Episode 2: What's the right price for carbon emissions? [Full Transcript]

What's the right price?

In today’s episode, Naomi and Casey speak with Nobel laureate William Nordhaus (a Sterling Professor of Economics at Yale), Fran Moore (an Assistant Professor of Environmental Science and Policy at UC Davis), Howard Shelanski (a Law Professor at Georgetown University and former White House administrator), and Senator Sheldon Whitehouse (US Senator from RI). They seek to understand the theory behind the “social cost of carbon”: the economic backbone of all carbon pricing schemes.

Cover Photo by Paul Rysz on Unsplash

Casey: Welcome to Pricing Nature, from The Yale Center for Business and the Environment, and the Yale Carbon Charge. I’m Casey Pickett. At Yale I implemented, and now run, the first fee-based carbon pricing system at a university.

Naomi: And I’m Naomi Shimberg, a student at Yale studying the economics of climate change.

Casey: Last episode, we got familiar with the idea of carbon pricing: Why, and how, would we put a price on a kind of pollution no one can even see? I shared the story of the wooded river bank behind my childhood home, and how for years, folks at the top of the hill had used it as a dump for old cars, cans, bottles...  Decades later, we had to clean up the riverbank to avoid cutting ourselves as we slid down it into the brook.  

Naomi: It was free for people to dump from the top of the bank, but all those years later, it cost your family time and energy to clean it up.  

Casey: Right. And that’s a lot like greenhouse gas, or carbon, emissions. In most of the world, it’s free to dump it into the sky.  But as it spreads out and sits there in the atmosphere, it creates real costs for people: 

Naomi: Homes lost to natural disasters; jobs lost to economic downturn; more disease; more conflict. Climate change costs us real money.

Casey: Right.  We know it’s real.  But how do we figure out how much money?  In this podcast, we ask: How do you determine the cost to society of a ton of carbon emissions? If we go back to the analogy of the riverbank-as-a-dump: It would be like asking: what’s the cost to society of throwing one car down the riverbank?  

Naomi: Well, we could start by asking: How many hours does it take to dig out the old cars and haul them to the road? 

Casey: And... How many tetanus shots will be required for kids who scrape themselves on the cars? How much chemical pollution will the cars leach into the brook, and how will that pollution impact people's health and property values downstream?

Naomi: Today, we’re going to ask questions like this, about carbon emissions. What goes into calculating the costs of carbon?  How do we tally up costs on a global scale? How do we grapple with the uncertainty of climate change? And perhaps most critically, how do we estimate future costs, and how should we value the wellbeing of future generations compared to our own?

Casey: Act 1 - What is the Social Cost of Carbon?

Casey: The intent of carbon pricing is to reduce greenhouse gas emissions efficiently.  We want to promote healthy economies in the long-term without hurting them in the short term.

Naomi: Right. And to do that, we need to set a price that’s high enough to curb emissions but not so high that it’s politically infeasible. You might have heard the term “social cost of carbon” before, and we used it briefly last episode. Bottom line is that it’s fundamental to understand before we can really get into questions of public policy...

Casey: So where should we start?

Naomi: Let’s get our heads around what the social cost of carbon is. For that, I spoke with William Nordhaus, Sterling professor of economics at Yale and a recent Nobel prize winner for his work on this very subject. I should also mention that he was my professor a few semesters ago, and a large part of the reason why I’m here. Ok, so, Professor Nordhaus, what is the social cost of carbon?

William Nordhaus: The social cost of carbon is a socially determined, or a social construct, which is designed to measure the harm that is done to societies now and in the future by a ton of emission of fossil fuels and in particular carbon dioxide.  So for example, if you take a plane, you have an airplane ride from New York to Los Angeles, your share of that jet fuel that's burned in that might be one ton. And then that would be priced, at the social cost of carbon, which is the cost of that one ton to the present generation and future generations.

William Nordhaus is a Sterling Professor of Economics at Yale University, and one of the two recipients of the 2018 Nobel Memorial Prize in Economic Sciences. Nordhaus received the prize "for integrating climate change into long-run macroeconomic analysis".

Naomi: And by “social cost” economists are referring to the externalities of carbon pollution--the costs outside the prices people pay for things like that plane ticket from New York to Los Angeles. So by adding a price to carbon, and thus raising the cost of that plane ticket, we’re able to account for the externality. 

William Nordhaus: So the prices reflect actually the fact that this particular substance in the air, uh, is doing some economic work. In fact, it's doing some economic harm and therefore it is natural when things do harm that there is a price on them.

