Philip Pilkington and Warren Mosler have teamed up to present a financial innovation that they believe could settle the eurozone’s sovereign debt crisis:  a special type of “tax-backed bond” that contains a clause stating that if (and only if) the country issuing the bond defaults, the bond can be used to make tax payments in that country.  “If an investor holds an Irish government bond, for example, worth 1,000 euros,” they write, “and the Irish government misses a payment of interest or principal, the investor can simply use the bond to make tax payments to the Irish government in the amount of 1,000 euros.”

Pilkington and Mosler call attention to the fact that countries like Japan that issue their own currency are not facing unbearably heavy interest costs on their debt; with the reason being that such countries can always make payments when due.  Investors know that Japan can always create enough yen to meet its obligations.  Eurozone member-states, however, are users, not issuers of the euro, and as a result, while many countries in the periphery have debt-to-GDP ratios that are smaller than Japan’s, they nevertheless face higher and higher debt servicing costs.

The idea behind the tax-backed bond, which draws inspiration from Modern Monetary Theory, is to provide a way of securing investor confidence in peripheral debt (the bonds are guaranteed to be “money good,” since they’re acceptable for the payment of taxes in the event of default) and thereby keep interest payments under control, without requiring a eurozone exit; to provide a way of endowing peripheral debt with an aura of safety comparable to that of the debt of a currency-issuing nation—but without requiring a country like Greece to actually leave the euro and revert to the drachma.

And as Pilkington and Mosler argue, if this plan works, the bonds would never actually be used for tax payments:  “since this tax backing would set an absolute floor below which the value of the asset could not fall, and because the bonds pay a fair rate of interest, there would be no risk of actual loss and no reason to part with them—and, hence, the bonds might never be used to repay taxes.”

You can read their proposal here.