Climate Economics with Arvid Viaene

#6 - From $0 to $190: How U.S. Presidents Price a Ton of CO₂

• Arvid Viaene

Share episode

Send us a text

Pricing carbon is the backbone of climate cost-benefit analysis in the U.S. If the price is high, stronger environmental rules pay for themselves; if it’s low, they don’t. In this episode, I trace how the social cost of carbon entered federal policy and why the number has shifted between administrations.

What we cover

  • From Reagan-era cost-benefit rules to a 2007 court case that rejected “carbon = $0”
  • The Obama team’s Interagency Working Group and a unified SCC built from leading IAMs
  • Trump’s shift to domestic-only damages and 7% discount-rate sensitivities — and what that does to the math
  • Biden’s restoration and EPA’s 2023 update: modern damage modules, mortality, and a ~2% near-term discount rate
  • Trump's second term executive order which essentially put the SCC at zero.
  • The discount-rate intuition: how $1,000 of damage in 100 years becomes $52 (3%), $138 (2%), or $370 (1%) today
  • What a better SCC means for agencies, investors, and reciprocity in global climate policy

#ClimateEconomics #Regulation #SCC #PublicPolicy #Podcast

For questions, comments or suggestions, you can contact me at arvid.viaene.ce@gmail.com

Speaker 1:

Hi and welcome back to the Climate Economics Podcast. I'm your host, arvid Vianna, and in the previous episode we saw some essential climate calculations to calculate climate damages, and one of the key numbers for that calculation was the social cost of carbon, which captures how harmful climate change is. But we also saw that the social cost of carbon, which captures how harmful climate change is. But we also saw that the social cost of carbon varied greatly between President Obama, president Trump and President Biden, going from $2 per ton of CO2 under President Trump to $190 per ton of CO2 under President Biden. So today we are tackling the history of the social cost of carbon in the United States policy and why it has varied so much, and along the way we will tackling the history of the social cost of carbon in the United States policy and why it has varied so much, and along the way we will cover a lot of the things that go into it, as well as cover the work of Bill Nordhaus, an economist who got a Nobel Prize for his work on climate economics. So let's start off with a refresher of what the social cost of carbon is. The social cost of carbon is the estimated economic harm from releasing one extra ton of CO2 into the atmosphere. In other words, what is the damage caused by one extra ton of CO2 to society, both today and in the future? But this is not just about climate models. It's about real-world impacts, such as lost agricultural yields due to droughts and heat waves, increased mortality from extreme heat, coastal damages, energy strain and so on. And here's also a key thing to know CO2 stays in the atmosphere for hundreds of years, so the damages unfold over decades, sometimes centuries. That means we need to think not just about today, but also about our children and grandchildren. So, with that said, let's go back in time.

Speaker 1:

Let's start with the Reagan administration in 1981, when federal agencies have been required to assess costs and benefits of major regulations. But for a long time, climate damages were effectively valued at zero in these cost benefit analyses. That means that no cost to society was assumed from additional greenhouse gas emissions, and that can matter when you look at regulations regarding oil or renewable energy or anything else. But this changed after 2007 court ruling, where the Ninth Circuit Court of Appeals founded and I'm citing arbitrary and capricious end quote for regulators to assign a zero value to carbon emission reductions. Noting that quote unquote the value of carbon emission reductions is certainly not zero. So what to do then?

Speaker 1:

Well, the court's ruling encouraged the government to find a scientifically grounded dollar value for climate damages, and there had been early attempts under George W Bush administration, but there was no unified approach. Different agencies had different approaches and devised their own ad hoc carbon cost estimates, so that led to inconsistent numbers. But that changed when President Obama took office, because in 2009, the Obama administration decided to harmonize the process of setting the social cost of carbon, and this was done by creating an interagency working group on the social cost of carbon, for which the goal was to develop a single set of social cost estimates for use across the federal government, and the working group was explicitly designed to base that number on the best available science and economics. So by early 2010, the working group, which included experts from the Environmental Protection Agency, the Department of Energy and other agencies, together in know Council of Economic Advisors and others. So there was a. It was a huge effort. So by early 2010, the working group released the first official social cost of carbon values, and the way they did it is they based it on three integrated assessment models that were developed in the academic literature at the time. The first was the dice model, the second was the page model, the second was the PAGE model and the third was the FUN model, and these were developed by economists William Nordhaus, chris Hope and Richard Tull respectively, and it's important to know that Bill Nordhaus got the Nobel Prize in economics for his work on the DICE model, because it integrated climate economics and macroeconomic models to allow for an estimation of the social cost of carbon. So this is some very seminal work that was then used during this process.

