August 23, 2013 5:17PM

An Example of the Abuse of the Social Cost of Carbon

In my recent op-ed for The Hill examining the Obama administration’s estimation of the social cost of carbon (SCC)—a measure of how much future damage is purportedly going to be caused by each ton of carbon dioxide that is emitted through human activities—I identified two major problems with their measure.

First, the administration’s SCC was based on an estimate of global rather than domestic damages from anthropogenic climate change—an odd scope for a measure designed to be incorporated in the cost/benefit analysis of U.S. rules and regulations governing domestic activities (such as the energy efficiency of microwave ovens sold in the United States). In fact, Office and Management and Budget (OMB) guidelines state that

Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these effects should be reported separately.

Instead of “reporting separately,” the administration’s SCC embodies “effects beyond the borders of the United States.”

Second, the administration recently revised (upwards) its initial calculation of the SCC. In doing so, it included updates to its underlying economic/climate-change/damage models, but it did not include any updates to the characteristics of the equilibrium climate sensitivity used by the models. Since the equilibrium climate sensitivity is the key factor in how much climate change will result from a given amount of anthropogenic carbon dioxide emissions, and since there is mounting scientific evidence that the equilibrium climate sensitivity is better constrained and lower than that used in the initial analysis, there is no defensible reason why the new science was not included in the administration’s revised SCC calculation.

So that’s two strikes against it.

What I didn’t go into in my op-ed, because it is a rather complicated topic, is the choice of discount rate used in the administration’s SCC analysis. The discount rate, generally put, reflects how much you are willing to pay now to avert future damages. The lower the discount rate, the more costly (in today’s dollars) future damages become. The same OMB guidelines mentioned above also cover the selection of the discount rate to use in cost/benefit analysis. The OMB guidance is that as a default an analysis should use a 7 percent discount rate as the base case, and to show the sensitivity of the results to the discount rate assumption, the analysis also should include the results of using a 3 percent discount rate.

The administration ignored that guideline as well. Instead it opted to determine the SCC using discount rates of 2.5, 3, and 5 percent, and didn't include results for a 7 percent rate—results that would have indicated a substantially reduced cost of future damages.

With now three strikes against it, the administration’s determination of the social cost of carbon should be tossed out.

The door to doing so has just been opened slightly with the announcement that the Department of Energy is opening for public comment a Petition for Reconsideration of its use of the administration’s newly figured and newly increased SCC in its above-mentioned microwave oven energy efficiency rule. We’ll see what becomes of that.

In the meantime, here's an example of how the SCC is currently being used and abused in the justification of new regulations. Economist Robert Murphy (who recently testified to Congress as to the problems with the administration’s SCC methodology) posted this gem from the Environmental Protection Agency discussions of a proposed new rule regulating discharges from steam electric power plants (and how the rule may impact carbon dioxide emissions from the plants):

Media Name: knappenberger_082213_fig1.jpg

Murphy comments:

As the above table shows, EPA is being a dutiful federal agency, following Executive Branch guidelines on how to calculate costs and benefits—it reports its findings using both a 3 percent and a 7 percent discount rate. Yet as the footnote explains, when reporting the benefits of reducing CO2 emissions, the EPA actually can’t use a 7 percent discount rate, because an estimate of the SCC (social cost of carbon) for a 7 percent rate is “not available.” Why is it not available? Because the [administration’s] Working Group explicitly ignored the OMB guidelines, and only reported the figures for 3 percent and 5 percent.

We thus have an absurd situation, in which EPA and other regulatory agencies will be following the rules and calculating benefits and costs at both the 3 percent and 7 percent discount rates. Yet, when they express the “social benefits” of reducing greenhouse gas emissions at the 7 percent rate, they are actually going to plug in the wrong number, and explain in a footnote why they are doing so. To repeat, this is important, because the “right” number would show that there are virtually no “social benefits” from reducing greenhouse gas emissions.

As I have explained elsewhere, there are far more problems to the Obama Administration’s computer-model-case against carbon, than just the choice of discount rate. Yet the knots into which the federal government has tied itself, in order to avoid revealing the truth about the actual economic literature, is quite revealing—not to mention hilarious.

The administration’s SCC is a devious tool designed to justify more and more expensive rules and regulations impacting virtually every aspects of our lives, and it is developed by violating federal guidelines and ignoring the best science.

All around bad news.