Interacgency Working Group on Social Cost of Greenhouse Gases, United States Government

“ When interpreting the SOC approach from the point of view of whether to invest in a single government project, it is asking whether the benefits from the project would at least match the returns from investing the same resources in the private sector. Interpreting the approach from the standpoint of a benefit-cost analysis of regulation, the approach focuses on adjusting estimates of benefits downward by discounting at a higher rate to offset additional social costs not reflected in the private value of displaced investment. ”

“ A robust and scientifically founded assessment of the positive and negative impacts that an action can be expected to have on society provides important insights in the policy-making process. The estimates of the social cost of carbon (SC-CO2) , social cost of methane (SC-CH4) , and social cost of nitrous oxide (SC-N2O) presented here allow agencies to understand the social benefits of reducing emissions of each of these greenhouse gases, or the social costs of increasing such emissions, in the policy making process. ”

“ Climate impacts occurring outside of U.S. borders will have a direct impact on these U.S. citizens and the investment returns on those assets owned by U.S. citizens and residents. The U.S. economy is also inextricably linked to the rest of the world. The U.S. exports over $2 trillion worth of goods and services a year and imports around $3 trillion. [19] Climate impacts that occur outside U.S. borders can thus impact the welfare of individuals and firms that reside in the United States through their effect on international markets, trade, tourism, and other activities. ”

“ When analyzing policies and programs that result in GHG emission reductions, it is important to account for the difference between the social and private rate of return on any capital investment affected by the action. ”

“ The IWG published SC-CO2 estimates in 2010 that were developed from an ensemble of three widely cited integrated assessment models (IAMs) that estimate global climate damages using highly aggregated representations of climate processes and the global economy combined into a single modeling framework. The three IAMs were run using a common set of input assumptions in each model for future population, economic, and GHG emissions growth, as well as equilibrium climate sensitivity (ECS) – a measure of the globally averaged temperature response to increased atmospheric CO2 concentrations. ”

“ GHGs, for example, CO2, methane, and nitrous oxide, are chemically stable and persist in the atmosphere over time scales of a decade to centuries or longer, so that their emission has a long-term influence on climate. ”

“ Using a global estimate of damages in U.S. analyses of regulatory and other actions allows the U.S. to continue to actively encourage other nations, including emerging major economies, to take significant steps to reduce emissions.
The IWG found previously and is restating here that because of the distinctive global nature of climate change that analysis of Federal regulatory and other actions should center on a global measure of SC-GHG. This approach is the same as that taken in regulatory analyses over 2009 through 2016. ”

“ Over the past four decades there has been a substantial and persistent decline in real interest rates (see Figure 1) . Recent research has found that this decline has been driven by decreases in the equilibrium real interest rate (Bauer and Rudebusch 2020) . Re-estimating the consumption rate of interest following the same approach applied in Circular A-4, including using data from the most recent 30 years, yields a substantially lower result. The average rate of return on inflation adjusted 10-year Treasury Securities over the last 30 years (1991-2020) is 2.0 percent. ”

“ Related to the development of damage functions, damages from climate change are uncertain and hence pose additional risks. Reductions in GHG emissions reduce not only expected damages, but also reduce the uncertainty and risks of catastrophic events. Evaluating the damages using the mean outcome does not account for the benefits of reducing uncertainty. ”

“ The proper way to specify a declining discount rate schedule remains an active area of research. One approach is to develop a stochastic model of interest rates that is empirically estimated and used to calculate the certainty equivalent declining discount rate schedule (e.g., Newell and Pizer 2003; Groom et al. 2007) . An alternative approach is to use the Ramsey equation based on a forecast of consumption growth rates that accounts for uncertainty (e.g., Cropper et al. 2014; Arrow et al. 2013) . ”

“ GHG emissions are stock pollutants, where damages are associated with what has accumulated in the atmosphere over time, and they are long lived such that subsequent damages resulting from emissions today occur over many decades or centuries depending on the specific greenhouse gas under consideration. [20] In calculating the SC-GHG, the stream of future damages to agriculture, human health, and other market and non-market sectors from an additional unit of emissions are estimated in terms of reduced consumption (or consumption equivalents) . ”

“ While point estimates are important for providing analysts with a tractable approach for regulatory analysis, they do not fully quantify uncertainty associated with the SC-GHG estimates. Figures ES-1 through ES-3 present the quantified sources of uncertainty in the form of frequency distributions for the SC-GHG estimates for emissions in 2020. The distributions of SC-GHG estimates reflect uncertainty in key model parameters chosen by the IWG such as the equilibrium climate sensitivity, as well as uncertainty in other parameters set by the original model developers. ”

