The Social Cost of Carbon
Estimating the Benefits of Reducing Greenhouse Gas Emissions
EPA and other federal agencies use the social cost of carbon (SCC) to estimate the climate benefits of rulemakings. The SCC is an estimate of the economic damages associated with a small increase in carbon dioxide (CO2) emissions, conventionally one metric ton, in a given year. This dollar figure also represents the value of damages avoided for a small emission reduction (i.e. the benefit of a CO2 reduction).
The SCC is meant to be a comprehensive estimate of climate change damages and includes changes in net agricultural productivity, human health, and property damages from increased flood risk. However, it does not include all important damages and, as noted by the IPCC Fourth Assessment Report [link], it is “very likely that [SCC] underestimates” the damages. The models used to develop SCC estimates, known as integrated assessment models, do not assign value to all of the important physical, ecological, and economic impacts of climate change recognized in the climate change literature because of a lack of precise information on the nature of damages and because the science incorporated into these models lags behind the most recent research. Nonetheless, the SCC is a useful measure to assess the benefits of CO2 reductions.
The timing of the emission release (or reduction) is key to estimation of the SCC, which is based on a present value calculation. The integrated assessment models first estimate damages occurring after the emission release and into the future, often as far out as the year 2300. The models then discount the value of those damages over the entire time span back to present value to arrive at the SCC. For example, the SCC for the year 2020 represents the present value of climate change damages that occur between the years 2020 and 2300 (assuming 2300 is the final year of the model run). The SCC will vary by year for two reasons that work in opposite directions. In model runs with the last year fixed (e.g., 2300), the time spanning covered in the present value calculation will be smaller for later analysis years—the SCC in 2050 will include 40 fewer years of damages than the 2010 SCC. In addition, the SCC should increase over time because future emissions are expected to produce larger incremental damages as physical and economic systems become more stressed in response to greater climatic change.
One of the most important factors influencing SCC estimates is the discount rate. A large portion of climate change damages are expected to occur many decades into the future and the present value of those damages (the value at present of damages that occur in the future) is highly dependent on the discount rate. To understand the effect that discount rate has on present value calculations, consider the following example. Let’s say that you have been promised that in 50 years you will receive $1 billion. In “present value” terms, that sum of money is worth $372 million today with a 2 percent discount rate. A higher discount rate of 3 percent would decrease the value today to $228 million and still the value would be even lower—$87 million with a 5 percent rate. This effect is even more pronounced when looking at the present value of damages further out in time. The value of $1 billion in 100 years is $138 million, $52 million, and $8 million, for discount rates of 2 percent, 3 percent, and 5 percent, respectively. Similarly, the selection of a 2 percent discount rate would result in higher SCC estimates than would the selection of 3 and 5 percent rates, all else equal.
EPA and other federal agencies have developed SCC estimates and used them to assess the benefits of rulemakings that reduce CO2 emissions. EPA participated in an interagency working group that convened in 2009-2010 to design an SCC modeling exercise and select estimates for use in rulemakings. EPA estimated the SCC under a variety of assumptions determined by the interagency group using three integrated assessment models, which each combine climate processes, economic growth, and feedbacks between the two in a single modeling framework.
The interagency group selected four SCC values for use in regulatory analyses. The first three values are based on the average SCC from the three integrated assessment models, at discount rates of 5, 3, and 2.5 percent. SCCs at several discount rates are included because the literature shows that the SCC is highly sensitive to discount rate and because no consensus exists on the appropriate rate to use for analyses spanning multiple generations. The fourth value is the 95th percentile of the SCC from all three models at a 3 percent discount rate, intended to show the potential for higher-than-average damages. The table below summarizes the four SCC estimates in certain years. See the SCC Technical Support Document (PDF, 51pp, 854K) for a complete discussion about the methodology and resulting estimates.
|Discount Rate and Statistic|
|Year||5% Average||3% Average||2.5% Average||3% 95th percentile|
a The SCC values are dollar-year and emissions-year specific.
EPA first used these SCC estimates in the benefits analysis for the final joint EPA/Department of Transportation Rulemaking to establish Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards; see the rule’s preamble (PDF, 405 pp, 5.6MB) for discussion about application of the SCC (75 FR 25324; May 7, 2010).
The interagency group noted a number of limitations to the SCC analysis, including the incomplete way in which the integrated assessment models capture catastrophic and non-catastrophic impacts, their incomplete treatment of adaptation and technological change, uncertainty in the extrapolation of damages to high temperatures, and assumptions regarding risk aversion. The Administration hopes that over time researchers and modelers will work to fill these gaps and that the SCC estimates used for regulatory analysis by the federal government will continue to evolve with improvements in modeling.
In light of these limitations, the U.S. government has committed to updating the current estimates as the science and economic understanding of climate change and its impacts on society improves over time. To help motivate and inform this process, Department of Energy and EPA have hosted a series of workshops. The first workshop focused on conceptual and methodological issues related to integrated assessment modeling and valuing climate change impacts, along with methods of incorporating these estimates into policy analysis. The second workshop reviewed research on estimating impacts and valuing damages on a sectoral basis.