Speaker 1:

So how do these integrated assessment models work? I think it's worth documenting the steps. First, the model needs to project future emissions, and you can do this using assumptions about population economic growth technology to estimate how CO2 emissions will evolve over time. Second, you need to model a climate response, so you need to translate CO2 emissions into changes in temperature, and this is a very science-based step, because then you need some models to convert CO2 emissions into increases in temperature. The third step, then, is to estimate the economic damages from the increases in temperature, and this means that you need to assess how those increases in temperature impact various outcomes such as agricultural yields, health, flood damages and so on, and this usually happens through a damage function that links temperature changes to monetary damages. And this is also one of the areas where there's been a lot of research since that time. I won't have the time today to go into it, but I might dedicate an episode to it in the future, because here there's been a lot of recent advances and what the impacts are in all these different areas. So also a lot more microeconomic research has been happening in this area. And then we have the fourth step, which means to discount future damages to the present value, and you can do that by converting future harm into today's dollars using a discount rate, and then, after you've done that, you can sum up all the damages to get to the total damage from one extra ton of CO2.

Speaker 1:

So the working group had three of these models and they ran each of them 10,000 times across various emission scenarios and assumptions, which then generated a whole distribution of these estimates. But the model's results were given equal weight in computing a central value and range, and for the year 2010, the central social cost of carbon was approximately $21 per ton of CO2. Now the working group also provided a low and a high bound, which was $5 and $35, respectively. Now, over Obama's two terms. The working group did issue technical updates to the social cost of carbon, for example, the sixth and final update, which was in 2016,. The social cost of carbon for 2015 was about $36 per ton and the estimated value for 2020 was around $50 per ton. So it started at $21 per ton of CO2, but then, using several updates, for example, in the value function, in the end it became around $50 per ton. So now let's switch to President Trump's first administration. It became around $50 per ton. So now let's switch to President Trump's first administration there.

Speaker 1:

Upon taking office in 2017, he moved swiftly to dismantle or diminish the social cost of carbon's role in federal policy, and this was part of a broader rollback of climate initiatives. And in March 2017, for example, trump issued an executive order which disbanded the interagency working group and withdrew the official social cost of carbon guidance as not representative of government policy. Furthermore, the executive order directed agencies to revert to earlier guidance from 2003 for regulatory analyses involving greenhouse gases. So what does that mean in practice? Well, in practice, agencies were no longer required, or even expected, to use the Obama-era global social cost of carbon values. Instead, they were instructed to focus on domestic impacts only and to apply higher discount rates. So that often meant 7% or 5% discount rate insensitivity, and the immediate effect was a drastic downscaling of the social cost of carbon values used for those federal analyses, and therefore the official position became that a ton of CO2 only would cause a few dollars of damage to the US economy, which is more than an order of magnitude smaller than the approximately $50 per ton of value used at the end of the Obama era.

Speaker 1:

Now, this huge drop was not because of any new signs showing climate change to be less costly, but purely a result of changing assumptions, because the Trump administration argued that prior social cost of carbon estimates were inflated and improperly included global benefits of carbon reduction that did not just focus on the American people. So by counting only domestic impacts, the Trump administration was able to ignore roughly 80 to 90% of the harm that a ton of CO2 would cause worldwide. So in essence, you could just ignore climate damages outside the US borders. And second, by applying a high discount rate like 7%, you're able to very heavily devalue future damages to today's dollars, further shrinking the social cost of carbon by excluding global damages and using a 7% discount rate.

Speaker 1:

The Trump administration obtained social cost of carbon. By excluding global damages and using a 7% discount rate, the Trump administration obtained social cost of carbon estimates that were near zero, on the order of $1 to $7 per ton of CO2. Now it is worth noting that the Trump administration's stance broke with the consensus of most economists and the international community, because, while many acknowledged uncertainties in the social cost of carbon, few support it. Using a 7% discount rate for intergenerational environmental problems, for example, the Office of Management and Budget's own guidance recognizes that 7% is analogous to private sector returns and is generally too high for intergenerational public projects. Similarly, ignoring non-US damages was criticized because climate change anywhere can affect US interests through global supply chain, migration, geopolitical instability and so on, and because US climate action is generally predicated on the fact that if you help others, then the others will help you.

