Technical guidance: how do we apply the SCC in our analyses?

What should we choose as our central estimate?

The IWG SCC estimates are not a single number, but instead a range of four estimates, based on three discount rates, plus a 95th percentile estimate that represents catastrophic, low-probability outcomes. 1 Discount rates allow economists to measure the value of money over time—the tradeoff between what a dollar is worth today and what a dollar would be worth in the future. 2 Higher discount rates result in a lower SCC; if future climate damages are discounted at a high rate, we would be placing less value on avoiding those damages today. The IWG uses discount rates of 5, 3, and 2.5 percent. 3 The fourth value is taken from the 95th percentile of the SCC estimates corresponding to the 3-percent discount rate, which represents catastrophic but unlikely situations. 4 Note that application of the 95th percentile value was not part of an effort to show the probability distribution around the 3-percent discount rate; rather, the 95th percentile value serves as a methodological shortcut to approximate the uncertainties around low-probability but high-damage, catastrophic, or irreversible outcomes that are currently omitted or undercounted in the economic models.

Frequently, agencies will conduct their economic analyses using a range of SCC values. 5  Often, other analyses focus on a “central” estimate of the SCC. 6 The IWG recommends using a 3% discount rate. However, Washington State, for example, selected the 2.5% discount rate as its “central” estimate, for reasons discussed above.

Choosing the most appropriate discount rate is crucial to obtaining the best SCC estimate. A policymaker might decide that the uncertainty associated with climate damages warrants using a discount rate that declines over time, leading to a higher SCC. 7  A consensus has emerged among leading climate economists that a declining discount rate should be used for climate damages, to reflect long-term uncertainty in interest rates. The National Academy of Sciences January 2017 recommendations to the IWG support this approach. 8 Furthermore, as noted above, the federal SCC estimate associated with a 3-percent discount rate should be interpreted as a lower bound. 9

Can we just calculate damages from a single year of emissions?

No. The values of the SCC in the IWG analysis are calculated by adding up the streams of future effects from a ton of emissions in the year of anticipated release, with discount rates reflecting the passage of time between the anticipated release and the future effects. It is necessary to include in the analysis emissions for each year that a plan, action or project is in place, because the SCC increases over time.

How does discounting work?

The IWG’s SCC values represent the damages associated with each additional ton of carbon dioxide emissions released from the perspective of the year of emission. It is necessary when conducting a policy analysis at the present time about policies that affect greenhouse gas releases in the future to make sure that the SCC values are translated into the perspective of the year of the policy decision. The proper way to accomplish this translation is by using the discount rate to convert the effects of emissions from the year of release into the present value.

Imagine a policy has costs today and would decrease emissions in the year 2025. The IWG estimates for 2025 are how much those reductions are worth to people in year 2025, looking at cumulative effects over a 300-year period and discounting back to the year 2025.. But because we prefer present consumption over future consumption, how we'd value that today isn't the same as how people in year 2025 would value it. Still, we need to discount from year 2025 back to today.

What about inflation?

Separate from the discounting considerations, which reflect the resource tradeoffs facing the actors in the relevant year of action, currency tends to inflate over time. The IWG’s calculations for the SCC are based upon 2007 dollars, but the purchasing power of the dollar has gone down since then, meaning that $1 in 2007 is worth $1.20 in 2017. 10 It is important to ensure that the analysis is consistent across time frames and makes sense to decisionmakers. Thus, before any calculations are done, the analysts should account for inflation by converting all of the SCC values from 2007 dollars into dollars for the year the analysis is taking place (currently, 2017).

So once we multiply emissions by the SCC and discount back, are we done?

Not quite. It is still best to include a qualitative description of omitted damages. Best practices for regulatory analysis require including all costs and benefits, even the hard-to-monetize ones. Include a qualitative description to emphasize that the SCC is a lower bound on damages.

And what are all of the steps put together?

To make the calculation, the SCC figure should be multiplied by the projected avoided emissions to provide a figure for the monetized benefits of an action’s or project’s avoided greenhouse gas emissions. Specifically, you should:

  1. Convert the SCC values from 2007 dollars to the year of analysis, using a consumer price index inflation calculator 11 (if the values have not yet been converted);
  2. Determine the avoided emissions for each Year X between the effective date and the end date of 2030;
  3. Multiply the quantity of avoided emissions in Year X by the corresponding SCC in Year X,12 to calculate the monetary value of damages avoided by avoiding emissions in Year X; 13
  4. Apply the same discount rate used to calculate the SCC to calculate the present value of future effects of emissions from Year X; 14
  5. Sum these values for all relevant years between the effective date and the end date to arrive at the total monetized climate benefits of the plan’s avoided emissions;15 and
  6. Qualitatively describe in the final discussion of the climate benefits all of the other damages that have been omitted from the SCC.

State agencies could conduct these calculations with a single, central discount rate for the SCC, or the agency could conduct the analysis several times, using a range of discount rates for the SCC, being sure to use the selected discount rate in step 4 for each different iteration.

