The following article was written by Dianne Callan, a Director of the New England chapter of Environmental Entrepreneurs, who is active in clean energy and environmental advocacy in New England and at the federal level. She also collaborates with the Environmental Law Institute and the New England Clean Energy Council, focusing on clean energy and efficiency. Dianne is a founding member of Green Pro Bono, which helps environmental non-profits and social entrepreneurs define their legal needs and get pro bono legal assistance.Her earlier professional career includes 30 years of corporate law practice. Recently, Dianne and Ruth Greenspan Bell co-authored More than Meets the Eye: The Social Cost of Carbon in U.S. Climate Policy in Plain English, published by the Environmental Law Institute and the World Resources Institute. The following article is an abridged version of “More than Meets the Eye”.
Presidents since Ronald Reagan have required that significant rules issued by the federal government include a cost benefit analysis as part of the intra-governmental review process. In addition, the Obama administration (like the Bush administration before it) has required an assessment of climate regulation through the lens of a figure (or range of figures) known as the “social cost of carbon” (SCC). The SCC estimates the benefit to be achieved, expressed in monetary value, by avoiding the damage caused by each additional metric ton (tonne) of carbon dioxide (CO2) put into the atmosphere.
The impact of SCC numbers is not theoretical and has consequences for the government regulatory process and therefore for the strength of regulations on climate change that emerge from it. What Is the Social Cost of Carbon?
The SCC is an estimate of the monetized damages associated with an incremental increase in greenhouse gas emissions in a given year. Another way of saying this is that the SCC is a measure of the benefit of reducing greenhouse gas emissions now and thereby avoiding costs in the future. As a very simple example, if emissions damage coral reefs, which in turn discourages tourists from visiting Australia, one cost incurred will be lost revenue to the tourist industry. Avoiding that cost is a benefit.
When economists seek to estimate the SCC, they must find a way to estimate the physical and human damages caused by CO2 emissions and the resulting climate change. Economists do not second-guess the climate scientists. But they do pick and choose among the latter’s many estimates, making judgments about which to include in the economic modeling of damages, and funneling the climate science through their own methods of modeling the world. SCC estimates are calculated by taking—or trying to take—into consideration learning from climate science about a wide variety of factors such as net agricultural productivity loss, human health effects, and property damage from sea-level rise and changes in ecosystems. Economists fit some subset of these factors into one or more “integrated assessment models” (IAMs), to provide a single consistent framework for evaluating a total system response to rising carbon dioxide emissions, including interactions between various component parts of the various dynamic human and environmental subsystems.
Regardless of the modeling approach, a fundamental challenge to this enterprise is uncertainty. Scientists cannot definitely state that certain pollution levels will lead to particular impacts, which means that the consequences for humans could be much less or much more severe than the median estimate. For example, the loss of a forest to pine-bark-beetle infestation removes those trees from their role in sequestering carbon dioxide and purifying air, but the root system from the same forest might also have been helping to filter and clean water used by downstream human populations, or might have prevented landslides. In addition, the forest might have harbored vegetation used in medicines. The total loss in this example is not simple; a single loss (i.e., the loss of forest) might lead to multiple unexpected effects (i.e., air-quality impacts, loss of clean water, and future landslides), the nature and cost of which we are currently uncertain. Why Estimate the Social Cost of Carbon?
Broadly, the SCC informs policymakers from a cost-efficiency point of view how stringent to make regulations, by providing them with a figure that purports to estimate the monetary value of the damages caused by each additional tonne of CO2 put into the atmosphere. In the review of federal regulations involving greenhouse gas emissions, the SCC estimates the benefits side of the cost-benefit equation. From that perspective, to conserve limited resources, society as a whole should not pay any more for these restrictions than is justified by the benefits received from compliance with the regulation. Thus, regulators seek to determine whether greenhouse emission standards for cars, which might cost $10 per tonne of reduced emissions, for example, will bring about benefits from reduced emissions that are worth that cost or more.
