up-to-date estimate of the costs of emissions discounted to the date of issue.

Without a resale market, this is equivalent to a Pigouvian tax stretched out across decades to account for the fact that estimates of the true costs of emissions will be better in 2043 than they are now. But if the bonds are tradable, the uncertainty can be transferred from the emitter to whomever wants to buy it. The paper notes that market mechanisms usually produce better predictions than systems based on data analysis, citing commodity futures and the Iowa Electronic Markets as two noteworthy examples.

In general I’m a fan of using prediction markets to guide policy (see everything that Robin Hanson’s ever written for more on this issue), but I’m not sure it would work in this case. The problem here is that future outcomes are “messy” in a way that’s not usually the case with election outcomes or box office receipts or any of the other categories Intrade used to let people trade. The whole point of the scheme is that we don’t know how to measure the true social costs of gas emissions—but to resolve the bonds, some regulatory body is going to have to do exactly that. This means the traders aren’t betting on the true costs at all; they’re betting on what some government muckety-mucks will declare the true costs to be.

If there’s enough time between a bond sale and maturity, traders with superior knowledge of the true costs might use it as a benchmark for the value of the bonds, but they’re counting on the regulator to catch up at some point before the bonds expire. Either way, the tax to polluters is going to be based on some government agency’s best estimate of the total social cost of emissions.

My main takeaway is that polluting should be a lot more costly than it is now, regardless of what it takes to make that happen.

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