A Theory of Impact Bonds as an Alternative to Pigouvian Tax and Public Provision: Application for Climate Change

Abstract

Instead of addressing externalities with taxes or subsidies, this paper proposes a process in which the government estimates the overall cost of an externality and then offers a lesser amount to the private enterprise that resolves the externality. This paper offers a theoretical framework for resolving externalities, applies this as a theory of social impact bonds, and uses private industry solutions to climate change as an example of how this process would work. Government could therefore identify the social price of public problems, offer a lesser amount to fix them, and then allow investors to organize markets around potential solutions.

Pigouvan Tax as a Support System for Economic Development of Indonesia

“…Pigouvian taxes aim to collect, from participants to the transaction, the amount of money demanded by persons not involved in the transaction to receive externalities and then compensate them for the money (Witkin, 2019). A Pigouvian intervention that is defined as equal to the marginal cost or benefit of an externality, theoretically eliminates the distortion of the externality and results in socially optimal consumption (Cawley & Ruhm, 2011).…”

“…It is important to remember that the size of a Pigouvian intervention does not reflect the costs of fixing externalities. Fixing externalities would involve finding and funding processes to reduce the social costs of negative externalities (making problem-causing market processes less harmful) or supporting the development of positive externalities (making profit-causing market processes cheaper or more effective) (Witkin, 2019). Externalities and fixes may not match perfectly -many externalities may not have a solution, and some may have several viable solutions.…”

“…Externalities and fixes may not match perfectly -many externalities may not have a solution, and some may have several viable solutions. For example, carbon capture technology is one possible solution to carbon emission externalities, but it is not the only solution (Witkin, 2019).…”

“…When the damage to the externality is less than the cost of the solution to the externality, the optimal approach is to let the externality exist with a Pigouvian intervention that redistributes funds to maximize social welfare (Witkin, 2019). Meanwhile, when the cost of the solution is less than the total cost of the externality, the optimal approach is to fund appropriate measures to improve or resolve the externality (Witkin, 2019). Determining which of the two approaches is more efficient requires a comparison of the total cost of resolving the externality to the total cost of allowing the externality to continue.…”