Casey: It’s natural to price something when it’s doing harm.  Professor Nordhaus is claiming it just makes sense to put a price on something when it’s creating additional costs to society, or negative externalities. Let’s think about another example of externalities….what about the health care costs associated with smoking cigarettes? We tax the cigarette in part to account for that additional cost. The tax makes cigarettes more expensive, so, ideally from an economics perspective, the cost to the individual consumer matches the cost to society.

Naomi: Right. And we end up with a price that’s more in line with the true societal cost of using the good. 

Casey: But, back to carbon pollution: how do we actually count up all the different costs that come with releasing carbon into the atmosphere and put them into a single number?

Naomi: That’s the question. This value shouldn’t be political and it shouldn’t be subjective. Economists estimate the social cost of carbon with sophisticated mathematical models. I spoke with another economist, Fran Moore, who’s an expert on these models.

Fran Moore: “Hi, I’m Fran Moore and I’m an assistant professor in the department of environmental science and policy at the University of California - Davis.”

Fran Moore is an Assistant Professor in the Department of Environmental Science and Policy at the University of California - Davis. working at the intersection of environmental economics and climate science. Her research seeks to improve our understanding of the economic and social impacts of climate change and to better understand our ability to adapt to those impacts. To do this she combines econometric analysis, experimental approaches, climate model output, and economic modeling.

Naomi:  Dr. Moore introduces the idea of a social cost of carbon as the sum of damages that come from emitting one ton of CO2:

Fran Moore: “I like to think of it as an accounting exercise. So if you imagine emitting a ton of CO2 and that ton of CO2 is going to go up into the atmosphere, and it's going to have these changes on various parts of the climate system, and those changes are going to manifest over decades if not centuries, and those changes to the climate system in turn are going to affect all kinds of communities and economic factors around the world in various ways. What social cost of carbon really does is it quantifies what those impacts are from that one ton of CO2 and converts them into common units, which we think of dollars, and then it just adds them up.”

Casey: It’s got to be hard to put a dollar figure on the damages from a changing climate. There are so many factors to consider in that calculation.

Naomi: Right, like exactly how much warming will result from one additional ton of carbon emissions? And how will that warming impact the natural world?

Fran Moore: Yeah, It's tricky, and you know an ambitious undertaking to do. This kind of bottom-up aggregation of everything we think climate change is going to do, right? So we can break down these many effects of climate change into say their effects on agriculture, maybe their effects on sea level rise and coastal communities, maybe their effects on the extreme events, like natural disasters or storms, the effects on say labor productivity, productivity growth in manufacturing sectors and things like that, the effects on human health. And then you can go through those sectors one by one and for each country, you can say okay for a given amount of climate change, what is the damage from this additional climate warming, right? And then you add them all up together and that's going to give you the ton of CO2.

Casey: So the most appropriate price for carbon would account for all of the damages that result from climate change, now and in the future. That’s bound to be a big number...

Naomi: You’re right. In fact...A recent study in Nature Climate Change showed that limiting global warming to less than 5°F (2.8°C) by the end of the century would save the US a total of about $10 trillion. That’s the order of magnitude we’re talking about here.

Casey: Act 2 - Integrated Assessment Models and Discount Rates… that might not sound exciting -- but just wait.

Naomi: It’s about to get crazy.

Casey: Buckle up everybody.

Naomi: Dr. Moore talked about computing the social cost of carbon as a big accounting exercise. Economists use models, called integrated assessment models to do this accounting.

Casey: OK, I hope everyone’s seatbelt is secure.  Let’s dive in.  Can you tell us more about these models that economists use to estimate the social cost of carbon?

Naomi: Each model is different - and there are several, all with their own acronyms (DICE,... RICE,... PAGE,... FUND) used by governments and economists all over the world. But let’s focus on the DICE Model. DICE stands for a Dynamic Integrated model of Climate and the Economy, created by Professor Nordhaus himself, back in 1992.

Casey: Dynamic Integrated model of Climate and the Economy...So what makes it dynamic? 

Naomi: Well, it’s dynamic because the costs of reducing climate change vary, depending on how much we reduce emissions. If we have net-zero emissions by 2050, we’ll pay a lot less to repair the damages of climate change in 2100.

Casey: So the model itself is dynamic: it calculates different future scenarios depending how much we reduce emissions in the near-term.

Naomi: Right.  

Casey: Dynamic Integrated model of Climate and the Economy.  And why exactly is this model integrated?

Naomi: It’s integrated because it is fundamentally interdisciplinary, incorporating elements of macroeconomics, mathematics, and climatology. 

William Nordhaus: You sort of stack them up and that's an integrated assessment model, but it's only as good and sound as the components that come and from the different, different fields. But integrated assessment modeling itself is just integrating it. It Isn't actually creating new knowledge it's integrating the knowledge and showing the implications of the knowledge.

