Carbon Dioxide

The Social Cost of Carbon Calculation Debate*

Fatally flawed metric or the most important number that you've never heard of?


Carbon Tax Center

"The social cost of carbon is the most important number that you've never heard of," according to University of Chicago economist Michael Greenstone. Greenstone led the interagency working group that devised this metric during the Obama administration. Since it was first calculated in 2010, the social cost of carbon has been used to justify 80 different federal regulations that purportedly provide Americans with over a trillion dollars' worth of benefits.

"The social cost of carbon is nothing but a political tool lacking scientific integrity and transparency conceived and utilized by an administration pushing a green agenda to the detriment of the American taxpayers," insisted Rep. Darin LaHood (R-Il.), chair of the Oversight Subcommittee of the House Committee on Science, Space and Technology. LaHood's remarks were made as he opened a hearing called "At What Cost? Examining the Social Cost of Carbon" earlier this week.

"This metric did not simply materialize out of thin, and dirty, air," countered Rep. Don Beyer (D-Va). Beyer argued that the social cost of carbon (SCC) metric was devised by the Obama administration through a process that "was transparent, has been open to public comment, has been validated over the years and, much like our climate, is not static and changes over time in response to updated inputs."

So what are these politicians fighting about? The social cost of carbon is a measure, in dollars, of the long-term damage done by a ton of carbon dioxide emissions in a given year. Most of the carbon dioxide that people add to the atmosphere comes from burning coal, oil, and natural gas. The Obama administration's interagency working group calculated that the SCC was about $36 per ton (in 2007 dollars). This figure was determined by cranking damage estimates through three different integrated assessment models that try to link long-term climate change with econometric projections. Notionally speaking, imposing a tax equal to the SCC would encourage people to reduce their carbon dioxide emissions while yielding revenues that could be used to offset the estimated damage, e.g., by building higher sea walls or developing heat-resistant crops.

Can citizens take that $36-a-ton estimate to the bank? Not really.

First, consider that integrated assessment models are trying to forecast how extra carbon dioxide will impact climate and economic growth over the course of this century and beyond. One of the critical variables is climate sensitivity, conventionally defined as how much warming can be expected from doubling the amount of carbon dioxide in the atmosphere. The working group calculating the SCC also used various discount rates. (One way to think of discount rates is to consider how much interest you'd require to put off getting a dollar for 10 years.) Finally, instead of focusing on domestic harms, the working group included the global damages in calculating the SCC.

Republicans, who convened the subcommittee hearing, argue that the SCC is bogus and therefore many of the regulations aimed at cutting the emissions of carbon dioxide by restricting burning of fossil fuels are too. In his 2013 analysis of the IAMs relied upon by the Obama administration's interagency working group, Massachusetts Institute of Technology economist Robert Pindyck concluded that all three models "have crucial flaws that make them close to useless as tools for policy analysis." He pointedly added, "These models can be used to obtain almost any result one desires." In other words: Garbage In, Garbage Out.

Having tossed the models aside, Pindyck earnestly sought another method for establishing a plausible SCC. In November, he published a new study in which he asked selected economists and climate scientists to provide their best guess of what the SCC should be, assuming the possibility of a climate-induced reduction in global economic output 50 years from now of 20 percent or more. Pindyck reports that his experts converged on an SCC estimate of about $100 per ton of carbon dioxide, which is considerably higher than that the Obama administration's figure.

At the subcommittee hearing this week, the majority of experts who testified agreed that the integrated assessment models are fatally flawed. However, they reached much different conclusion: The Obama administration's SCC is much too high.

Ted Gayer of the Brookings Institution argued that the working group should have followed standard regulatory practice and produced estimates based on the harm to U.S. citizens that could be expected from carbon dioxide emissions. "The difference between global and domestic benefits of greenhouse gas regulations is significant, as the global measure is 4 to 14 times greater than the estimated domestic measure," he testified.

Using the $36 per ton SCC, the Environmental Protection Agency calculated that Obama's Clean Power Plan to cut U.S. electric power plant emissions by 30 percent would yield climate benefits amounting to $30 billion in 2030. "However, estimated domestic climate benefits only amount to $2–$7 billion, which is less than EPA's estimated compliance costs for the rule of $7.3 billion," noted Gayer. "The use of a global social cost of carbon to estimate benefits means that agencies will adopt regulations that could cost Americans more than they receive in climate-related benefits."

In his testimony, Heritage Foundation statistician Kevin Dayaratna looked at how the working group used discounting to calculate its SCC estimate. The first problem he noted is that the working group ran the IAMs using 2.5 percent, 3 percent, and 5 percent discount rates, ignoring the Office of Management and Budget's guidance that specifically stipulates that a 7 percent discount rate be used as well. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy. The choice of discount rate makes a huge difference. Consider that the present value of $100 in damages in 100 years at 3 percent is $5.20, whereas at 7 percent it falls to just 12 cents. When Dayaratna ran one of the models with the 7 percent rate, the 2020 SCC fell by more than 80 percent from over $32 to just under $6 per ton.

Dayaratna also pointed out that the Obama administration working group relied on a 10-year-old estimate of climate sensitivity that many climate scientists now regard as way too high. Taking the new lower estimates into account dramatically reduces the SCC. Even at the 3 percent discount rate preferred by the working group, the SCC in one model would fall to $16 per ton; at the 7 percent rate, it would amount to a negligible $2.50 per ton. In fact, Dayaratna reports, applying the 7 percent rate to another of the models used by the working group would make the SCC negative, at about $1 per ton. In that outcome, subsidizing carbon dioxide emissions would actually provide extra benefits to consumers.

Michael Greenstone also testified at the hearing. He justified the use of global damages in calculating the SCC by arguing that if the U.S. expects other countries to cut their emissions because they damage Americans, we must take into account the harm that our emissions cause them. He also contended that the lower discount rates are needed to allow for the risks of possibly catastrophic climate change. "The case for using a low discount rate to determine the social cost of carbon is in many respects similar to the case for purchasing life, fire, and other insurance policies that protect against major disruptive events," he argued.

According to a persuasive 2015 analysis by the European Commission statistician Andrea Saltelli and her colleagues, "The uncertainties associated with mathematical models that assess the costs and benefits of climate change policy options are unknowable. Such models can be valuable guides to scientific inquiry, but they should not be used to guide climate policy decisions." Given that man-made global warming could become a significant problem as the century advances, a plausible estimate for possible future damages would be useful. But the Obama administration's SCC calculations do not fulfill that role.

*Harkens back to the "socialist calculation debate" between Ludwig von Mises and Friedrich Hayek who asserted that efficient central planning is impossible and Oskar Lange and Abba Lerner who claimed that market socialism could be more efficient than competitive free markets.