Tallying the Social Cost of Carbon

Q: What is the social cost of carbon?

When I was growing up in Vermont, we didn’t have to worry about Lyme disease because deer ticks couldn’t survive winter. Now, winters are milder so when people in northern Vermont get Lyme disease and they’re out of work for a couple of weeks—or worse if it goes unchecked for a long time and they’re debilitated—that’s a real cost that real people pay because of the changing climate.

If your city’s reservoirs are drying up and it’s costing substantial amounts of money to find other ways to supply the population with water, that’s a real cost that real people pay because of the changing climate. If you are a homeowner whose house burns in a wildfire that was much more intense because the landscape is drier as a result of changing precipitation patterns or if you are the neighbor whose home didn’t burn but whose insurance is now impossible to afford, these are real costs that real people pay because of the changing climate.

The social cost of carbon is an attempt to measure all of those kinds of costs—and to tally them against benefits like more productive agricultural seasons in northern latitudes or decreased heating costs as a result of milder winters. The final calculation is an estimate of the cost to society of one additional ton of greenhouse gas emissions.

Carbon dioxide is the most prevalent of the greenhouse gases, so carbon is a shorthand. And each ton of emissions is just a tiny drop in the bucket since, as a global economic system, we currently put about 50 gigatons of carbon dioxide and its equivalents into the atmosphere every year.

Q: Why does calculating the social cost of carbon matter?

A funny thing about the human mind is that when dollars are associated with something, we tend to take it more seriously. We know externalities skew markets; a social cost of carbon could correct the externality that’s driving the climate crisis. By building in the true costs of different activities, the market has more information contained within it to help participants make choices that fit the physical realities of the world that we’re operating in.

The social cost of carbon signals that it’s rational to invest in carbon reduction and removal. It also creates a decision-making tool to answer the question, “How much should we invest?” And it gives you a way to decide which approach to carbon reduction provides the best return. Converting to electric buses sounds good, but electric buses are expensive. And buses are already really efficient ways of moving people around, so by replacing a biodiesel bus with an electric bus each ton of carbon reduction is quite expensive—I did this analysis not too long ago—while prioritizing energy efficiency in buildings results in a lot more carbon reduction for the same cost or the same amount of carbon reduction for a much lower cost.

Q: We talk a lot about putting a price on carbon. A price on carbon and the social cost of carbon are not necessarily the same thing, right?

Absolutely, that’s right. The social cost of carbon aims to provide a price that reflects all of the costs to internalize the externality of greenhouse gases. But there are lots of other ways that you could determine a price for carbon. For example, Lord Nicholas Stern and Joseph Stiglitz proposed setting the price of carbon based on what it would cost to achieve the Paris Agreement goal of limiting warming to 1.5 degrees Celsius.

Regardless of how you determine a price for that signal to guide markets, you then need a way to implement it—a carbon tax, a cap-and-trade system, etc..

Q: Why use the social cost of carbon over a number that gets us to a target?

Matt Kotchen, an economist at the Yale School of the Environment, responded to Stern and Stiglitz with a letter in Science arguing that determining the price based on reaching a specific target centers everything on the political decision of how much should we reduce. If you agree with the target, that may be fine—but not everyone will. He believes that we’d be better off taking a science-based approach to figure out what emitting greenhouse gases is actually costing us and then working from there.

I agree. I think using the social cost of carbon is important to framing our response to climate change because when we get serious about an economy-wide transformation there will be a lot of decisions to make. Giving people the better tool—a more accurate and comprehensive assessment of the costs of carbon—will help decision-makers move through those decisions more quickly.

Every year that we delay serious action to reduce our carbon emissions and to remove carbon from the atmosphere makes the work harder and makes the negative consequences much more likely and more severe. There are huge delays built into the physical systems of the planet, so while we can still influence how much worse it gets, we’ve probably already locked in about 30 more years of warming.

Beyond that, there are thresholds in the earth’s systems; we don’t know exactly where they are, but crossing them can start feedback spirals. For example, if we cross a temperature threshold in Arctic regions, we’ll release enormous amounts of methane that’s stored in the permafrost. Methane is between 20 and 85 times as potent as carbon dioxide. Methane released by melting permafrost will make the planet warmer, leading to a cycle of more melting permafrost and more methane release. There are many similarly catastrophic feedback loops.

