Law & Economics Working Papers
The harm that each individual causes others is unverifiable in some circumstances where the total harm caused by everyone is verifiable. For example, the environmental agency can often measure the total harm caused by pollution much easier than it can measure the harm caused by each individual polluter. In these circumstances, implementing the usual liability rules or externality taxes is impossible. We propose a novel solution: Hold each participant in the activity responsible for all of the excessive harm that everyone causes. By "excessive harm" we mean the difference between the total harm caused by all injurers and the optimal total harm. We call this rule "total liability for excessive harm." We show that total liability for excessive harm creates incentives for efficient precaution and activity level. Consequently, actual harm is not excessive and actual liability is nil. For example, the environmental agency can set a target for clean air and announce that each factory is liable for pollution by all factories that exceeds the target. Since the liability rule causes the factories to hit the target, they pay no damages. Thus the environmental agency gains control over emissions without having to monitor individual polluters, and the polluters do not have to pay damages or conform to bureaucratic regulations.
Robert D. Cooter & Ariel Porat, "Total Liability for Excessive Harm" (John M. Olin Program in Law and Economics Working Paper No. 266, 2005).