The U.S. Department of Energy’s official estimate of the “Social Cost of Carbon” (SCC) is $21/ton of CO2, which amounts t0 $0.21/gallon of gasoline. That’s the weighting factor (set by DOE rule) used to decide how much importance to give to the future damage from global warming in a panoply of decisions both inside and outside government. The SCC can be viewed as an estimate of the “true” cost of fossil fuels — the cost of doing nothing about global warming. In economic theory it’s the “optimal” Pigouvian carbon price or tax — it would tell us how much effort to make to reduce our CO2 emissions to minimize economic harm from global warming. But if the SCC estimate is too small, we won’t do enough to avert disaster; if it’s too large we’ll over-react. Setting the SCC is a bit like deciding how much to spend on fire insurance– except that in this instance, we know that if we do nothing, there’s a “fire” coming, we just don’t have a good handle on how bad it will be or when it will get really bad. According to “Revising the Social Cost of Carbon,” by economists Frank Ackerman and Elizabeth Stanton (E3 Network), the government’s SCC estimate is far too low because of three crucial assumptions:
1) Climate Sensitivity. How warm will Earth’s climate get if we double CO2 levels from the historic 270 ppm to 540 ppm? The working consensus among climate scientists is that CS is about 3 degrees Celsius (5 degrees Fahrenheit). But four years ago, the IPCC concluded that there’s at least a 5% chance that CS is 7 degrees C. For a sense of that magnitude, the difference between our climate and that of the last ice age (when North America was covered by glaciers) was about 8 degrees C. Recent data and weather events suggest that CS will need to be revised upward– scientists have almost certainly overlooked some important feedback mechanisms that will make the Earth get hotter as CO2 levels rise.
2) Severity of Damage from global warming. How much harm will a given amount of warming cause and how soon? Ackerman and Stanton critique the DOE estimates which are based in part on work by economist William Nordhaus which assumes that half of world economic activity would continue even when Earth’s temperature had risen 19 degrees C. In contrast, economist Martin Weitzman estimates that 6 degrees C would wipe out half of world economic activity. Credible estimates suggest that a 12 degrees C rise would result in large parts of the world experiencing temperatures at least once a year too high for humans to survive, suggesting that Nordhaus’ (and DOE’s) estimate is far too low.
3) Discount Rate. Discounting reduces the importance of the future by making it seem farther off. A high discount rate represents an assumption that future well-being is less important than a low discount rate which weighs the future more heavily in our present-day decisions. If we assume that the future will be prosperous, maybe it’s not so bad to lose half of whatever we value in life to the ravages of global warming. But if the future looks like a long stretch of hard times, losing half might really be painful, especially if we lose half of our food production. DOE uses a discount rate of 3%; Ackerman and Stanton point to the Stern review which used 1.5%. In some ways, the discount rate is a value judgment, somewhat like the question of how much to save for your child’s education when she’s only 2 years old. But like the decision to start saving early, the discount rate affects results later very strongly, especially when the potential for larger future damages is also factored in.
Ackerman and Stanton argue that low damage assumptions and over-discounting mean that the official $21 figure is far too low. Using a range of more realistic assumptions, they calculate SCC values ranging from $56 to $893. But they point out that when the SCC — essentially the present value of the future damage if we do nothing about climate — becomes large enough, standard cost-benefit analysis stops making sense. In that situation, any effective action we can take will cost less than the discounted present value of the damage. Translated into pricing policy, that means that if a carbon tax is meant to internalize the social cost of carbon, it needs to aim high. There may be little advantage in setting the carbon tax very high initially, but it needs to rise and be expected to rise briskly enough to induce as much reduction in CO2 emissions as fast as our economy can deliver.
In short, the message of “Revising the Social Cost of Carbon” sounds like parental advice: Start modestly, don’t delay, and aim high. Ironically, it’s Generation Hot who will need to deliver that message to its elders.