The pitfalls of the ‘social cost of carbon’

Most of us are rightly concerned about global climate change and its implications for human and ecological wellbeing. However, the most popular metric for assessing the benefits from reducing carbon dioxide (CO2) emissions is of little practical use for policymakers. This is creating uncertainty about what we should do to mitigate climate change, and — in some cases — it may even undermine the credibility of such efforts.

The most common metric used by economists to value the impacts of CO2 emissions is the “social cost of carbon” (SCC). The SCC is an estimate of the dollar value of the damage of emitting an additional ton of CO2 into the atmosphere. It’s used by federal regulatory agencies to determine the desirability of individual regulations targeting global warming.

It is hard to know, for example, how much money society should be willing to spend on a policy expected to reduce CO2 emissions by 100,000 tons. But if the SCC is $40, then these emissions reductions could be assigned a dollar value of $4 million to compare against the anticipated financial costs of the policy.

This seems simple enough — and it is what agencies like the Department of Energy (DOE), the Environmental Protection Agency (EPA), and the Department of Transportation (DOT) do — but it’s also a mistake. That’s because it’s not an apples-to-apples comparison.

The SCC is an estimate of the impact of climate change on consumption — the value of goods, services, and even environmental amenities climate change forces society to forgo enjoying. The compliance costs of a regulation are different. They displace some consumption, but inevitably displace some investment, too. A dollar’s worth of investment and a dollar’s worth of consumption are two different things, but federal agencies routinely treat them as if they are the same in their regulatory analysis.

Some of the most widely cited economic estimates of the effect of climate change suggest its effects will hit consumption in a largely one-time fashion. Over the course of the next century, it’s as if we lose about a year’s worth of economic output. As troubling as that is, it’s relatively finite, at least according to the prevailing wisdom.

Meanwhile, regulating involves paying an economic cost — taxes, government spending, business expenses, etc. — for an expected future benefit. That means foregoing investments that could otherwise compound and eventually swamp whatever finite, one-time future hit to consumption the SCC value represents. Even a $1 investment can, with enough time, overtake any static dollar amount, no matter how large.

Keep in mind that one could easily argue that climate change will very much impact investment, for example because the economic models used to calculate the SCC are unreliable. Yet we shouldn’t dismiss the notion outright that climate change won’t impact investment much: The developer of one the most popular models for estimating the SCC, known as the DICE model, was William Nordhaus, who won the Nobel Prize in economics in 2018 for his work in this area.

If economists like Nordhaus are correct about the investment question, it might lead us to delay inefficient regulations that mainly consume scarce resources in favor of other approaches — perhaps those that mobilize investment instead of stifling it. More investment eventually means new or better technologies to fight global warming and higher living standards that lend themselves to greener lifestyles. 

The main reason agencies like DOE, EPA and DOT don’t typically recommend delaying marginal, costly regulations is that they largely ignore the investment question in their cost-benefit analysis. This is a major oversight, but one that is perhaps finally on the verge of being addressed.

A committee was recently convened by the National Academy of Sciences, Engineering, and Medicine to review the DOE’s analytical practices for its energy efficiency standards. It will likely look into how the SCC is used, and it should recommend that the agency start to account for the opportunity costs of investment that it currently overlooks.

The SCC can be a useful tool, but not as currently applied. The Trump administration would be wise to either present SCC estimates separately from those impacts that affect investment activity or curb its use altogether until more credible metrics are developed. 

Some good policies are certainly worth their cost, so it’s critical that regulators have the best possible information to inform their choices — costly or otherwise. But currently, the SCC is as likely to mislead as to inform. We need to seek consensus on an approach to climate change, and poor analytical practices undermine trust in the idea that regulators and other experts act in good faith.

James Broughel is a senior research fellow with the Mercatus Center at George Mason University and an adjunct professor of law at the Antonin Scalia Law School.