Casey: He’s like a very humble chef: Oh, I just put some ingredients in a pan and cooked them up.  I didn’t grow the vegetables or anything.

Naomi: Humble and clever...DICE makes for a nice acronym..it implies that humans are gambling with our future.

Casey: Could you tell us a bit more about how this model works?

Naomi: Professor Nordhaus’ model consists of only ten equations. Some of the equations predict how the environment will respond to greenhouse gas emissions, and some of them are economic equations, assigning monetary value to the environmental impacts. Let’s start by talking about the environmental equations.  To understand them, we need to understand three concepts: Feedback loops; tipping points; and fat-tail risks. Let’s start with feedback loops.

Casey: And just to be explicit: a feedback loop is a self-reinforcing cycle, right? Like, the louder people talk at a party, the louder the DJ makes the music, the louder people talk, the louder the DJ makes the music, and so on… 

Naomi: Right – a less-fun example in the context of climate is the ice-albedo feedback loop. Sea ice has a high albedo, which means it reflects a large percentage of solar radiation: it’s bright white, super reflective. With warmer temperatures, the area of sea ice decreases, exposing more ocean, which absorbs more solar radiation, which warms the water and melts even more ice.

Casey: So it’s a vicious cycle.  With warmer temperatures every summer, the sea ice shrinks more and more, but then each winter, it grows back again.  What happens if the water gets so warm one summer that the next winter the ice can’t re-form?

Naomi: That’s an example of the second concept: A tipping point. In this example, there’s an amount of melting—a tipping point—after which it will be nearly impossible to return to the original amount of sea ice.  The whole system tips into a new dynamic state, and it takes a tremendous change to get back to the way it was before.

Casey: So we have these feedback loops and various crucial tipping points for different systems. Do we have any sense of where the tipping points are so we can try to avoid them?

Naomi: Good question. We don’t understand them well, which means there is a lot of uncertainty around the damages of climate change. Dr. Moore says this is one of the areas we know least about:

Fran Moore: If we think about the natural system impacts, they are substantial and they are long lasting. They are by and large irreversible probably. They're potentially one of the, you know, largest kinds of effects of climate change and our understanding of the economic consequences of those I would say at the moment it's fairly limited.

Casey: So Dr. Moore is saying, we don’t know where a lot of the key tipping points are, which makes our cost predictions kind of... imprecise.

Naomi. Exactly. But, I mean think about it, what would you expect? Do we really know what the world will look like 200 years from now, and how we’ll deal with the damages from climate change then? Here’s Professor Nordhaus:

William Nordhaus: We have very poor measures of damage. There are many sectors which are very poorly studied... This is a very complicated area. We're asking, what are the damages going to be a hundred years from now? They're going to be in societies that are going to be completely different. The societies that we have now, there're going to be technologies...So we're trying to ask what we're damages are going to be when the robots are running around.

Casey: We have complicated mathematical models, but we don’t have a crystal ball.

Casey: So we understand feedback loops and tipping points. Now let’s do the third concept: What are fat tail risks?  

Naomi: So the risk of these tipping points—like the point past which a large ice sheet will no longer return—are what economists refer to as “fat tail risks.” Which are part of fat tailed distributions. So...remember back in statistics 101 when you learned about normal distributions? 

Casey: I do. A normal distribution looks like a big bell curve of data where the edges of the bell rest on the zero line.

Naomi: Right. Many distributions are quote normal: for example, the height of adult men in the U.S. The average man is 5’7’’ and the vast majority of men have a height within 3 inches. And very few men have a height more than 6 inches above or below 5’7”. However, many economists believe that the effects of climate change are not well represented by a normal distribution. Instead, the effects of climate change should be represented by a “fat-tailed” distribution. 

Casey: So help me picture that:

Naomi: Picture a normal bell curve...and then..smush the top down. There’s more area under the edges--the extremes--of the curve than in a normal distribution. Remember, virtually no men were more than 6 or so inches away from 5’ 7”. While in a normal distribution, the probability of an event on the extremes is really low, under fat-tailed distributions, events on the extremes are much more probable than in a normal distribution.  And I should mention here, this is pretty hard to explain on air...if you want a visual representation of fat-tail distributions check out our website, which is linked in show notes.

Casey: Okay, we're dealing with fickle feedback loops, unpredictable tipping points, and now these fat-tail risks. With all this uncertainty and potential for extreme disaster, where does this leave us with models? Are we even able to model something so... volatile?

Naomi: Theoretically, yes. But one problem we run into is that there are known unknowns and unknown unknowns.

Casey: Channeling your inner Donald Rumsfeld?