Speaker 1:

Nonetheless, the political motivation was clear. By lowering the social cost of carbon, the Trump administration aimed to remove the cost of carbon from regulatory decisions, making it easier to justify deregulatory actions that were a priority for the fossil fuel industry and then consistent with the administration's skepticism of climate regulations. Now, what about in court? Because these decisions were challenged in court, but legally the move generated debate but largely survived in the short term. There was not a specific court ruling invalidating the Trump social cost of carbon approach, though some Trump-era rules were later struck down on other grounds. But what is interesting is that many states and experts continued to use the more robust social cost of carbon estimates from the Obama administration even during this period. For instance, some US states, like New York, adopted the Obama-era social cost of carbon or even higher values in their own policy decisions, despite the federal pullback.

Speaker 1:

So then let's switch to President Biden, who took office in 2021. And on his first day in office, which was January 20th, he issued an executive order re-establishing the interagency working group. And the working group was tasked with two immediate goals First, to publish social cost values for CO2, methane and nitrous oxide in the short run, and these should reflect the Obama era approach. And then, second, it should undertake a thorough updated assessment to produce final new estimates by 2020. And his motive was clear he had a climate agenda, he rejoined the Paris Agreement, he regulated emissions and there was some need for credible estimates of climate benefits. So, within a month, the interagency working group released these interim social cost of carbon values, which essentially reinstated the Obama era central social cost of carbon, adjusted for inflation and for CO2, this came out to be about $51 per ton in 2020, using a 3% discount rate and again using global damages.

Speaker 1:

What about the update of the values that President Biden demanded? Well, in November 2023, the EPA the Environmental Protection Agency released a comprehensive report called the Report on the Social Cost of Greenhouse Gases Estimates, incorporating Recent Scientific Advances, and this is part of the regulatory impact analysis for a major EPA climate rule which targeted oil and gas methane emissions, and the report presented new social cost of carbon estimates using improved methodologies. For example, one thing they did is they used a dynamic discount rate framework. So, rather than using a fixed discount rate, it applied a declining discounting approach over time, and so, as time goes on, you would use a lower and lower discount rates. It's a little bit technical, but it can have quite a bit of impact. The central case they used was actually around a 2% near-term discount rate, so Obama used a 3%, but then under Biden, it became a 2% discount rate. So, as a result, damages went up, and then, for the modeling itself, they incorporated better damage functions. For instance, they explicitly modeled how climate change affects human mortality, which some of these previous models had handled in a very rough way and the results were striking. Had handled in a very rough way and the results were striking. Using a 2% discount rate, together with this declining over time, the social cost of carbon for emissions in 2020 was estimated at around $190 per ton. So this is roughly 3.7 times higher than the interim 51 value they had before. So one remark about that is the EPA's report noted that simply moving from a 3% to a 2% discount rate accounts for the majority of that increase in damages, reflecting how crucial discounting is, while updated mortality and other damage estimates also contributed. So we've covered the three precedents.

Speaker 1:

I want to pause here and explain one key idea further, which is the discount rate. The discount rate reflects how much we value the future relative to the present. A high discount rate means future damages are worth a lot less today. A low discount rate means we value future harms almost as much as present ones. In essence, the discount rate is the inverse of the interest rate. The interest rate is if you invest money today, how much will it be in the future?

Speaker 1:

So, just to provide a framework, if I told you that climate change will cause a thousand dollars in damage in a hundred years. How much would that be worth to us today? Well, with a 3% discount rate, it's worth about $52. So, going from $1,000 to $52 today, with a 2% discount rate, it's worth about $138. And with a 1% discount rate it's worth over $370. But with a 7% discount rate, that $1,000 is only worth $1.2 today so much much lower. So you can see that the discount rate matters a lot.

Speaker 1:

So what are the arguments? Well, under the Trump administration it was argued let's use the 7% discount rate because that's an approximation of the rate of return in the capital markets. The 3% discount rate, which was mostly used under Obama, was used at the time and also proposed by the Nobel Prize winner, bill Nordhaus. The 2% discount rate was then later used under the Biden administration and there it was argued that this is the long-term risk-free interest rate, so that should be used.

Speaker 1:

But I probably will do another episode just on this topic, because this is the topic that has been the most intensely debated in economics and policy. So I'll get back to this at some point in the future. So let's wrap up. Today we saw that the social cost of carbon is the price tag of one ton of emissions, but that it can vary greatly based on the discount rate used, the geographic scope and the damage assumptions. And then President Obama, trump and Biden use very different approaches, and so the estimate goes from $1 to $190 per ton. And the way then you would use the social cost of carbon matters, because it will really factor into cost-benefit analyses for policies, for investments and the way we value the future. So thanks for tuning in. I hope you enjoyed it. If you did, please leave a rating or share it with a friend. I much appreciate it and I hope to see you in a next episode. Bye.