Accurately Estimating the Social Cost of Carbon

Apologies for getting into a more academic mode today, but I feel that this issue is one that needs a good deal of research to fully address it, especially considering the recent changes that the Obama Administration made to the U.S.'s "official" social cost of carbon.

Carbon dioxide (CO2) is a greenhouse gas (GHG) that is emitted as a side effect of burning various fossil fuels. It is the primary cause of global climate change, and yet its impacts on mankind differ because of the different locations humans inhabit, and the discrepancies in wealth and socioeconomic status that various countries possess. These conditions make estimating the social cost of carbon quite difficult, but an accurate assessment of carbon’s costs to mankind is essential to raise awareness of and spur action on climate change.

The social cost of carbon (SCC) is defined, broadly speaking, as the damage each ton of carbon emitted into the atmosphere causes to mankind. The SCC is what agencies such as the Environmental Protection Agency (EPA) and Department of Energy (DOE) use when crafting regulations: as the SCC rises, the regulations promulgated by these agencies become stricter, and vice versa. This makes estimating the SCC of vital importance to the preservation of the environment and the economy. If the SCC is underestimated, countries will not take sufficient steps to reduce their emissions, and further damage to the environment, and eventually countries’ economies, will result. However, if the SCC is overestimated, the regulations put into place will be onerous and a drag on current and future economic growth. Therefore, getting the price of the SCC right is essential for harmonizing the relationship between economic growth and the environment.

Because of its importance to both environmental and economic conditions, several governments, academics, and advocacy organizations have studied the social costs of carbon and come up with what they believe to be accurate estimates for that number. In 2010, the United States had a SCC of $22/ton, assuming a discount rate of 3%. However, in May 2013, the Obama Administration updated the SCC to a price of approximately $35/ton, citing changes in sea level rise projections, as well as agricultural impacts, among other things. Other studies looking at the social costs of carbon have an average of $43/ton, but also reveal a large spread in the data, with a standard deviation of $83/ton. This spread occurs in reality as well: while Norway plans to double its carbon tax (which is a reflection of the SCC) to $70/ton this year, the EU’s cap-and-trade system currently only prices carbon at $6.50/ton.

Difficulties When Accurately Pricing the SCC

 Uncertainty of future climate impacts causes spreads in CCS price estimates.

The aforementioned large spread in SCC prices primarily reflects the uncertainty in what impacts climate change will have on the globe, and for specific countries and regions. One of the hardest things for climate change scientists to predict is the specific impacts increasing CO2 levels will have on the environment. While scientists can make generalizations about what impacts are more likely to occur in a GHG-intensive world, translating those impacts into specific monetary figures is a daunting task.  For example, agriculture in many regions around the Mediterranean Sea may suffer in a warmer world because of shifts in precipitation patterns and timing, but farmers at higher latitudes may enjoy longer growing seasons, increasing their productivity. This uncertainty means that, consequently, SCC prices vary greatly.

 SCC calculations do not take all variables into account.

While many SCC studies do their best to include as many variables in their calculations as is feasible, certain environmental aspects are left out of the equation because of their incalculable nature. For example, biodiversity is a valuable part of our environment; understanding the makeup and interaction of different species has resulted in many notable medical advances such as the development of gene mapping and cell division, among other things. However, biodiversity by itself carries no explicit monetary value in equations. As a result, it is not included in SCC equations. This means that the SCC price may end up being undervalued.  Many other environmental assets are also not included in SCC equations for the same reasons, so the full costs to the environment are not captured by current SCC prices.

 Model biases and incompleteness may skew results.

One more factor that leads to inconsistent SCC prices is the use of the models themselves. Three main models are used to calculate SCC prices: the FUND, PAGE,and DICE models. These models are almost always used to calculate the SCC, while other models that are available are discarded in the process. The data sets used by these models are developed by the same authors, and are not usually questioned. Additionally, the models do not account for variation in local effects, choosing instead to make uniform assumptions, and also ignore potential high-impact climate effects, like the melting of the Greenland ice cap. These conditions limit the potential for really understanding the full scope of carbon impacts, as well as SCC price ranges. Some of these changes may result in an order-of-magnitude difference in a carbon cost, which means ignoring them could have serious ramifications for both the environment and the economy in the future.

Recommendations

 Provide an open comment period when SCC models are updated.

One of the major issues with models exploring SCC prices is that the models themselves are subject to the inherent biases of the researchers developing and modifying them. Including an open comment period when the models are updated can ensure that outside concerns about model assumptions or specific operating parameters are taken into account. This will help to make sure that different ideas about SCC factors are heard and understood by the researchers updating the models, and help the models more accurately identify the correct SCC price.

 Use a declining discount rate for projections of SCC prices over 25 years into the future.

One of the main issues with SCC price projections is that discount rates (which are used to help determine whether it is preferable to fund a project with public money, or to let the private sector handle it) can substantially reduce the damage estimates from climate change in the future. Including a declining discount rate can help to offset the impacts of discounting across generational timespans. While France and the United Kingdom already use a declining discount rate, the U.S. Office of Management and Budget instead recommends using a flat discount rate. Having a flat rate means that even discount rates of 3% create damages in the future that are quite minimal compared to climate change projections. Reducing the discount rate to 1% over time will account for future damages due to climate change more accurately and paint a more realistic picture of climate change’s intergenerational impacts. Because one generation is approximately 25 years, declining the discount rate to 1% after that time in the future can help to measure intergenerational impacts of carbon with more clarity.

Include climate change “tipping points” in model calculations.

One of the major concerns of climate change scientists today is the possibility of a climate “tipping point,” where changing temperatures cause rapid and unexpected shifts in the climate that could be catastrophic for the global economy. These events have a relatively small chance of happening, but their costs are extremely high, so much so that including them in SCC models will change the output prices. Including these events will help models to capture the full scope of potential effects from future climate change and produce a more accurate cost of carbon in the process.

While the social cost of carbon is difficult to estimate and project because of the complexity of climate change, it is nonetheless a very necessary and important part of climate economics. Getting the price of carbon right will help policymakers to assess and develop policies to mitigate climate change’s effects while providing for economic growth. Because many of the problems with calculating the SCC lie with the models used to calculate the value, modifying those models to more fully include the effects of climate change will be instrumental in getting the “correct” SCC price. Changing the discount rate will also better account for the intergenerational effects. Hopefully, if the SCC price is closer to the “actual” price observed in reality, it will provide policymakers with better information so that they will be able to make the necessary changes to mitigate climate change and adapt the global economy to its effects.