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Presentation on the SCC.aba SEER.oct 2011

Presentation on the SCC.aba SEER.oct 2011

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10/14/2011

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On the US Government’s Estimation of the Social Cost of Carbon
Prepared for Fall Meeting of the ABA Section on the Environment, Energy,and ResourcesOct 13, 2011, Indianapolis
Daniel H. ColeProfessor of Law and of Public and Environmental AffairsIndiana University, Bloomington
Outline of PresentationBottom line of this presentation
Establishing a social cost of carbon (SCC) is the most significant step the USgovernment has yet taken toward establishing a national climate policy. Butthat’s not saying much.
What is the SCC?
 Technically, the social cost of carbon is the sum of the private cost of carbonproduction and consumption
 plus
the externalized costs associated withcarbon production and consumption activities. Many of those externalizedcosts are not priced in markets. As a matter of practical politics, the SCCconstitutes the price society should be willing to spend to mitigategreenhouse gas emissions. More expensive policies would constituteinefficient over-regulation; less expensive policies would constituteinefficient under-regulation. In determining the efficient price for carbonemissions, the SCC tells us the efficient Pigovian tax rate.
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Why do we need to price carbon in the first place?
1
In fact, a Coasean tax would be more socially efficient than a Pigovian tax. The differenceis that a Coasean tax would not seek to internalize
all
externalities but only inefficientexternalities (those for which the social benefits of internalization would exceed the socialcosts).
1
pp
1
p
2
qS
1
(private and social costs)S
2
(private costs only)
Dq
1
q
2
 
Climate change is a classic externality (or, from another point of view, publicgood) problem, symptomatic of market failure. The market price of goodsand services produced from carbon fails to account for some of the costs of carbon-based production and consumption. Those costs are externalizedfrom the market, but ultimately are borne by people somewhere. Thus, theclassic externality graph (above), which describes all conventional pollutionproblems, equally applies to the problem of climate change.
How is the SCC established?
Economists determine the damage function from different levels of carbonemissions and/or ambient concentration levels. The physical consequencesof climate change entail socio-economic consequences, not all of which arepriced in markets. For non-market harms (and benefits) economists must usesecond-best proxies, such as contingent valuation, to estimate values. Onceall of the external costs (and benefits) from carbon emissions have beenestimated, economists calculate net costs (or benefits). Virtually alleconomic models have found net social costs. Those net social costs areadded to the private-market costs associated with carbon emissions toderive the SCC.
 
Different economic models and interpretations of those models, in the peer-reviewed literature, have yielded different values for the SCC, ranging fromless than $10 per ton of carbon dioxide equivalent to more than $300 perton.
2
In 2010, the US government’s Federal Interagency Working Group(hereinafter “working Group”) derived a central estimate of the social cost of carbon (for 2010) of $21.40 per ton of carbon dioxide equivalent.
3
 
2
See Richard S.J. Tol,
The Social Cost of Carbon: Trends, Outliers, and Catastrophes,
Economics Discussion Papers 2008-25 Table A-1 (Sept. 19, 2007). Tol’s meta-analysis quiteproperly does not consider estimates outside of the peer-reviewed literature, some of whichestimate far higher values of the SCC. Other estimates, from the non-peer-reviewedliterature, derive values for the SCC exceeding $1000/ton.
See, e.g.,
Frank Ackerman andElizabeth A. Stanton, “The Social Cost of Carbon: A Report for the Economics for Equity andthe Environment Network” (April 1, 2010)<http://www.e3network.org/papers/SocialCostOfCarbon_SEI-20100410.pdf>.
3
Federal Interagency Working Group, Appendix 15A, Social Cost of Carbon,
Social Cost of Carbon for Regulatory Impact Analysis under 
 
Executive Order 12866
(2010).<http://www1.eere.energy.gov/buildings/ appliance_standards/commercial/pdfs/mhlf_preanalysis_appendix15a.pdf>.
2
 
Source: Federal Interagency Working Group, Appendix 15A. Social Cost of Carbon forRegulatory Impact Analysis under Executive Order 12866 (2010).
As the table above indicates, the Working Group set the SCC using a basesocial discount rate of 3%, along with sensitivity analyses using alternative5% and 2.5% rates. A 3% discount rate is approximately two times higherthan the discount rate employed in the UK Treasury’s
Review of theEconomics of Climate Change
,
4
(
The Stern Review,
2006), which manyeconomists criticized for being too low. On the other hand, the WorkingGroup’s 3% discount rate is well below the base rate of 7% required byExecutive Order for all federal regulatory impact analyses. In that respect, atleast, the Working Group’s choice of a central rate of 3% is marginally pro-environmental, but defensible even based on OMB’s own guidelines (fromCircular A-4).
5
It is important to note that discounting for intergenerational problems andpolicies is a controversial exercise and no single social discount rate isobjectively right or wrong; arguments can be made favoring lower or higherdiscount rates, which is why the Working Group sensibly crunched thenumbers using a variety of discount rates (although one can quibble aboutwhether the range of rates they used was sufficiently broad).In all columns of the table above, except the far right-hand column, theWorking Group takes the aggregate mean estimate of damage functionsfrom the three most prominent integrated assessment models (IAMs) of climate change, known respectively as “DICE,” “FUND” and “PAGE.” An IAMis an elaborate benefit-cost analysis that derives economic costs andbenefits from scientific data. Like all benefit-cost analyses, they includeinherently subjective elements, including valuations of non-market goods
4
T
HE
S
 TERN
R
EVIEW
 
OF
 
 THE
E
CONOMICS
 
OF
C
LIMATE
C
HANGE
(2007).
5
A clear majority of economists seem to believe that the OMB’s base rate of 7% is too highfor regulations with intergenerational effects.
See
Martin Weitzman,
Gamma Discounting
, 91A
MER
. E
CON
. R
EV
. 260 (2001).
3

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