Simkovic Presents Pigouvian Contracts Today At Northwestern

Michael Simkovic (USC; Google Scholar) presents Pigouvian Contracts (with Meirav Furth-Matzkin (UCLA)) at Northwestern today as part of its Advanced Topics in Taxation Colloquium hosted by Gregg Polsky:

Pigouvian taxes are often used to limit environmental externalities such as pollution. We argue that consumer contracts generate externalities by overwhelming consumers’ attention. Depleting each consumer’s attention harms consumers collectively because lower comprehension levels enable sellers to adopt less efficient and more one-sided terms. We propose to tax sellers in proportion to the costs that comprehending their contracts would impose on consumers. This would force sellers to internalize these costs and incentivize them to invest in contract simplification and forego strategic obfuscation. As a result, the costs to consumers of comprehending would decrease, and comprehension rates would rise. To further penalize inefficient contracts while reducing the tax burden on efficient contracts, we propose subsidizing consumer comprehension and information sharing efforts. Inefficient contracts would thereby be strongly disincentivized.

Conclusion
Many legal scholars, regulators, elected officials, and consumer advocates have noted consumers’ limited ability to comprehend standard form contracts. Some have suggested ways of reducing comprehension costs to consumers. However, to the best of our knowledge, we are the first to propose and formally model Pigouvian taxation of contracts and subsidization of consumer comprehension.

We propose mechanisms to estimate the comprehension costs that sellers’ contracts impose on consumers and charge these costs back to sellers. Making sellers internalize these costs would incentivize them to considerably reduce contractual length and complexity. To deviate from defaults, sellers will have to pay a quasi-Pigouvian tax that will rise in proportion to how difficult their contract is for consumers to understand.

We further propose to subsidize consumer comprehension and information-sharing. We show that the extent to which contract terms are inefficiently one-sided in favor of sellers is a function of the proportion of consumers who comprehend the contract, which depends largely on the cost of comprehension, which sellers control. Increasing consumer comprehension reduces contractual inefficiency.

A major advantage of our proposal is that it requires relatively little regulatory expertise or knowledge about the optimal length or complexity of sellers’ form contracts. Our approach permits sellers to customize their contracts while setting background conditions so that private markets will channel contractual innovations in a prosocial direction.