Magazine article Regulation

The Social Cost of Carbon: How Is It Derived and How Is It Used to Justify Americas Climate Policy?

Magazine article Regulation

The Social Cost of Carbon: How Is It Derived and How Is It Used to Justify Americas Climate Policy?

Article excerpt

The Social Cost of Carbon (SCC) is an estimate of the monetized damages from a marginal increase in carbon dioxide emissions in a given year. The SCC is important to the design of climate change policies intended to reduce C[O.sub.2] emissions because the marginal benefit of reducing emissions is the avoided marginal damages from emissions. Basic economic principles tell us that policies should reduce emissions until the marginal benefit equals the marginal cost. The calculation of the SCC by economists has allowed federal agencies such as the U.S. Environmental Protection Agency to conduct cost-benefit analysis of regulatory actions that reduce such emissions.

The inclusion of the SCC often changes the evaluation of many other environmental regulations from creating net costs to net benefits. For example, according to Michael Greenstone et al., the EPA estimate of the costs of its greenhouse gas (GHG) tailpipe emission regulation for light-duty gasoline-powered cars and trucks (which required increases in average miles-per-gallon fuel efficiency) was $350 billion. Without taking the SCC into account, the various benefits of the regulation--such as increased energy security from reduced oil imports, and reduced local air pollutants, noise, and congestion--totaled only $280 billion. However, once the EPA added the SCC as a quantified benefit, what would have been a net cost of $70 billion from the rule became a net benefit of $100 billion.

The SCC number that the EPA and other federal agencies now use was produced by an interagency working group (IWG) and presented first in 2010 and then revised in 2013 (and corrected in minor ways in 2015). Between 2010 and 2013, the IWG significantly raised its estimate of the SCC for 2020 C[O.SUB.2] emissions from $7, $26, or $42 per ton emitted (using discount rates of 5 percent, 3 percent and 2.5 percent, respectively) to $12, $42, or $62 per ton.

Such quantification suggests the SCC is derived by rigorous economic methods, with a solid foundation in theory and actual empirical evidence about how economic performance is affected negatively by increased atmospheric C[O.SUB.2] levels. In fact, the SCC is not such a number. Existing estimates are based not on testable (let alone tested) economic models of how changes in climate generate economic costs, but on conjecture, guesswork, and sometimes simply by asking "experts"--the people who construct SCC estimates--what they think the damages from climate change might be.

HOW THE SCC IS DERIVED

The quantitative SCC estimates used in government rulemaking come from Integrated Assessment Models (IAMs). According to William Nordhaus, the creator of the first IAM, the Dynamic Integrated Climate-Economy (DICE) model, three IAMs are the basis for "virtually all" SCC estimates. Of 27 studies producing independent estimates of the SCC over the period 1980-2012,19 were different versions of these three IAMs, while the eight others were based on one of the three. All three IAMs are structurally similar.

IAMs are computer models whose equations link changes in GHG emissions to changes in atmospheric GHG concentration and future temperatures, and then link changes in future temperatures to changes in future economic output and consumption. The relationship between GHG concentration and temperature is the key focus of climate science and will not be discussed here, although recent empirical work in climate science suggests that climate may not be nearly as sensitive to increases in atmospheric GHG concentration--with smaller expected temperature increases--than IAMs assume. Instead, I will examine the purely economic relationship between temperature and gross domestic product.

Climate damage function / In DICE and similar IAMs, future net output (and hence potential consumption) decreases as a result of damage from change in average surface temperature, as well as by amounts spent to reduce GHG emissions. …

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