The Cost of Climate Pollution

Working Group Estimated, GAO Approved

by by Peter Howard September 3rd, 2014

The U.S. social cost of carbon (SCC)—the set of calculations estimating that a ton of carbon dioxide emitted today causes about $40 worth of damages to human health, ecosystems, and the economy—now comes with a stamp of approval from the U.S. Governmental Accountability Office (GAO).

At the behest of Senator David Vitter and several other Congressional Republicans, the non-partisan watchdog group was tasked with investigating the SCC and the process by which it was calculated, after a 2013 update increased the official SCC by approximately 50%. The SCC was first estimated in 2010 by the Interagency Working Groups (IWG), consisting of several executive agencies and cabinet offices (see the GAO report for a list).

In its recent report, the GAO found that the IWG did a sound job. The report even highlights the IWG’s finding that the current U.S. SCC estimate may be too low due to omitted climate impacts.

In a separate report issued earlier in the summer, the GAO also found that the Office of Management and Budget (OMB) agrees with the IWG’s choice of discount rates (2.5%, 3%, and 5%). Critics have insisted that 2004 OMB guidelines (Circular A-4) mandate a higher discount rate, but the IWG and OMB have been clear: high discount rates do not make sense in the context of climate change because intergenerational benefits and costs are present.

The GAO concluded that the IWG’s work was transparent—it utilized group consensus and well established climate-economic models from the academic literature (i.e., the DICE, FUND, and PAGE models). In addition to finding that the IWG clearly laid out the limitations of the resulting estimates, the GAO found nothing inappropriate in the process or substance of the IWG’s updated SCC. The IWG was simply carrying out its stated 2010 plan to update the SCC every two years, or when significant, peer-review updates to climate-economic models are made available. The 2013 update met these conditions. The 50% increase in the SCC between 2010 and 2013 was solely the result of updates by the model developers to the science and economics underlying the three climate-economic models used by the IWG.

Moving forward

Now that the IWG process has the GAO’s blessing, what’s next for the SCC?

The IWG timetable calls for another update in 2015-2016, and new improvements to DICE and FUND are already publically available. But is there more that can be done to improve the SCC calculations, beyond plugging in the latest versions of these models every two to three years?

The IWG’s stated goal is that the SCC “should be updated over time to reflect increasing knowledge of the science and economics of climate impacts,” (see its 2010 Technical Support Document). From an economic and legal perspective, the IWG is off to a good start. However, it should make several key improvements in the next round of updates:

• Include additional climate-economic models – Since the IWG convened in 2010, when the three peer-reviewed models were chosen, several additional peer-reviewed climate-economic models have become available. Two of the most promising are the World Bank’s ENVISAGE and Fondazione Eni Enrico Mattei’s ICES. In addition to providing a detailed sectoral breakdown of the world economy, both models capture price changes and allow climate change to impact economic productivity.

• Include a declining discount rate – Given the long time horizon and vast uncertainty surrounding climate damages, the IWG appropriately selected consumption discount rates (2.5%, 3%, and 5%) to calculate the current value of future climate impacts. However, based on the growing consensus in the economic literature, the 2015-2016 IWG should carry forward its sound economic argument for introducing the 2.5% discount rate (long-run interest rate uncertainty) to its logical conclusion, and introduce a declining discount rate.

• Expand its modeling of uncertainty – In addition to adopting a declining discount rate, the IWG should also consider expanding the set of uncertain parameters for which it explicitly modeled uncertainty. It made a good start by employing various possible values of the climate sensitivity parameter and multiple socio-economic and emission scenarios, demonstrating the uncertainty underlying the SCC and its sensitivity to critical parameters. In its 2015-2016 update, the IWG should expand how it captures uncertainty, with an added focus on the possibility of black swan events–unknown unknowns–through the use of fat-tailed parameter distributions.

• Update current uncertainty analysis – The IWG should update its current uncertainty analysis to reflect up-to-date science. This can be accomplished by updating the distribution underlying the climate sensitivity parameter from the 2007 to 2013 IPCC consensus on the climate sensitivity parameter. The IWG should also update their current socio-economic and emission scenarios. In particular, the IWG should consider including a pessimistic scenario with respect to CO2 concentrations to bring balance to its current set of five scenarios— four business as usual (BAU) scenarios and one optimistic scenario with respect to CO2 concentrations.

• Improve its modeling of the implications of uncertainty – The IWG used various economic tools to address uncertainty, including reporting the range of uncertainty, performing multiple simulations, and including an updating process (e.g., the 2013 IWG) to capture new information. Additional uncertainty concepts are available in the literature, including a risk premium and an option value, to improve the SCC for use in cost-benefit analyses. Relative to the current IWG approach—the simple averaging across different possibilities (i.e., taking the expected value)—including a risk premium and an option value could significantly improve SCC estimates.

• Address omitted and outdated climate impact estimates – As highlighted by the GAO, the IWG states that the SCC is likely biased downwards due to omitted climate impacts in the climate models’ damage functions—the functions that translate a temperature increase into a monetary cost. Many significant impacts are currently omitted (see our report), generally due to a lack of quantification. Additionally, many of the monetary impact estimates date back to the 1990s. At a minimum, the IWG should conduct sensitivity analyses with respect to the parameters in the models’ damage functions.

With respect to this final point, the IWG and various government agencies, such as the National Science Foundation, should increase funding for work that aims to estimate the monetary cost of future climate impacts. This would be consistent with the 2010 IWG goal of “revisiting the SCC values within two years or at such time as substantially updated models become available, and to continue to support research in this area.” In particular, by funding interdisciplinary research with this aim, these agencies could substantially move our nation forward in understanding the cost of climate change. This would help agencies make the most efficient policy decisions, and increase social well-being.

The IWG should not rest on its laurels. Now that the GAO has approved its process for updates, it should consider a more thorough update of the science behind the SCC. Many of these steps are easy and within reach. Others will take encouragement and research by academics, as well as the IWG and other agencies, starting right now.