Naomi: Ummmm, yes? Anyway, Casey, there are things we know we don’t know – but more dangerous are things we don’t even know we don’t know. 

Casey: Like who is Donald Rumsfeld.

Naomi: I wouldn’t know. 

Casey: Ahh, to be young and to have basically missed the George W. Bush presidency.  Well, at least you got the key lesson: known unknowns vs. unknown unknowns.

Naomi: Yeah, okay boomer.  

Casey: I deserved that.

Naomi: Anyway, these unknown unknowns are extremely difficult to incorporate in models...and so some economists believe most models are under-accounting for vast damages that might be caused by the low probability outcomes of climate change.

Casey: You’re saying that since many of the risks of climate change are part of complex systems, and are fundamentally unknown, we can’t model them well.  

Naomi: Exactly. Professor Nordhaus makes this point really well: it’s not lack of modeling capacity that’s preventing accurate modeling, but simply lack of knowledge.

William Nordhaus: It's really the intrinsic uncertainties themselves are unknown. It's not, it's not a lack of modeling. It's not a lack of the technology or the computation. It's just insufficient knowledge. It's like trying to project what the pandemic is going to look like six months from now, we could model that, but we just don't know the answer.

Naomi: This is one of the frontiers of environmental economics – there is a large debate in the literature about fat-tailed risks. Pause And then there are some risks, these unknown unknowns, such as possibly catastrophic feedback loops within the carbon cycle, that most models don’t account for at all. Bottom line is that the models are the best we’ve got, but we have to remember that they’re entirely fallible - just like all of us. 

Casey: So it’s like Nassim Taleb’s The Black Swan: There’s a somewhat predictable risk of low-probability, catastrophic things, and we’re not properly accounting for that risk. The future continues to resist prediction.  Which makes it tough to estimate the appropriate social cost of carbon.

Naomi:  Let’s move from the environmental to the economic equations in the model. These economic equations help us give a dollar value to all of those environmental impacts we just discussed. Remember, the goal is to estimate the monetary impact of emitting one ton of carbon. 

Casey: Okay, so...How many homes will be destroyed? How many people will lose their jobs? 

Naomi: Right. These models aim to reflect the impacts, or damages, in various economic sectors... Most notably areas like agriculture, forestry, tourism, energy, and real estate... As well as impacts on human health and ecosystems. But there’s one really crucial piece of these economic equations, and it’s...pretty controversial.

Casey: You have my attention...

Naomi: Good. We have to remember that emissions and damages don’t just occur all at once, right? Our emissions today will have some impacts today, but those impacts or damages will be much bigger after 50 or 100 or 300 years of those greenhouse gases sitting in the atmosphere, trapping the sun’s heat. Remember the junk cars from your story? 

Casey: I do

Naomi: I was asking you questions like: How much will the leached chemical pollution from the cars cost society today. But what about chemical pollution that occurs...10 years from now? We have to ask the question: is money today worth the same to us as money tomorrow? What if I said to you Casey… I’ve got $100 here with your name on it. You can have it today, or you can have it in ten years. What would you say?

Casey: … uh Naomi I think I would very much like that $100 today please?

Naomi: Precisely. To you, $100 today is more valuable than $100 in ten years. So can we really value damages of $100 in ten years the same as we value damages of $100 today? That’s the type of question we need to ask to get a more accurate understanding of the damages associated with that single car, over time. 

Casey: That’s a really interesting point Naomi. Aside from the fact that I just want that $100 now, I have a practical reason: If (and when) you give me that $100, I could put it in a savings account, or buy a bond, or a stock… And then in ten years, that $100 might be $110, $120, $150 if I’m lucky. 

Naomi: Exactly - when we estimate the cost of carbon emissions, we can’t just think about the effects of the emissions today. We also need to consider the effects of emissions in the future. We not only need to figure out how much we value resources and services and even human life today, but also tomorrow, or 100 years from now, or 500 years from now.

Casey: Yikes. pause. I think I see what you meant by “controversial”... How do we put together a calculation like that? 

Naomi: Well, economists actually have a strategy they use to think about these types of future valuations. It’s called a social discount rate

Casey: Act III - The Social Discount Rate

Naomi: Many believe that the social discount rate is the single most important factor in determining the social cost of carbon. We need to figure out how much money people living today should invest in limiting the impacts of climate change in the future. This can be hard to wrap your head around at first; I’ll have Professor Nordhaus explain.

William Nordhaus: So that it's really the discount rate is to reflect the fact that many of these damages occur in most of them in the future. And the weight that you put on them is this social discount rate. It's how much you discount the future damages, depending on how far away they are. You can, you can think of it: things in the distance appear smaller because of the perspective. So the house next door, it looks smaller than my house and the house further away. It looks smaller still. And the further you go, the further these, the smaller these objects appear, and that's just the way discounting works. The more distant objects in time also are more distant in terms of their dollars.

