This article was originally published in the Wall Street Journal.
Last month, the Environmental Protection Agency moved to repeal the centerpiece of President Obama’s climate policy, the Clean Power Plan, which regulates greenhouse-gas emissions from the power sector.
Among other rationales given, the EPA explained that the costs of the rule exceed the benefits. EPA’s new analysis found the benefits of avoided climate change damages from the Clean Power Plan totaled less than $3 billion per year in 2030, and perhaps as low as $500 million. By contrast, President Obama’s EPA originally estimated the climate benefits to be $20 billion per year. What explains such a stark difference?
The answer is found in a relatively arcane, but critically important, metric known as the “social cost of carbon” (SCC). The SCC is an estimate in dollars of how much damage is caused over the long run by a ton of CO2 emissions in a given year. It monetizes the cost of climate change from impacts like reduced agricultural productivity, increased flood damage or worsened health and mortality.
Such an estimate, albeit imperfect, is necessary to assess whether a proposed regulation is worth the costs. In setting fuel-economy standards, for example, regulators must weigh costs, such as more expensive cars, reduced size and safety, and increased miles driven, against benefits like reduced air pollution, oil use and—using the SCC—avoided climate impacts.
According to the Obama administration, the cost to society of putting a ton of CO2 in the air in 2020 is $45 (there’s a range, but that’s the central estimate). According to the Trump administration, it is somewhere between $1 and $6.
The dramatic downward revision results from two key disagreements. First, in estimating the SCC, the Obama administration accounted for global damages from a ton of CO2. Traditionally, the federal government looks only at domestic impacts in its cost-benefit analysis. The argument for a global value, however, is that climate change is a unique sort of problem. Unlike other regulated pollutants that have almost entirely domestic consequences, CO2 impacts are global, and climate change is a “tragedy of the commons” problem. A ton of CO2 contributes equally to climate change regardless of where it comes from. If all nations looked only at the impact of a ton of CO2 on their own nations, the collective response would be vastly inadequate to address the true damages from climate change.
The second disagreement the Trump administration has with Obama is how to value the future damages of climate change in today’s dollars. In other words, how much is it worth to us today to prevent a dollar of climate change damage decades from now?
The choice of discount rate may sound technical, but it makes an enormous difference. Suppose the damages from climate change were $1 trillion in the year 2100. Using a 3% discount rate (the Obama administration’s central value, and Trump administration’s low value), it would be worth $86 billion to us today to prevent it. Using 7%, the upper bound chosen by the Trump administration, it would be worth only $4 billion. In short, discount rates matter. A lot. The use of a high discount rate effectively means that the impact of our actions today on future generations is given very little weight in assessing costs and benefits.
The Trump administration’s choice of 3% and 7% is consistent with longstanding White House guidance. Yet few economists use 7% in modeling the costs of climate change. As the Council of Economic Advisers (CEA) has explained, 7% was intended to represent the average before-tax return on private capital. The 3% rate reflects how much the average saver is able to earn. Over long horizons, such as those relevant for climate change, the 3% value is more consistent with the models used to generate the SCC estimates. CEA recently recommended even 3% is too high given decline in long-term interest rates.
White House guidance notes discount rates even lower than 3% can be used when there are important intergenerational impacts. Moreover, a number of leading economists recommend using declining discount rates because of uncertainty about future returns to investment and growth.
Additionally, the distribution of climate change risk has a “fat tail,” meaning there’s a larger probability of truly catastrophic impacts. A willingness to pay extra for insurance against those risks suggests erring on the side of lower discount rates.
How best to calculate the SCC is not yet settled, and work continues to improve and refine existing approaches. While many reasonable researchers may disagree, there needs to be more bipartisan agreement on key questions about climate change costs and benefits. Consumers, businesses and policy makers cannot plan and make long-term investments if the U.S. government’s estimates rise or fall 10-fold every time the party in the White House changes hands.
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