“ Uncertainty about the value of the SC-GHGs is in part inherent, as with any analysis that looks into the future, but it is also driven by current data gaps associated with the complex physical, economic, and behavioral processes that link GHG emissions to human health and well-being. ”

“ Another area of active research relates to discounting, including the best available evidence on the consumption rate of interest and the application of discount rates to regulations in which some costs and benefits accrue intra-generationally while others accrue inter-generationally. As described in Section 3.2, new empirical evidence suggests that consumption interest rates are now below the previous estimate of 3 percent presented in OMB’s Circular A-4. ”

“ Additional recommendations were offered for improving the socioeconomic module centered on four broad criteria: time horizon, future policies, disaggregation, and feedbacks. Climate science: Adopt or develop a simple Earth system model (such as the Finite Amplitude Impulse Response (FaIR) model) to capture relationships between CO2 emissions, atmospheric CO2 concentrations, and global mean surface temperature change over time while accounting for non-CO2 forcing and allowing for the evaluation of uncertainty. ”

“ Reduced complexity sea level rise models are also being developed that can provide projections for damage functions that require sea level estimates, including the contributions of thermal expansion and glacial and ice sheet melting based on recent scientific research (e.g., Wong et al. 2017) .
Damage functions. At the core of IAMs are “damage functions” that map global mean temperature changes and other physical impacts of climate change into economic (both market [38] and nonmarket [39] ) damages. ”

“ In response, the National Academies convened a multidisciplinary committee, the Committee on Assessing Approaches to Updating the Social Cost of Carbon. In addition to evaluating the IWG’s overall approach to SC-CO2 estimation, the committee reviewed its choices of IAMs and damage functions, climate science assumptions, future baseline socioeconomic and emission projections, presentation of uncertainty, and discount rates. ”

“ It is important to note that even if an appropriately specified blended SOC rate could be calculated based on the share of regulatory costs that are expected to displace investment that would not obviate the need to carefully consider issues of uncertainty and ethics when discounting in an intergenerational context, pointing to a lower rate. ”

“ As illustrated by the frequency distributions in Figures Figure 2 through Figure 4 , the assumed discount rate plays a critical role in the ultimate estimate of the SC-GHG. As explained in Section 3, this is because GHG emissions today continue to impact society far out into the future, so with a higher discount rate, costs that accrue to future generations are weighted less, resulting in a lower estimate. ”

“ In developing the SC-CO2 estimates, the IWG considered various sources of uncertainty through a combination of a multi-model ensemble, probabilistic analysis, and scenario analysis. For example, the three IAMs used collectively span a wide range of Earth system and economic outcomes to help reflect the uncertainty in the literature and in the underlying dynamics being modeled. The use of an ensemble of three different models is also intended to, at least partially, address the fact that no single model includes all of the quantified economic damages. ”

“ In each simulation the uncertain parameters are represented by random draws from their defined probability distributions. In all three models the equilibrium climate sensitivity is treated probabilistically based on the probability distribution described in the 2010 TSD. The equilibrium climate sensitivity is a key parameter in this analysis because it helps define the strength of the climate response to increasing GHG concentrations in the atmosphere. In addition, the FUND and PAGE models define many of their parameters with probability distributions instead of point estimates. ”

“ This is a natural result of the fact that most regulations have a limited impact on individuals residing outside of the United States and do not reflect any other scientific, legal, or other rationale. ”

“ In the context of climate policy, equity considerations are discussed by economists, ethicists, and others in several ways: distributional effects within a specific country, effects across countries, and intergenerational equity impacts. ”

“ One part of this effort is focused on developing probability distributions for future paths of population, GDP, and emissions via using econometrics and expert elicitation techniques. For example, economic growth projections are being built off the results of a formal expert elicitation of leading growth economists together with recent research by Muller, Stock and Watson (2020) , who have refined a foundational statistical methodology for generating long-run projections of economic growth at the country level. ”

“ Account for the relationship between economic growth and discounting; explicitly recognize uncertainty surrounding discount rates over long time horizons using a Ramsey-like approach; select parameters to implement this approach that are consistent with theory and evidence to produce certainty-equivalent discount rates consistent with near-term consumption rates of interest; use three sets of Ramsey parameters to generate a low, central, and high certainty-equivalent near-term discount rate, and three means and ranges of SC-CO2 estimates ”

“ Based on their review of the literature and latest climatological and economic evidence, they present their current estimates as a “likely underestimate [of] climate-related damages to society” and the side analysis as a way “to illustrate a range of plausible values if the Department were to update its [social cost of carbon] estimate based on new versions of the models currently used.” [45] Specifically, the side analysis includes SC-CO2 estimates based on DICE2016 and PAGE-ICE ($135 and $440/mtCO2 for 2020 emissions (2019 Canadian dollars) ) . ”