Casey: The house farthest away from me appears smaller...the damages from climate that are far in the future are weighted less than damages today...? 

Naomi: It’s a whole lot to consider, so let’s be really explicit here. There are two central reasons for discounting the future. First, we make an important assumption that societies will grow wealthier over time as a result of economic growth, and therefore a dollar today is worth more than a dollar in the future, when we expect to have more dollars. But second – and this is where the controversy comes in –  social discount rates also take impatience into account. They reflect people’s tendency to prefer income today rather than tomorrow, regardless of how much money they will have in the future. The controversy stems from whether this feature of people’s attitudes to time should be reflected in policy making...because, when applied to problems like climate change, it effectively weighs the wellbeing of future generations lower than present, living generations.

Casey: So the central question here is should people’s impatience be reflected in policy?

Naomi: Yes. And I’ll have to stop myself from getting too into the gritty economics here…

Casey: Oh, don’t hold yourself back.  Bring on the grit.

Naomi: Okay.... So there are two approaches to answering that question: the prescriptive, or quote “ethical” approach and the descriptive, or market based, approach. 

Casey: Where shall we start?

Naomi: Let’s start with the prescriptive camp. These people prescribe the social discount rate using ethical principles..that is, they believe that the only ethically responsible thing to do is to value the wellbeing of future generations equally to our own, and therefore they assert a social discount rate very close to 0. Impatience has no place in our models.

Casey: Well, that seems hard to argue with. It seems like we wouldn’t want to discount the future too much…

Naomi: Agreed, and that’s what I thought when I first learned about these two approaches. But we can’t look at this solely from an ethical perspective—because it's really an issue of economics. This came to a head in climate economics a little less than 15 years ago in an epic intellectual battle between William Nordhaus and Lord Nicholas Stern.

Casey: A battle? Like fisticuffs?  What do you mean? 

Naomi: Casey, I mean these are two of the most well-respected economists in the world, they fight with light sabers.

Casey: Touche

Naomi: They were debating in the way that economists do, with the mightypen and paper, air-tight counterfactuals, you know.... It wasn’t a real battle...but it was newsworthy. It was covered in the NYTimes, the Guardian….Anyways, in 2006, Lord Nicholas Stern authored a 700 page official Report for the British Government known as the Stern Review. The Stern Review took the prescriptive approach:

William Nordhaus: The prescriptive approach or the ethical approach is one that says that rate is not ethically fair because it doesn't take into account the opportunities of future generations and the impacts on future generations. And the ethical approach starts from basically first principles that says we should be fair to future generations, we should not discriminate against future generations and makes the argument that by discounting, future yields or future returns, we are in effect differentiating or discriminating against future generations, because we will impose damages on above what they should have from an ethical point of view.

Naomi: The problem with the prescriptive or ethical approach, as Professor Nordhaus argues, is that none of us actually behave this way. You wanted that 100 dollars now, right? 

Casey: Yes, I still do.

Naomi: If we behave like our great-grandchild deserves our money as much as we do, we would never go out to dinner or pay to see a concert or go to a baseball game again. Instead, we would invest the $50 we would have spent on dinner because we’d be confident that it would grow over time and become perhaps $1,000 for our great-grandchild to put toward health care or education or the newest supercomputer.

Casey: You’re saying a dollar today is genuinely more valuable to us than a dollar tomorrow or a dollar a century from now. 

Naomi: Yes. But then here’s the really controversial question: should this economic behavior be reflected in policy making? In a rebuttal to Lord Stern, Professor Nordhaus, says yes: our actual behavior should guide policy making and that’s why he asserts a descriptive, or market based, approach. He says the social discount rate should describe how we actually behave -- how the market behaves, how our investments behave -- and not be based on what we believe. And, he argues that this approach leads to better policy: 

William Nordhaus: I would be very reluctant to make an investment that is decided on some ethical ground, when you're not using the same ethical argument for other investments. So you're just using that for climate. You're not using that for infrastructure. You're not using that for roads. You're not using that for education. It's a kind of blinded way to make your investment policies and you should make your investment policies in a unified framework.

Casey: So Professor Nordhaus is arguing for consistency here. He says that we can’t artificially impose our ethics here but not elsewhere, because it will disproportionately favor investments in climate mitigation. He’s worried that we could overdo it. If we only use ethics to determine the social discount rate for climate, we might invest too much in solving climate change, thereby missing other really important investments in education or infrastructure or pandemic response as a result.  

