What Is the Social Cost of Carbon and How Is It Calculated?

The social cost of carbon is the dollar value of the damage done by each ton of carbon dioxide (CO₂) that is put into the atmosphere. It is considered the most important concept in climate change economics because many regulations have been written using the social cost of carbon to calculate how much they will cost. It is used to explain climate change policies and to implement them.

Estimating the social cost of carbon is not easy, and scientists and economists disagree about what its true value should be. Earth’s climate continues to warm at historic rates, and there is more urgency than ever to find the best way to predict the future harm that will be caused by the amount of CO₂ emitted into the atmosphere today.

As policymakers work to find a way to keep climate change from accelerating, the need to measure and value human impact on the environment becomes more urgent. The social cost of carbon is the most common tool used to do this, but it may not be the best one.

Definition

When CO₂ is emitted, there are several effects it can have on the environment. As a greenhouse gas, CO₂ can trap heat in the atmosphere and change the global climate. As a result of these climate changes, conditions such as increased drought, flooding, severe weather, and other threats to humans and the environment can occur. The social cost of carbon predicts the cost of the long-term damages caused by emitting CO₂ into the atmosphere and estimates how much they will cost in current dollars.

For example, if a state is considering putting in a high-speed rail line, it would have several costs to consider. The largest would be the initial cost to build the rail line, and then maintain it year
after year. But how much environmental damage would they avoid by building a high-speed
rail line instead of having more cars on the road emitting CO₂? To find out, they would use the social cost of carbon and multiply it by the tons of CO₂ that would be saved each year by a high-speed rail line. If you subtract that number from the construction and maintenance costs, you have
the real cost of the rail line. By looking at the cost of releasing an extra ton of CO₂, policymakers can make informed decisions about the economic benefits of cutting back on carbon.

As of 1981, US government agencies are required to consider the cost of CO₂ emissions when they make rules. The United States Government first created its own estimates of the social cost of carbon in 2010 to use in policymaking. The estimates were updated in 2013 and 2015. Another way to view it is that they are legally required to look at the potential monetary benefits of reducing CO₂ emissions that come from their operations. Other countries like Germany and Canada also use this tool, and even states and local governments have begun taking it into consideration.  

Estimates of the social cost of carbon come from models that tie together different elements such as human health, damage to property from flooding, changes in energy costs, and changes in the net productivity of all agriculture. But even the most recent official models are not able to capture all of the damages that could happen because of climate change.

Created in 1969 under the National Environmental Protection Act (NEPA), the Council on Environmental Quality is responsible for developing environmental policy related to areas such as climate change, public lands, sustainability, and environmental justice. The Council advises the President of the United States on environmental policy. It also issues guidance on how NEPA should be implemented within different agencies.

Federal government agencies are required by NEPA to take environmental impacts into consideration when they are planning and making decisions about actions they will take. Part of calculating these environmental impacts is using the social cost of carbon to determine future damages. While some economists and industry members argue that the social cost of carbon does not include enough potential benefits of increased atmospheric CO₂ and that there are too many uncertainties about the future impacts to predict an accurate number.

The interagency working group that was put together in 2009 to put one single value on CO₂
emissions also noted that things like future advances in technology are not fully included in the models that decide the social cost of carbon. But even though the value put on the social cost of carbon is not perfect, federal agencies are still required to use it in decision making the best they can. It’s important for policymakers and legislators to understand how damages from CO₂
emissions will affect the economy.   

How Is the Social Cost of Carbon Calculated?

Calculating the social cost of carbon is complicated. Economists input data into computer models to get the best estimate they can for the social cost of carbon. First, they have to add together things like population, economic growth, technology, and other inputs to predict what future CO₂ emissions will be. Increasing population numbers, for example, would change the amount of
economic growth. Then, they can model what the climate will do in the future and look at changes like sea level rise or global warming and cooling. Next, they must decide how much economic impact these changes will have on different parts of the economy like health and agriculture. Some
models estimate these impacts out to the year 2300. And finally, they take those future economic damages and multiply them by the discount rate to get their value in today’s dollars.

Because there are many different models that have been created to calculate the social cost of carbon, there are even more estimates of what the actual value should be. The way the models are set up and the different factors that are used mean that the numbers from each model can
differ by a lot. To account for those differences, the U.S. government recommends four different values for agencies to use, based on several models.   

Discount Rate

The discount rate is a percent of the value of damages caused by CO₂ emissions. Climate
scientists estimate that most of the damages from climate change will occur decades from now. The discount rate is used to find the difference between the present value of climate change damage and the future value of climate change damage. In other words, it’s the rate at which we are willing to trade present benefits for future benefits. It is a market-based number. Applying the discount rate to future damage costs is like applying an interest rate in reverse. The future cost of damages is multiplied by the discount rate, and then that number is subtracted from the future costs. This is done for each year between the future year and the present year. For example, someone trying to decide if they should buy an electric car to replace their conventional gas car has to calculate the future benefits of owning an electric car. These benefits could include lower gas costs, fewer repair bills, and the value of not emitting pollution directly from their car. Then they must compare those benefits to the cost that they will pay right now to buy a new electric car.

Applications

Since 2010, the EPA has used the social cost of carbon to estimate future damages caused by CO₂
in a number of policies, including:

• The Joint EPA/Department of Transportation rules to establish Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards
• Amendments to the National Emission Standards for Hazardous Air Pollutants and New Source
  Performance Standards for the Portland Cement Manufacturing Industry
• Standards of Performance for New Stationary Sources and Emission Guidelines for Existing Sources: Commercial and Industrial Solid Waste Incineration Units Standards.
• Proposed Carbon Pollution Standard for Future Power Plants

Even though there are many uncertainties about the accuracy of the social cost of carbon, it is still one of the most valuable tools for policy analysis. By using what we currently know about what will affect damages caused by climate change, we can begin to make changes to the model
and eliminate problems. Making the models more accurate as we learn new information will help reduce the future harm caused by climate change.