Because the SCC has been used in a number of federal regulatory impact analyses and environmental impact statements, there are a number of examples from which states can learn how to conduct their own SCC analysis. 16

How is the SCC used in an analysis with other discount rates?

In its Phase 1 report, NAS recommended that the SCC be used with a “consistent” discount rate in cost-benefit analysis. 17 “Consistent” should be interpreted to mean “compatible” and based on the same theoretically-sound methodology (i.e., theoretically consistent): for example, applying a higher discount rate (say 3%) to other costs and benefits may be “consistent” with a lower discount rate (say 2.5%) for the SCC, to account for the greater uncertainty with respect to climate change relative to more short-run benefits and costs. This approach is appropriate when climate uncertainty exceeds the short-run uncertainty captured by most benefit-cost analysis in which the SCC is applied.

  1.  TSD 2010, supra note 3; TSD 2013, supra note 62; Interagency Working Group On The Social Cost Of Carbon, Technical Support Document: Technical Update Of The Social Cost Of Carbon For Regulatory Impact Analysis Under Executive Order 12866 (2015); TSD 2016, supra note 2. ↩︎
  2.  If offered $1 now or $1 in a year, almost everyone would choose to receive the $1 now. Most individuals would only wait until next year if they were offered more money in the future. The discount rate is how much more you would have to receive to wait until next year. ↩︎
  3.  The IWG correctly excluded a 7% discount rate, a standard private sector rate of return on capital, in its SCC calculations for two main reasons. First, typical financial decisions, such as how much to save in a bank account, focus on private decisions and use private rates of return. However, in the context of climate change, analysts are concerned with social discount rates because emissions mitigation is a public good, where individual emissions choices affect public well-being broadly. Second, climate change is expected to primarily affect consumption, not traditional capital investments. ↩︎
  4.  See Envtl. Defense Fund, Institute for Policy Integrity, Natural Res. Defense Council, & Union of Concerned Scientists, Comments on Proposed Exception to the Colorado Roadless Rule (RIN 0596-AD26) and Supplemental Draft Environmental Impact Statement to Forest Service, Council on Environmental Quality & Office of Information and Regulatory Affairs (2015), to describe importance of 95th percentile value. ↩︎
  5.  See, e.g., Energy Conservation Program: Energy Conservation Standards for Miscellaneous Refrigeration Products, 81 Fed. Reg. 75,194 (Oct. 26, 2016); Cross-State Air Pollution Rule Update for the 2008 Ozone NAAQS, 81 Fed. Reg. 74,504 (Oct. 26, 2016). ↩︎
  6.  See, e.g., Proceeding on Motion of the Commission in Regard to Reforming the Energy Vision, Order Establishing the Benefit Cost Analysis Framework, New York Public Service Comm’n Case No. 14-M-0101 (Jan. 21, 2016) [ “BCA Order”]. ↩︎
  7.  See Weitzman 2001, supra note 93; Kenneth J. Arrow et al. (2013), supra note 95; Kenneth J. Arrow et al. 2014, supra note 95; Maureen L. Cropper et al. 2014, supra note 95; Christian Gollier & Martin L. Weitzman 2010, supra note 95. Policy Integrity comments to NAS, supra note 68. ↩︎
  8.  NAS Second Report, supra note 76. ↩︎
  9.  See Omitted Damages, supra note 6; Richard L. Revesz et al. 2014, supra note 74. ↩︎
  10.  See CPI Inflation Calculator, available here. ↩︎
  11.  See CPI Inflation Calculator. ↩︎
  12.  In general, the SCC goes up over time because greenhouse gases accumulate, exacerbating the effects of climate change—and therefore the harm from each additional unit of emissions—over time. TSD 2010, supra note 3, at 28. ↩︎
  13.  In general, the SCC goes up over time because greenhouse gases accumulate, exacerbating the effects of climate change—and therefore the harm from each additional unit of emissions—over time. TSD 2010, supra note 3, at 28. ↩︎
  14.  Using a consistent discount rate for both the SCC (assessed from the perspective of the actors in the year of emission) and the net present value calculation (assessed from the perspective of the decisionmaker) is important to ensure that the decisionmaker is treating emissions in each time frame similarly. The decisionmaker should not be overvaluing or undervaluing emissions in the present as compared to emissions in the future. NAS First Report, supra note 66. ↩︎
  15.  Steps 4 and 5 combined are equivalent to calculating the present value of the stream of future monetary values using the same discount rate as the SC-CO2 discount rate. ↩︎
  16.  See, e.g., Energy Conservation Program: Energy Conservation Standards for Commercial Refrigeration Equipment, 79 Fed. Reg. 17,726, at 17,728, 773, 779, 811 (Mar. 28, 2014); U.S. Department of Energy, Technical Support Document: Energy Efficiency Program for Consumer Products and Commercial and Industrial Equipment, 12-22, 13-4 to 13-5, 14-2 (2014). ↩︎
  17.  NAS First Report, supra note 66, at 49. ↩︎