The Social Cost of Carbon Tells a Story about Carbon Pricing Policies

By Sheldon Zakreski

The Social Cost of Carbon (SCC), which places a dollar figure on the long-term damage done by a metric ton of carbon dioxide emissions (mtCO₂) in a given year, is a phrase many folks have never heard of, yet it greatly affects both our economy and the environment. As of early 2017, the SCC has been used to justify regulations that have more than $ 1 trillion in benefits, according to Yale University economist William Nordhaus. The SCC is an important tool in federal policy because proposed environmental regulations must demonstrate that the benefits outweigh the costs.

The U.S. Environmental Protection Agency (EPA) came out with updated SCC figures this past October that are a marked departure from the past. Reducing the previous 2020 SCC estimate of $45 per mtCO₂ to roughly $3.50 per mtCO₂. The effect of such a change is that it will become more difficult to propose policies that substantially lower emissions. For example, under the prior SCC figure, the Clean Power Plan (CPP) would have generated $20 billion in benefits, but the benefit estimate under the updated figure is a significantly diminished $1.6 billion. Therefore, if the Trump Administration’s efforts to repeal the CPP are blocked by the courts, the lower SCC figure could be used to justify substantially weaker emissions reductions than those originally envisioned in the Plan.

Beyond the obvious change in administrations, the two primary factors driving the SCC figure are the scope of the damage assessment, and the discount rate. The EPA under President Obama factored in global damages from CO₂ emissions, whereas the most recent update only considers damages within U.S. borders. The rationale for including global damages is that climate change is a global problem, and that this inclusion signals to the world that the U.S. is considering the global impact of emissions originating within its borders. This is a critical message, as it gives the U.S. leverage to push for other countries to commit to greenhouse gas reductions as their emissions cause damage to the U.S.

The second factor explaining the significant drop in the SCC is the discount rate. As a measure intended to factor in the cost of damages years out from emissions occurring today, the SCC must incorporate a discount rate. The higher the discount rate the lower the value of the future benefits from reducing emissions today. The $45 in 2020 SCC figure is based on a 3 percent discount rate, while the October 2017 update uses a discount rate of 7 percent, which basically means Trump’s EPA assumes future damages from greenhouse gas emissions will be relatively inconsequential economically speaking.

The SCC is often cited as an important benchmark for carbon reduction policies, but as states fill the void left at the federal level, the following considerations might serve as a useful guide for how the SCC may, or may not, inform state carbon policies.

• The Social Cost of Carbon is subject to politics. This should seem obvious based on the above, but a cautionary tale for states linking carbon prices to the SCC is that they could see prices fluctuate widely as a result of political changes at the federal level. The current carbon price in California’s cap and trade market of $15 was a fraction of the SCC figure under Obama’s EPA, but is now a multiple of the SCC under Trump’s EPA.

• Multiple policies impose a spectrum of carbon prices. While carbon taxes and/or cap and trade are explicit carbon price policies, it’s important to recognize that states can impose a suite of complementary policies, each with different implicit carbon prices. For example, the Electric Power Research Institute estimates the carbon cost from California’s Renewable Portfolio Standard and Lower Carbon Fuel Standard amount to $277 per metric ton and $131 per metric ton respectively in 2020. Therefore, it’s important to think of the overall portfolio of policies. The portfolio approach will create a range of carbon costs, some of which may be lower than the SCC and some higher, both of which are okay.

• Think globally. As carbon policy moves to the sub-national level, the global nature of climate change can become muted. This is a mistake. In the case of the SCC, reducing the scope of damages to the nation underprices the SCC and cedes the leverage for pushing other nations to act. States that design policies that fixate on direct benefits at the state level undercut their ability to have other jurisdictions adopt carbon reduction policies. The end result is that these efforts only do so much in advancing carbon reduction goals because it leaves these States susceptible to damages from emissions from other jurisdictions.

The Social Cost of Carbon is a critical figure for establishing federal policies, as it prices the damages from climate change. The extent to which a value is placed on avoiding those damages today depends on the scope of damages (national versus global) and the discount rate one places on future damages. While it is a useful regulatory metric for policy making, applying it to carbon price policies can be challenging given the subjective nature of the SCC.

Image credit: Flickr/Bureau of Land Management

Sheldon Zakreski is the Director of Asset Management for The Climate Trust