How Biden Is Putting a Number on Carbon’s True Cost

(Bloomberg) -- It’s a number with a name its inventors concede is baffling. But it may also be, as many in the field have called it, the most important number you’ve never heard of. The “social cost of carbon,” or SCC, was created to show policy makers the gap between the market price of fossil fuels and the cost of the environmental damage they cause. The Trump administration all but ignored climate accounting in its regulations, but President Joe Biden has ordered his staff to move promptly to calculate new social cost estimates for CO₂, plus nitrous oxide and methane.

1. What is the social cost of carbon?

It’s a tool used in federal benefit-cost analysis to account for the damage greenhouse gas pollution inflicts on society, whether it comes in the form of deadly heat waves, water shortages or disappearing crops or animals. One of its champions, Michael Greenstone, says it can also be regarded as “the benefit, in money terms, of reducing carbon emissions.” Those benefits can justify regulations that make polluting activities more expensive. To distinguish among the effects of the greenhouse gases, the SCC in recent years has fractured into separate “social costs” of CO₂, methane and nitrous oxide.

2. Where does the number come from?

A federal court slapped the Department of Transportation in 2008 for failing to account for the benefits of cutting carbon-dioxide emissions. In the early years of the Obama administration, Greenstone, now the Milton Friedman Distinguished Service Professor in Economics at the University of Chicago, and Cass Sunstein, a law professor at Harvard University then working at the White House, led a team that developed a formula that agencies could use to factor in the benefit of avoiding emissions when pricing out a new policy. Social-cost estimates can also help inform legislation dealing with carbon pricing, such as taxes or cap-and-trade programs, although legislators tend to take into account other economic and political factors as well.

3. How high is the social cost of carbon?

In 2010, when the formula was first used, the social cost of carbon was set at $21 in 2010, a figure that had risen to an inflation-adjusted $42 per ton by 2020. (For comparison, the cost of a ton of carbon in the European Union’s emissions-trading market was $46 on Feb. 12.) The Obama administration used the figure in its calculations of the costs and benefits of dozens of regulations. But by tinkering with the formula’s assumptions, the Trump administration lowered the SCC practically to zero, allowing it to try and undo many of those same rules.

4. What does Biden have in mind?

President Biden reactivated the interagency group responsible for calculating the social cost of greenhouse gases. In late February, it set an interim figure of $51 a ton, adjusted for inflation. A more complete update is expected in 2022. Biden has already signaled that he will embed considerations of climate risk throughout the government, giving economic estimates of the benefits of carbon-cutting paramount importance in policy.

5. Are there problems with the formula?

Yes, and they’re the same ones faced by any model that assumes interest rates at levels higher than markets have actually seen in recent years (think pension funds). Social cost estimates are notoriously sensitive to changes in the value of money over time. The Obama administration used a 3% discount rate, meaning that $100 today would be worth $5.20 in a century; Biden’s interim panel did the same. Greenstone now suggests updating that figure to 2% to reflect the decline in 10-year Treasury notes over the last 20 years. A lower discount rate means a higher social cost of carbon.

6. Are there other formulas like this for calculating the cost of emissions?

The U.K. used a similar practice for several years before moving to a system that estimates carbon prices by working backward from climate targets. Some economists have come to reject the social cost of carbon because of its sensitivity to assumptions and have proposed other mechanisms. One alternative is called “Near-Term to Net-Zero,” which estimates how high fossil fuel prices would need to be in a given country in the next few years to bring its net carbon emissions to zero by 2050. Another formula builds on pricing tools developed by financial economists that suggests setting an initial carbon price very high that could then decline over time as climate risk abates.

The Reference Shelf

• A report on “Valuing Climate Damages” from the National Academies of Sciences, Engineering and Medine from 2017.
• A January 2021 paper on updating the U.S. government’s social cost of carbon by the University of Chicago’s Energy Policy Institute.
• Resources for the Future’s page on its Social Cost of Carbon initiative.
• The Carbon Pricing Leadership Council issued this report in 2017.
• A Bloomberg News article on how “Life and Death in Our Hot Future Will Be Shaped by Today’s Income Inequality.”

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