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Climate Change Hero

Climate Change Blog

  • 13
  • February
  • 2015

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Using the Social Cost of Carbon to Measure the Impact of Federal Actions

As discussed in a  previous post, the Council on Environmental Quality (CEQ) recently released new  Draft Guidance on Considering Climate Change in NEPA Reviews. The guidance suggested that the social cost of carbon (SCC) could play a role in assessing a project’s Greenhouse Gas (GHG) emissions in a NEPA cost-benefit analysis. This post explains the federal government’s current use of SCC, and identifies some potential issues with its application.

What is the social cost of carbon? 

Since the 1990s, environmental economists have been trying to develop a way to quantify the impact of GHG emissions in present economic terms. The SCC has emerged as a potential tool for doing just that. Competing SCC models attempt to quantify the incremental climate impact that the modelers think will result from a unit of carbon dioxide (CO2) emissions so that an economic value can be assigned to the emissions. The value is then used as a point of comparison for actions action that reduce CO2 emissions. A number of competing models exist, each of which makes different predictions about future interactions between human behavior and the climate. These models tend to include predictions regarding changes in net agricultural productivity, human health, property damages from increased flood risk, and the value of ecosystem services due to climate change. The models attempt to calculate impacts over the next several hundred years, and then to apply a discount rate in order to determine what the future impact means in current economic terms. 

In 1993, President Clinton issued  Executive Order 12866, which requires federal agencies, to the extent permitted by law, “to assess both the costs and the benefits of the intended regulation and, recognizing that some costs and benefits are difficult to quantify, propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs.” By 2008, federal agencies had begun using SCC as part of their cost-benefit analysis. Originally, these agencies relied on differing models and estimates to assess SCC. These estimates ranged anywhere from approximately $0-150/ton CO2. In 2010, the Interagency Working Group (IWG) released a  report which created a uniform SCC value for federal agencies to use. The stated purpose of the SCC value was to “incorporate the social benefits from reducing carbon dioxide emissions into cost-benefit analyses of regulatory actions that have small, or ‘marginal,’ impacts on cumulative global emissions.” 

The report included four different values for SCC. These values resulted from IWG’s attempt to aggregate three different models, known as DICE, FUND, and PAGE. The first three values in the report differ based on whether a 2.5, 3, or 5 percent discount rate was used in the calculation. A discount rate is used to determine net present value of future benefits and costs. As the Office of Management and Budget (OMB) has explained, “this discounting reflects the time value of money. Benefits and costs are worth more if they are experienced sooner.” The idea of discounting is based in economics: we assume that people put more value on a benefit they receive today, than an identical benefit that they will not receive until the distant future.  Guidance from OMB instructs agencies to discount “[a]ll future benefits and costs, including nonmonetized benefits and costs.” The fourth value in the IWG report “represents the 95th percentile SCC estimate across all three models at a 3 percent discount rate, is included to represent higher-than-expected impacts from temperature change further out in the tails of the SCC distribution.” In 2010, these calculations resulted in SCC estimates of $7, $26, $42 and $81/ton CO2 (in 2007 dollars) for 2020. The IWG reached these figures by amalgamating the results of three different SCC models, each of which includes different assumptions and damage calculations. 

The IWG revised its  report in 2013, increasing the SCC estimates for 2020 to $12, $43, $65, and $129/ton CO2 (in 2007 dollars). For practical purposes, this means federal agencies are valuing the SCC at about  $37/ton CO2 for 2015, which is based on a 3 percent discount rate. According to a recent  GAO report, these 2013 figures raised public interest because they were approximately 50 percent higher than the 2010 estimates. The new report also has sparked a debate about the use of SCC values to analyze the effects of regulatory action. Unsurprisingly, critics on both sides have argued that the current IWG values are either too high or too low to accurately reflect GHG impacts. 

Limitations in current SCC estimates

The possible problems with incorporating SCC into a cost-benefit analysis of federal actions include: 

Should the analysis use a global or domestic value? 

The SCC values can be calculated based on global or domestic impacts. Global impacts result in a much larger cost per unit of GHG. For example, the Department of Transportation (DOT) was simultaneously using both a domestic SCC value of $2/ton CO2 and a global SCC value of $33/ton CO2 for 2007 emission reductions. Under the current IWG approach, federal agencies are using a global value. Those supporting the use of a global value argue that the global value better captures the total costs of emissions. As EPA has  explained, GHGs do not remain locally concentrated; instead they disperse uniformly into the atmosphere. The domestic SCC value, on the other hand, has the benefit of being more readily used in a cost-benefit analysis of a particular action, because the other costs and benefits of an agency action are often more limited in geographic scope.

What discount rate should apply?

The Office of Budget Management (OBM) has  concluded that agencies should provide estimates of net benefits using both 3 percent and 7 percent discount rates for regulatory analysis, with 7 percent as the default position. By contrast, the IWG used smaller discount rates of 2.5, 3, and 5 to reach its SCC figures. This appears to fly in the face of OBM’s guidance. As OBM has explained, “[t]he further in the future the benefits and costs are expected to occur, the more they should be discounted.” Because the SCC is trying to quantify impacts over such a vast time period, even a small change in the discount rate can have a large impact on the present value of GHG emissions. According to estimates in a recent presentation by the American Enterprise Institute, at a 7 percent discount rate the SCC becomes small or even negative. 

Are the SCC models adequately capturing all of the possible costs?

Environmental groups like the NRDC  argue that the current models underestimate the full costs of the ecosystem damage that could result from GHG emissions. Critics like the NRDC argue that the models give preference to damages which are easy to quantify, but leave out many “intangible” harms to the environment, such as an alleged loss of biodiversity.

Can multiple models be fairly aggregated into a single SCC value?

The IWG’s SCC values are the result of aggregating three different models that all rely on very different assumptions about the future. The Electric Power Research Institute (EPRI)  reports that fundamental differences in modeling make it hard to compare and aggregate these three approaches. EPRI concluded that the IWG’s SCC estimates “are difficult to interpret, discuss, and evaluate in terms of the societal risks they do and do not represent, and how well they reflect current scientific knowledge, because little is known about the disaggregated modeling.” 

The SCC provides an analytical framework to consider the costs and benefits of regulatory actions that impact GHG emissions. As these various criticisms of the IWG’s SCC values suggest, however, we may not yet have an accurate way to assess those impacts in present economic terms.

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