Assessing the Social Costs and Benefits of Regulating Carbon Emissions

Policy Study

Assessing the Social Costs and Benefits of Regulating Carbon Emissions

New analysis finds carbon emissions may have a net beneficial effect, recommends setting social cost of carbon at zero

Atmospheric concentrations of greenhouse gases (GHGs), which include carbon dioxide and methane, have been increasing for more than a century. Rising human emissions of these gases, especially from the combustion of fossil fuels and from agriculture, appear to be the primary cause of this increase in concentrations. The temperature of the atmosphere has also increased over the past century. Some of that increase is likely the result of the increase in concentration of GHGs.

Such an increase in temperatures has various consequences, some of which are likely to be beneficial, others harmful. In the late 1970s, economists began assessing the impact of rising greenhouse gas concentrations-and the consequences of restricting emissions. The framework they adopted for this analysis is called “cost benefit analysis.” The objective of such analysis is to identify policies whose benefits exceed their costs.

In 1993, President Clinton signed Executive Order 12866 which, among other things, requires agencies of the U.S. government to “assess both the costs and the benefits of the intended regulation and, recognizing that some costs and benefits are difficult to quantify, propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs.”

Starting in 2008, in compliance with this executive order, some agencies of the U.S. government began to incorporate estimates of the “social cost of carbon” (SCC-see box) into their regulatory impact analyses (RIAs). However, not all agencies were using the same estimates of the social cost of carbon, resulting in regulatory impact analyses that were inconsistent. In response, the Office of Management and Budget and the Council of Economic Advisors convened an interagency working group in order to establish a consistent SCC for use in RIAs relating to regulations that restrict emissions of these gases.

In February 2010, the Interagency Working Group (IWG) published “Technical Support Document: Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866.” In that document, a range of estimates was given for the SCC. The SCC was calculated at five-year increments from 2010 to 2050 and it is expected to rise over time. As with all U.S. government estimates of costs and benefits, future costs and benefits are discounted (that is to say, future amounts are reduced by a certain percentage per annum to give their current dollar value).

However, unusually, the IWG did not discount at the rate recommended by the Office of Management and Budget (7% per year), instead choosing to use a range of lower and variable discount rates (these averaged 2.5%, 3% and 5%). In addition, while most of the estimates provided are for the average (in this case, median) forecast of future costs and benefits, the IWG also gave an estimate of the “95th Percentile”-that is, the estimate that is above 95% of all forecasts, or in other words the estimate that is expected to occur with only 5% probability. The IWG has revised its estimates three times since 2010. In the first revision (May 2013), the range of costs shifted upwards dramatically. In the second revision (November 2013), the costs were revised downwards slightly compared to the May 2013 revision. In the third revision (June 2015), the costs were again revised down slightly.

Study Outline

This study seeks to assess the Interagency Working Group’s estimates of the social cost of carbon (SCC). It begins with a discussion of the framework that underpins the SCC, i.e. cost-benefit analysis.

Part Two provides a brief history of economists’ attempts to estimate the social costs and benefits of carbon.

Part Three reviews some of the estimates of the social cost of carbon that have been derived using integrated assessment models (that is, the types of models used by the IWG).

Part Four describes the methodology adopted by the IWG for calculating the social cost of carbon and assesses some of the criticisms of that assessment.

Part Five focuses on two key factors affecting the “damage function”: the sensitivity of the climate to increases in greenhouse gases and the ability of society to adapt to climate change.

The final section draws conclusions and recommends that policies and regulations predicated on the assumption that the SCC is different from zero should be adjusted to reflect an SCC of zero.

Attachments

Julian Morris is vice president of research at Reason Foundation, a non-profit think tank advancing free minds and free markets.