Since we don’t know exactly where the thresholds are for any of them, it pays to put this genie back in the bottle as fast as we possibly can.

Q: While it’s not being applied economy-wide the way a carbon tax might be, the Biden administration is using $51 per ton as the social cost of carbon within federal agencies in policy making, regulation, and spending. How valuable is it to have that number is place?

It’s incredibly valuable, not just because the U.S. government is using it, but because the inter-agency working group that calculated the number employed a robust scientific and economic process—which, by the way, draws heavily on the work that won Yale economist William Nordhaus his Nobel Prize.

A well-thought-through estimate of the social cost of carbon from the U.S. federal government provides a benchmark. Not every government or organization has the capacity to determine the social cost of carbon from scratch.

Q: Is the number high enough to fully account for all the social costs?

That’s a question best posed to the academics, which I am not. I can say there’s a range of estimates out there. The numbers that you hear most often are in the $50 to $125 range. University of California economist Fran Moore has suggested three frameworks that put the price at $72 or $133 or $160 per ton depending on how expansive a view of social costs we take. Others see the uncertainties associated with climate change as so great that the price might be much higher.

The Biden administration is reviewing the number. Fifty-one dollars is an inflation-adjusted return to the calculation used by the Obama administration. The Trump administration was using prices between $1 and $7.

Q: How did the number swing so wildly?

The Obama administration used a global estimate of the costs and benefits to calculate the social cost of carbon. The impacts of climate change are not equally distributed. The costs are very high in places near the equator that are likely to become so hot that they are less habitable, or small island nations that are being inundated by rising sea levels. While for the U.S., which is well into the northern hemisphere, the costs are significant but not as high. The Trump administration only considered domestic costs and changed the discount rate from around 3% to as high as 7%.

The discount rate is a way to compare the value of money today versus money in the future. A high discount rate assumes that in the future we will be sufficiently richer and more capable as a society, which would encourage us to postpone dealing with the challenges. Conversely, the lower the discount rate, the more incentive we see to take on the problems today.

While the Biden administration has again lowered the discount rates that agencies use in their calculations, there’s discussion of whether the discount rate should be more on the order of 1%- 2%.

From the perspective of addressing climate change, a global price on carbon and agreed-upon discount rate would be the ideal. Politically, that’s pretty unrealistic, so the next best thing is probably to have national carbon pricing with agreements among groups of countries to harmonize prices.

At a subnational level, states or groups of states that form a rational economic unit, like the Northeast, can be effective. As you move down to smaller and smaller jurisdictions, I think you get to a point where it doesn’t make a lot of sense except as an internal incentive to reduce emissions, much like the Yale Carbon Charge.

Q: Would you explain the Yale Carbon Charge?

The Yale Carbon Charge is the university’s internal carbon pricing system. In 2014, William Nordhaus mentioned the idea at an Earth Day panel. Jennifer Milikowsky, who was then a joint-degree student [at Yale SOM and the Yale School of the Environment], developed the idea with some fellow students and wrote a paper for Dan Esty’s environmental management class. Dan suggested they send it to President Salovey and Provost Polak, each of whom loved the idea.

Eventually, Jennifer and Yale College graduate Ryan Laemel led a pilot implementation with 20 buildings on campus. It looked only at building energy consumption because that’s what we have good data for; things like travel and purchasing are harder to track. I joined the effort in 2016 to expand it to the whole campus.

We charge each building per ton of carbon dioxide emissions.

Based on learning from the last few years, we are changing the policy: Over the next three years we will raise the price from $40 per ton to $50 per ton, close to the current federal estimate of the social cost of carbon. The revenue from the internal carbon charge will be used to fund carbon reduction projects on campus. It will be a way to help the university reach its pledge to eliminate carbon emissions from campus operations by 2050.

For more from Casey Pickett, listen to Pricing Nature, a podcast he hosts about carbon pricing and climate policy.