Given the importance placed on the economic efficiency of regulatory decisions, the social cost of carbon could have a major impact upon the U.S. government’s approach toward combating climate change. How Does the SCC Influence U.S. Government Policy Decisions?
In 2009, the Obama Administration created an interagency working group (IWG) to standardize the estimate of SCC to be used across federal agencies as they conduct Regulatory Impact Analyses. Using mainstream economic modeling, the IWG panel report recommended a range of SCC values—$5, $21, $35, and $65 (in 2007 dollars)—per tonne of carbon dioxide with the intent that these values be used in individual rulemakings across government involving the regulation of CO2. $21 is the “central number” and carries the most weight in analysis.
The IWG produced a range of numbers to reflect the fact that numerous important judgments must be made to calculate the SCC for any given rulemaking. The first three values reflect the use of three different discount rates (as discussed below, the choice of discount rate is controversial; the IWG sidestepped the issue by using three); the fourth shows the cost of worst-case impacts.
The impact of the IWG’s 2009 SCC calculation on federal policy and U.S. climate actions is substantial. With an SCC estimate of $21, only rules that, when implemented, would cost less than $21 per tonne of CO2 reduced would be considered economically efficient. How Is the Social Cost of Carbon Estimated?
The basic unit of emissions for the SCC calculation is a metric ton (tonne) of CO2. U.S. residents emitted, on average, 21 tonnes of CO2 per person in 2005. Across the United States, one tonne of CO2 is emitted, on average, by:
- A family car every two and half months;
- A household’s use of heating and cooking fuel every four months (if energy use were spread equally throughout the year and throughout the country);
- A household’s use of electricity every six weeks;
- A microwave oven in typical use for seven years or a refrigerator for 15 months.
These are only a small sampling of the vast array of human activities that contribute to GHG emissions. How do the SCC Models Work?
Each modeler selects his or her own method to represent each of the relevant factors. This requires many simplifying assumptions. For example, it is common for models to simply represent global climate change as an increase in global or regional average temperature. The more accurate, but harder to implement, alternative would be to try to capture in the model every detail of expected change in the climate system, and the consequences of those changes. In other cases, modelers make a variety of assumptions about the severity of the damages from changing weather, trying to approximate details of the dynamic process whereby natural systems interact on Earth and the way carbon-cycle feedbacks have been distorted by anthropogenic GHG emissions.
Each of the models tries to capture the carbon cycle, for example, but with its own approach to distilling the particular physical phenomena into manageable bites for the model to digest.
However, important factors that all economic modelers should consistently take into account if they are to be faithful to the climate science include:
- The impacts of increased temperature from altering the balance of incoming and outgoing energy in the Earth-atmosphere system as a result of rising concentrations of greenhouse gases (“radiative forcing”)
- Possible cooling effects (for example, certain pollutants create a form of haze that reduces the warming impact of the sun although they have harmful impacts on human health)
- Regional temperature effects (since, as noted, different parts of the Earth may react in different ways)
- The possibility that changes in the climate system occur in “nonlinear” ways via feedback cycles, tipping points, and/or cascading effects that are irreversible
- Economic as well as environmental and social impacts
- The possibility of humans engaging in adaptive measures to buffer or mitigate the impacts of an increasingly hotter world, for example, engineering agriculture to survive in changed environments
In sum, the models used by the federal government to estimate the SCC apply a variety of approaches to estimate the economic harms that might be caused by climate change, with each model adopting a unique approach. These models are not always transparent, may not take into account catastrophic climate change, contain many extrapolations and assumptions, and do not factor in all aspects of climate science. Why Is the Discount Rate So Important?
A key variable in calculating the social cost of carbon is the “discount rate.” Also known as the “rate of time preference,” the discount rate reflects the challenge of capturing the time factor in climate policy.