Naomi: Right. And this is why it’s an interesting debate and why there is such a vast body of literature around discounting, because I think both sides have strong points….If I’m part of the ethical, or prescriptive camp, I can basically come back at you and say climate change is fundamentally different than other issues of policy because the damages are so far out into the future, so we need to bring in ethics here. But then the market based, descriptive camp can come right back and say it is precisely because the damages are so far out in the future that we need to use a market-based discount rate that gives us this unified decision-making framework.

Casey: I've struggled with this. The ethical approach to the social discount rate makes much more sense to the intuitive part of my brain. I’ve found it helpful to come at this from a legal, as opposed to an economic angle. Richard Revesz, former Dean of NYU Law School and Director of the American Law Institute, supports Bill Nordhaus's call for consistency. They both say we shouldn't use a special social discount rate for climate because we need to have a consistent rate across issue areas. Richard Revesz points out that US climate politics are so difficult that policy tends to swing wildly as presidential administrations change. And if we use a special social discount rate for climate policy, it would make it far easier for a future administration, or a Supreme Court challenge, to argue that the special discount rate is arbitrary and capricious, and should be thrown out.  His view is that if we want robust, lasting climate policy, we need a consistent social discount rate to defend against legal challenges that could derail effective climate policy.

Casey: Act 4 - The social cost of carbon in policy

Naomi: Now, this debate provides us with two clear sides. A survey of 200 economists in 2015 found that most experts were in between, favoring a median social discount rate of 2%. 

Howard Shelanski: A lot of very prominent economists thought that we were using a discount rate that was dramatically too high, even at 3%, and that we should be using a 1% or even lower discount rate.

Howard Shelanski served as Administrator of the White House Office of Information and Regulatory Affairs (OIRA) from 2013-2017. He is currently a Professor of Law at Georgetown University.

Naomi: That’s Howard Shelanski. Shelanski was the administrator of the White House Office of Information and Regulatory Affairs from 2013 through 2017. In that role, Shelanski reviewed and designed environmental policy regulations that impacted emissions. He was also part of the Federal Interagency Working Group on the social cost of carbon.

Casey: Okay. And here he’s saying that critics thought that the interagency working group on the social cost of carbon was using a social discount rate that was “dramatically too high” at 3%?

Naomi: Yes. The interagency working group chose a central estimate for the social discount rate of 3%. Smaller than Professor Nordhaus’ 4.25% but larger than Lord Stern’s 1%.

Casey: Tell us more about this interagency working group... How has the US Federal Government been involved with discussions around the social cost of carbon?

Naomi:  Well, it goes back three administrations, actually.  At the end of the George W. Bush Administration, it became obvious the Federal Government needed one standard social cost of carbon estimate across all agencies.  

Howard Shelanski: So we always want to think about what are the benefits that we gain from a regulation. With environmental regulations, and particularly greenhouse gas emissions regulations, there were lots of benefits that one could come up with, but the estimates of the benefits from reducing carbon emissions were sort of all over the map. And different federal agencies were either not estimating those benefits or sort of guessing at what those estimates were, or coming up with very inconsistent estimates.

Casey: I see. So before about 2010, there was no standard? Like every agency had their own special yardstick for measuring these impacts and the yardsticks were different sizes. Not a good way to set national policy.  

Naomi: Yeah, and shouldn’t we be using meters by now? Anyway, under the Obama administration, this group was convened to develop a standard social cost of carbon so that each government agency could use a consistent estimate. The group consolidated multiple models drawn from the academic literature to arrive at one number. I asked Shelanski about how the federal government uses the social cost of carbon in actual policymaking:

Howard Shelanski: So the way those federal agencies would use the social cost of carbon is first they would do an estimate of what is the tonnage of carbon emissions that the rule might eliminate. Then in order to calculate the costs and benefits, they would attach the dollar value per ton that comes from the social cost of carbon estimates and say, okay, we will eliminate, let's say 10,000 tons of carbon from the atmosphere from this energy efficiency rule. What's the value of that to society? Well, we know that, um, the social cost of carbon is something like $37 per ton. By eliminating 10,000 tons, we eliminate, uh, 10,000 times $37. That's the savings for society.

Casey: Makes sense. Then I assume the agency compares the $370,000 savings to society with whatever costs such a rule might have, and then selects whichever option, rule or no rule, makes society better off?

Naomi: Yes, we just have to hope here that the working group was looking at all of the benefits that such a rule might have. I think it goes back to our conversation about fat tailed risks: there are just so many unknown unknowns. 

Casey: I noticed Mr. Shelanski referred to the federal social cost of carbon estimate that the Interagency Working group developed: 37$ per ton. That’s the number we used at Yale in 2016 to guide our internal carbon charge price.  It was useful to have a research-based, consensus number as a benchmark. But that was nearly five years ago… where does the federal government stand today?

