Cost of Carbon

To: Office of Management and Budget of the United States

Date: 10/7/14

Subject: Discounting Cash Flows in the Long Run: Social Cost of Carbon

It is important to investigate the policies regarding greenhouse gas emission that the government implements. Paramount to these policy decisions is the costs associated with damage done by greenhouse gasses. This cost measurement is hard to calculate because it is hard to accurately quantify climate change and the way people value commodities such as water and land. However, it is important to have an accurate model for these costs because they shape policy. One of the main components of these calculations is the social cost of carbon.

The social cost of carbon (SCC) is defined as the present value of damages from emitting carbon. The SCC is a rather abstract cost because it inputs population and economic changes and outputs the increase in emissions and the resulting effects on the environment and atmosphere. These effects on the environment and atmosphere are then translated to costs using damage functions. Since there is not a single way to calculate how and to what extent environmental changes cause damage, there are a wide range of estimations on the SCC.

In order to calculate the SCC, accurate models that assess damages and their costs from carbon dioxide emissions are needed. These damage models are complex because it is hard to determine exactly how the environment will react to climate changes. The ecosystem is also quite complex as it has positive and negative feedback loops that would affect the SCC. Despite this complexity and many parameters for damage models, it is important to create an accurate picture of the social cost of carbon.

Accurate social costs of carbon are necessary to shape regulatory policy about greenhouse gas emissions. Currently the US uses a constant discount rate, which does not give the most accurate picture into the SCC. Using a constant discount rate does not account for any uncertainty regarding damage models and leads to inconsistencies in the SCC and therefore policy. Using a declining discount rate (DDR) is a more accurate model because it accounts for more of the uncertainty in our society. Economists suggest that using a DDR would be more effective because it would set discount rates in the future much lower than the standard 4%. This would result in a higher, and likely more accurate estimations of the social cost of carbon.

Many economists believe that using a constant discount rate underestimates the SCC, and using a DDR would be a more accurate assessment of the costs of carbon. Using a DDR results in a higher value, suggesting that the cost of carbon is greater than the standard model suggests. If the cost of carbon is higher, than perhaps more strict and influential