In addressing climate change, it is an unfortunate truth that the costs of reducing greenhouse gas emissions (“mitigation”) must typically begin earlier, while the benefits—in the form of catastrophes or costs avoided—accrue many years, decades, and even centuries in the future. Economic analyses sum the costs current generations might impose on themselves to benefit future generations in the form of a discount rate. The IWG selected discount rates of 2.5 to 5% a year.
In the calculation of costs, benefits, and the SCC, the choice of discount rate has enormous impact, influencing whether economists recommend investing today or much later. From the policy perspective of the economists who value this calculation, the higher the discount rate, the less significant future costs become. The choice of discount rate for investments in managing greenhouse gas emissions, following publication of the Stern Review, ignited intense debates in the economics profession. Stern used a low discount rate, approximately 1.4%. By contrast, William Nordhaus, a professor at Yale University, currently uses a discount rate of about 3% in calculating SCC. Three percent values an environmental cost or benefit occurring 25 years in the future at about half as much as the same benefit today.
Economists wrestling with these issues admit that many of the elements that either are or ought to be considered to rank the desirability of action against climate change, and at what level, require “normative” judgments; one example is how we weigh the welfare of future generations compared to our own. But many of these value judgments are deeply engrained in the approach neoclassic economics takes to analysis. Decision makers outside the profession, and indeed the public, if they entered the debate, might make different assumptions about the present generation’s responsibility to future generations and their assumed relative wealth. What may make this conversation particularly confusing to people who don’t work with these tools on a daily basis is that the analysis results in a mathematical “answer” comparing benefits and costs, potentially masking the large number of judgments made in the estimation process. It is vital that the SCC be understood with these significant limitations and caveats in mind. What Roles Should SCC and/or Cost-Benefit Analysis Play in Assessing Climate Policy Options?
The discussion above identifies important caveats about various factors employed in IAMs to estimate the SCC. In addition, a deeper general critique is surfacing of the very use of these models in the context of assessing and making climate-change policy.
For example, Harvard economics professor Martin Weitzman has systematically called into question the adequacy of cost-benefit analysis, including its component, SCC, as a tool to examine climate-policy alternatives. His initial work focused on the so-called “fat tail.” In climate science, the fat tail is the right edge of a distribution of, for example, potential temperature variations caused by climate change. Economists often cut off both extreme sides of the curve (5% on each side) for convenience of analysis. But Weitzman says the fat tail is where they should be looking carefully, because it expresses the probability of extreme events.
How these models assess future damages and harms that might occur from climate change is a major issue. Climate scientists research the damage that increasing temperatures and their consequences are imposing on all facets of nature, a uniquely complex undertaking. The economic models essentially selectively filter the climate science, and translate it into numerical representations. There is ongoing debate among economists and climate scientists concerning how the SCC models handle the complexities and uncertainties of climate science, including:
- Which parts of climate science to factor into the model and at what level of severity
- Whether to use a discount rate and what rate to use
- How to account for potentially “catastrophic” climatic events
- How to identify and monetize potential consequences of climate change such as loss of species, mass migrations, spread of disease, and agricultural disruptions and shifts
Perhaps the most important and debated judgment made by modelers is the selection of the discount rate. The IWG selected discount rates of 2.5 to 5% a year. At 3%, a damage that is valued today at $100 in damages shrinks to as little as $5 in a century, suggesting those costs will be less onerous to people in 100 years, and discouraging current regulatory action.
It is a seductive idea that SCC and cost-benefit analysis produce precise numbers backed by hard science. In truth, no single value should be accepted by policymakers unless all the assumptions and choices that underpin the calculation are transparent and well understood. Otherwise the regulatory process risks being held hostage to choices made by unelected experts, rather than grappling with the inherently political and ethical questions posed by climate-change policy.
Please see More than Meets the Eye: The Social Cost of Carbon in U.S. Climate Policy in Plain English
, by Ruth Bell Greenspan and Dianne Callan, July 2011, for the complete publication, including citations.
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