Naomi: Well, the Interagency Working group was disbanded under President Trump in 2017.  The Biden Administration has already revived it, which is really exciting. But for a little history, the Group made its first central estimates of the social cost of carbon in 2010.  They landed on about 22 dollars per ton. The number kept increasing under President Obama until 2016, when the federal government stated that the social cost of carbon was 51 dollars per ton. 

Casey: And so how did the Trump administration treat the social cost of carbon?

Naomi: They cut it dramatically in 2017.  The latest estimates proposed in June 2020 are on the very low end, around 5$ per ton. 

Casey: Politics aside, why would an administration want to change -- or drop in this case -- the Social Cost of Carbon by more than 90%

Naomi: Politics aside is a BIG ask...

Casey: Well sure, Naomi, but considering that Dr. Moore and other economists think we might already be systematically underestimating damages.  I want to understand what the Biden Administration will have to adjust.

Naomi: So Trump’s EPA did two big things. First, they changed the discount rate used to calculate the social cost of carbon. Here is Senator Sheldon Whitehouse – the Senator from my home state of Rhode Island. When we interviewed Senator Whitehouse back in 2020, he criticized the Trump Administration’s decision to raise the social discount rate....

Sheldon Whitehouse: What they have done is tweaked the discount rate, so that you diminish the value of the harm to those future generations, and if you crank up your discount rate enough, you can diminish that harm to virtually zero. Which makes a certain amount of economic sense if I'm buying an instrument that's going to pay me a hundred dollars tomorrow, and I'm comparing it and value the one that's going to pay me a hundred dollars in thirty years, that's all fine. It's a totally different thing when you're dealing with the health of the planet, and when you're dealing with impact that future generations are going to feel 100%. When they feel them, they're not going to be discounted. And the fact that it doesn't matter to us so much now because it's not us and it's not now, that's just a really morally creepy way to think about this problem.

Naomi: Senator Whitehouse is referring to the Trump Administration’s decision to use a 7% social discount rate to calculate the social cost of carbon. Remember that that’s nearly three percentage points higher than the market-based social discount rate asserted by Professor Nordhaus.

William Nordhaus: You can't argue against something being unethical. I mean, I think it's a hard argument to say, well, we should use an unethical discount rate. My view is that's actually not what the question is about.  The question is what are you going to use your scarce resources for? We have a certain amount of scarce resources we can use for investment, or we can use them to slow climate change. We can use them for recovering from pandemic. We can use them for education. We can use them for infrastructure. We can use them for manufacturing, there are all kinds of places we can use our investments. And the key argument from an economic point of view is when you use them as effectively as possible.

Casey: So Professor Nordhaus reframes the question here. The question is not: should we use a quote ethical discount rate. The question is: how can we make the best investment decisions? 

Naomi: Right, and he answers this question by saying we can make the best decisions by using a social discount rate determined by the market, close to 4 percent. Nearly all of the economists who work on this problem agree that a social discount rate as high as 7 percent is not economically sound. 

Casey: So Trump’s social discount rate is neither “ethical” in the eyes of the prescriptive camp, nor “market based” in the eyes of the descriptive camp.

Naomi: Nope.

Casey: Okay so that’s number one. They changed the social discount rate. What else did they do?

Naomi: They switched from considering global damages to domestic damages. Here is Dr. Moore again:

Fran Moore: Well, the Trump Administration decided to only think about the damages from that ton of CO2 to the United States. And that was a major reason why they came up with a number that's much much lower than what the Obama Administration was doing. That change alone I think cut the number by about 90%.

Casey: And so when I hear that, I essentially understand it as an extension of President Trump’s orientation to favor the interests of the U.S. above other countries. 

Naomi: Me too. But it’s not that simple. Dr. Moore said, before the Obama Administration, it was standard practice to only consider national damages.

Fran Moore: It was actually fairly unusual for administrations to consider the benefits or costs to non US citizens in the regulatory analysis. The decision by the Obama administration to do that was clearly within the executive authority to do it, but it was also very different from actions and analysis that have been undertaken before. It is really up to the administration to decide whether or not they want to include kind of just the benefits to the United States or the benefits to the whole world.”

Naomi: Before the Obama interagency working group decided to take a global outlook, it was fairly unusual for administrations to consider costs and benefits outside of the US. But it is standard practice for economists, who mostly agree that existing methodologies can’t accurately calculate an estimate for only one country.

Casey: Because of all of the spillover effects of climate damages into other countries...What did Shelanski say about these low estimates?

Naomi: Well, he left the White House several years ago. But we asked him what he thought of a social cost of carbon of about $5 per ton.

