Blog Post

A Path Forward for the Social Cost of Carbon

May 10, 2017 | Casey J. Wichman

The social cost of carbon is a critical tool for accounting for the impacts of carbon dioxide (CO2) emissions. It measures the cost (in dollars) of the economic damages from one ton of additional emissions released into the atmosphere or, equivalently, the economic benefit of the damages avoided by not doing so. Historically, US government agencies have been required to use the social cost of carbon to assess the effect of CO2 emissions on climate change and the resulting net damages to society when analyzing rules or regulations that affect CO2 emissions.

The Trump administration’s recent Executive Order on Promoting Energy Independence and Economic Growth changes that approach. The mandate disbands the Interagency Working Group (IWG), the group of top economists and scientists within the government responsible for developing estimates of the social cost of carbon and updating them over time in accordance with changes in the underlying science and in response to public comments. Trump’s executive order also states that several of the IWG’s documents that provide estimates of the social cost of carbon are “no longer representative of governmental policy.” The order instructs regulators to follow OMB Circular A-4, an official document from 2003 that provides guidance to agencies undertaking benefit–cost analyses to support federal rules, to measure the impact of greenhouse gas emissions.

When taken in the context of the order’s additional rollbacks of other regulatory actions on climate change, the move on the social cost of carbon seems to indicate that the Trump administration is disengaging from scientific questions related to the benefits of emissions reductions. So how can experts bring the best science to bear on this issue?

In 2015, the IWG asked the National Academy of Sciences (NAS) just that: How could the methodology for estimating the social cost of carbon be updated to reflect the best available scientific and economic research? The NAS committee (co-chaired by RFF President Richard Newell and Senior Fellow Maureen Cropper) issued two reports: an interim report on the impact of CO2 emissions on global temperature change and, most recently (in January), a comprehensive report that put forth a recommended methodological framework for estimating the social cost of carbon.

To help answer that original question in light of Trump’s executive order, I’ve highlighted some implications of the NAS committee’s recommendations for future methodological updates to the measure below.

Developing a Modular Framework: First, the committee recommended an integrated framework that unbundles the IWG’s earlier methodology by “modularizing” each of the steps. Under this new approach, each step in estimating the social cost of carbon is developed as a module that reflects the state of scientific knowledge in that portion of the analysis. Each of the four modules—which individually address socioeconomics, climate modeling, damage assessments, and discounting—would be developed by experts in related areas. One reason to adopt such an approach is that the frontier of knowledge moves within different disciplines at different rates, so allowing progress to be made and implemented independently for each module ensures that the most current scientific advances—reflecting overarching criteria of scientific basis, adequate representation of uncertainty, and transparency—are brought to bear on estimates of the social cost of carbon.

For work in each of the modules outlined in the new framework, the committee additionally proposed novel analytical advances to do the following:

  1. Socioeconomics module: provide projections of per capita economic growth, using statistical analysis and expert elicitation;
  2. Climate modeling module: design analyses specifically to capture the relationships over time between CO2 emissions, atmospheric CO2 concentrations, and global mean surface temperature change and sea-level rise;
  3. Damage assessments module: incorporate the growing understanding of climate change impacts on economic outcomes; and
  4. Discounting module: establish a procedure to account for the relationship between economic growth and discount rates.

Standardizing the Process to Update the Social Cost of Carbon: Second, the committee recommended a regularized process to update the methodology, to fully incorporate peer review and public and stakeholder comments to ensure transparency. Such a process also enables regulatory certainty so that federal agencies and industry know what to expect, and when, from the regulatory process.

Accounting for the Implications of Discounting Climate Damages:Third, one technical but important detail is the way in which climate damages are discounted—that is, how costs in the future are valued today. Because CO2 emissions today continue to impact society far out into the future, the discount rate plays a critical role in the ultimate estimate of the social cost of carbon. With a higher discount rate, costs that accrue to future generations are weighted less, resulting in a lower estimate. Circular A-4 recommends that costs and benefits be discounted using the rates of 3 percent and 7 percent to reflect the opportunity cost of consumption and capital, respectively. To account for ethical considerations of future generations and potential uncertainty in the discount rate over long time horizons, Circular A-4 offers guidance to use a “lower but positive rate” for sensitivity analyses when comparing intergenerational costs and benefits (i.e., costs and benefits that our grandchildren will bear).

Although the NAS committee does not recommend a specific nominal discount rate, it is worth noting that climate change impacts are measured in terms of “consumption-equivalent” impacts, so using a 7 percent rate is inconsistent with the conceptual underpinnings in Circular A-4. Likewise, Arrow et al. (1996) suggest that the conceptually appropriate discount rate for climate impacts is one that is based on how individuals make trade-offs between current and future consumption. What the committee does recommend is that the discount rate should explicitly take into account its relationship with uncertainty in economic growth, a functional relationship driven by economic principles (see work by RFF’s Maureen Cropper for more on this). Such an explicit analytic connection is especially important when considering uncertain climate damages that are positively or negatively associated with a level of consumption. It is important to note that this discounting recommendation does not necessarily lead to a higher estimate of the social cost of carbon or a lower effective discount rate—rather, the change in the discount rate (and the resulting social cost of carbon estimate) depends on the correlation of economic growth with climate damages.

So, what does this mean for the future of the social cost of carbon—and therefore the related assessments of the effect of CO2 emissions on climate change and resulting impacts to society? With the dissolution of the IWG, one thing is clear: implementing a methodological framework for the social cost of carbon that reflects the best available science will require significant effort from the broader research community, including RFF. Stay connected with RFF for more on this important issue.

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.