A way to resolve intergenerational conflict over the environment under the Pareto criterion using green bonds

Any policy designed to combat climate change will likely create intergenerational winners and losers because the associated costs appear up-front while the benefits come downstream. In such cases, cost benefit analysis seeks potential Pareto-improvements in the Kaldor–Hicks sense, the hypothetical potential for the winners to compensate the losers. Of course, once the policy is indeed implemented and has unleashed distortions and general-equilibrium effects, such potential improvements may not lead to actual improvements. We ask, which policies, once implemented, would pass the Pareto test that no generation subsequent to policy action be made worse off than before. We study a “business as usual” (BAU) overlapping-generations economy in which pollution is a by-product of productive activity by the current generation but “damages” production for future generations. Over time, the BAU economy gets increasingly polluted, consumption falls, and generational welfare levels decline. A government introduces costly pollution abatement and finances it via distorting taxes and the sale of green bonds. Pollution levels start to decline, generating downstream welfare gains. Some of these gains are taxed – without hurting anyone, in a Pareto sense – to help pay off the debt. Along the transition, every generation faces less pollution, consumes more and is happier than if life had continued in the BAU world.