Howard Shelanski: That would be literally shocking because that's not supported by any data or study or analysis that I'm aware of. In fact even corporations that use their own social cost of carbon numbers to try to assess various things like some of the big oil and gas companies [...] have numbers in the 30s and had numbers in the 30s several years ago. So where a number in the single digits would come from, I don't know. So my instinct would be to be extremely suspicious of a number that was in the single digits, even one adjusted to take only domestic benefits into account, and I have not heard anybody who is serious in the scientific debate on this suggest such a number is even remotely plausible.

Casey: So even though many of the assumptions that inform the integrated assessment models are subjective, the estimates out of the Trump White House seem like they were...how shall I put this?... inconsistent with the best science.

So, to summarize, the Trump Admin changed the federal estimate for the social cost of carbon by playing with two dials: they dialed the social discount rate way up to 7% and they dialed the scope of damages way down from global, to just national.

Naomi: Yes. And President Biden’s newly revived Interagency Working Group will almost certainly turn these dials the other way.


Casey: So Naomi, what is the right price for carbon?

Naomi: I’ll let Dr. Moore take that one. So we asked her, how much should carbon cost?

Fran: [laughs]

Casey: Hm.  We didn’t actually figure out the right price for carbon, did we?

Naomi: Not quite. 

Casey: It seems to me there is a large range of viable numbers for the SCC. And there are several dials that economists can twist that cause extreme variation.

Naomi: Certainly. The estimate of 50 dollars by the interagency working group has been described as the lower bound: the known knowns of damages we can expect from climate change. But I think this is where we have to start asking some deeper questions - like what should be the role of economists in setting these policies in the first place? Professor Nordhaus believes economists should create tools:

William Nordhaus: I think the role of the scientific community, this would be the natural sciences and the social sciences and economists, are to create the tools that public policy makers can use….[27:19] We are trying to provide a tool or a set of tools for slowing this, this terrible scourge that's that's landing on us in the form of climate change.

Naomi: Dr. Moore talked about economic models as presenting a guide for policy makers.

Fran Moore: You don't, in my opinion, you don't want to be tying regulation to something that is fundamentally that uncertain, right? You don't want it to be the case that we come out next year and like to have some new research in the social cost of carbon has tripled. And that means everyone's carbon tax triples, right? That's just no way to run serious climate policy. Um, and so I think using it is something of a guide for the magnitude of the kind of carbon prices that we're talking about. But the other guide for the magnitude of carbon prices is also how much we want to reduce emissions.

Naomi: And creating these tools and presenting this guide is only going to get even more important.

Howard Shelanski: I think that they should be a very high priority destination for research funding and for young scholars interested in getting into related scientific and social fields, because we really do need to understand what the social costs of carbon are. If they are much lower than we think, well then thank goodness. That's great. You know, maybe we don't have at least the crisis of emissions reduction that we think we do. Unfortunately, all the evidence is to the contrary, and so we need more urgently to understand because if the social costs of carbon are far higher than we think, then we really need to take much more dramatic action to try to reverse course and reduce carbon emissions. I think understanding that not as a political fact, not as an article of faith,not as some kind of partisan thing that we feel or believe, but rather something that we learn and know about and can take meaningful action on us as a society. That's vitally important.

Casey: And even if we can’t agree on a specific, concrete price, any meaningful price is better than none at all, right? Many people who have implemented carbon pricing systems, myself included, argue that it’s much more important to get a price in place than to make sure it’s the exact right price. We could delay implementing carbon prices for decades arguing over the amount.  

But the practice of figuring out a meaningful price is still an important one. We need to closely examine the costs of emitting carbon, in order to fully understand the scope of the damage it causes. 

Naomi: Yes. We need to understand these feedback loops and tipping points. We need to establish systems for assigning costs to these damages. And we need to examine the relationship between the market and our ethics. 

Casey: It may be that the process of understanding what the right price is, is just as important as the price itself.

Naomi: Join us next time for The Road to Paris. We’ll learn about international climate agreements, and how they’ve evolved over the last three decades.

Casey: Thank you all for listening. This is Pricing Nature from Yale University. 

Naomi: To get in touch, email us at carbon@yale.edu.

Casey: This episode was written by Naomi Shimberg with help from Whitney Mann, Casey Pickett, Ben Linthicum, Jacob Miller, and Maria Jiang. Sound engineering by Jacob Miller with help from Ryan McEvoy. Original music by Katie Sawicki. Special thanks to Julie Vance, Tom Erb, Stuart DeCew, Heather Fitzgerald, and Peter Boyd for their advice and for helping to make this episode possible.

Cover photo by Paul Rysz on Unsplash