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Apr 23, 2021

Understanding the Social Cost of Carbon

The effects of climate change are being felt all over the world. Increased occurrence of disasters such as flooding and fire, food insecurity, and the spread of disease can and should be attributed to global warming. These impacts are already costing taxpayers, businesses, families, and governments hundreds of billions of dollars through rising health care costs, destruction of property and increased food prices. 

What is the Social Cost of Carbon?

The social cost of carbon (SCC) is a dollar value estimate of the economic damages that would result from emitting one additional ton of greenhouse gases. 

The SCC puts the effects of climate change into simple dynamic financial terms to help policymakers and other decision-makers understand the economic impacts of decisions that would increase or decrease emissions. It factors into a wide variety of policy decisions, including EPA regulations and government spending.

History Incorporating Social Cost of Carbon

The Reagan administration first brought up the idea of the social cost of carbon in 1981. Federal agencies such as the Environmental Protection Agency (EPA) and the Department of Transportation (DoT) independently developed and integrated unique types of social cost calculators during through the early 2000s, but the implementation and effectiveness of these metrics varied widely. It wasn’t until 2009, following a 2008 US Court of Appeals decision requiring the federal government to account for the economic effects of climate change in regulatory cost-benefit analyses, that an Interagency Working Group began to develop a uniform estimate for the social cost of carbon that could be used consistently by agencies across the government. 

Since the Biden administration was sworn in on Jan 20th, 2021, at a Federal level, it is once again expensive to contribute to global warming. The Biden administration has set the cost of carbon to about $51 per ton, closely mirroring the Obama-era policies when it was $50/ton. By contrast, under President Trump, the value of carbon had fallen to as little as $1 per ton. The large swing illustrates that the SCC is highly sensitive and subject to the inputs and assumptions used in the calculation. 

Calculating the Social Cost of Carbon 

An SCC is typically calculated in four steps using advanced regression modeling:

  • Step 1: Predict future emissions based on population, economic growth, and other factors.
  • Step 2: Model future climate responses, such as temperature increase and sea-level rise.
  • Step 3: Assess the economic impact that these climatic changes will have on agriculture, health, energy use, and other aspects of the economy.
  • Step 4: Convert future damages across sectors and stakeholders into their present-day value.

SCC estimates are typically the result of hundreds of thousands of modeling iterations. Once assessed, the SCC helps compensate for a failure in the market to otherwise integrate the external costs of climate change. 

Relationship Between SCC and Carbon Taxes

Carbon taxes essentially incorporate into legislative tax policy the learnings and costs derived from the SCC.

A carbon tax is an excise tax on the production or consumption of carbon, and creates an incentive structure to reduce emissions that can be scaled up or down as circumstances dictate. There are plenty of other examples of similar excise taxes throughout the US, which is why a carbon tax is often referenced as a viable tool. 

It is unlikely that the correlation between the SCC and a carbon tax will ever coincide perfectly. The inputs and assumptions used in calculating the SCC are necessarily dynamic and change regularly, and thus might quickly fall out of step with any static carbon tax. Also, different political interests put different weights on the potential short-term burden on the economy versus the assumed benefit over the long-term. 

To date, the potential harm from climate change hasn’t generated enough momentum for federal policymakers to overcome the short-term burden to implement a significant national carbon tax. Certain states like California have introduced significant policies. Over time, the SCC will continue to change as will the cost of inaction. If markets were perfect, a carbon tax would be equal to and change according to the social cost of carbon.

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