Social Cost of Carbon (SCC)
Social Cost of Carbon (SCC)
The social cost of carbon (SCC), also known as the shadow price of carbon, is the estimated future economic loss caused by emitting 1 metric ton (2,204 lb, or 1,000 kg) of carbon today. In this context, “carbon” is shorthand for carbon dioxide (CO2), the most important greenhouse gas. Economists calculate SCC by assigning a monetary value to all of the harms that are predicted to arise in the future from emitting 1 metric ton of carbon.
However, this calculation is not straightforward, especially when uncertainty and discounting are brought into the picture. Uncertainties arise in the scientific description of climate change and in economics, which must make guesses about the economy of the future in order to calculate the harms that may be done to that economy by climate change. Discounting is the practice in economics of assigning a lower value to the well-being of future generations than to the present one.
Because of scientific and economic uncertainties, a wide range of values for SCC has been suggested by various experts (from US$5 to $350 per metric ton). Persons who favor fast, drastic action to mitigate climate change tend to favor high estimates for SCC, because high future cost makes it reasonable to spend more
money right now to avoid that future cost. Conversely, those who favor minimal or no action to mitigate climate change tend to favor low estimates for SCC.
Historical Background and Scientific Foundations
Economics is the study of the production, consumption, and transfer of wealth. The concept of social cost was developed in the early twentieth century, in the sub-field now known as welfare economics. (Here “welfare” refers to all kinds of human well-being, not just government aid for people in need.) The founding work of welfare economics was the book The Economics of Welfare (1919), by American economist Arthur Cecil Pigou (1877–1959). Pigou was the first to study the economics of what happens when actions by one person have consequences for others that the first person does not have to pay for.
For instance, someone who dumps acid in a stream running across their property may save money by not having to pay for a toxic-waste collection service, but their neighbors downstream may have poisoned drinking water, or a rare species of fish living in the stream might be made extinct, or both. In modern economics, consequences of this kind are called externalities because they are outside of, external to, the economic interests of the decision-maker.
Pollution is an externality of the major industries on which we depend for life and luxury. The private cost of emitting a large amount of CO2 or other greenhouse gas—that is, the direct dollar cost to the polluter—may be zero, yet society bears costs in the form of climate-change impacts, externalities. The total cost imposed by an externality on society is called the social cost of the externality. The amount of social cost imposed by emitting 1 metric ton of carbon is called the social cost of carbon (SCC). Each emitter of CO2, from a motorist driving his or her car to an oil company flaring off natural gas at an offshore oil well, derives a private value from their emissions yet bears only a tiny share of the social cost of their emissions.
WORDS TO KNOW
CAP AND TRADE: The practice, in pollution-control or climate-mitigation schemes, of mandating an upper limit or cap for the total amount of some substance to be emitted (e.g., CO2) and then assigning allowances or credits to polluters that correspond to fixed shares of the total amount. These allowances or credits can then be bought and sold by polluters, in theory allowing emission cuts to be bought where they are most economically rational.
CARBON CREDITS: Units of permission or value, similar to monetary units (e.g., dollars, euros) that entitle their owner to emit one metric ton of carbon dioxide into the atmosphere per credit.
CARBON SINKS: Carbon reservoirs such as forests or oceans that take in and store more carbon (carbon sequestration) than they release. Carbon sinks can serve to partially offset greenhouse-gas emissions.
CARBON TAX: Mandatory fee charged for the emission of a given quantity of CO2 or some other greenhouse gas. Under a carbon taxation scheme, polluters who emit greenhouse gases must pay costs that are directly proportional to their emissions. The purpose of a carbon tax is to reduce greenhouse emissions. Carbon taxation is the main alternative to emissions trading.
DISCOUNTING: The practice, in economics, of assigning lower value to the well-being of future generations than to that of the present one. A controversial aspect of efforts to calculate the social cost of carbon.
EXTERNALITIES: Costs of an economic activity that are not borne, for the most part, by participants in that activity. For example, the harms caused by pollution, including greenhouse pollution, are externalities for polluters.
GREENHOUSE GASES: Gases that cause Earth to retain more thermal energy by absorbing infrared light emitted by Earth's surface. The most important greenhouse gases are water vapor, carbon dioxide, methane, nitrous oxide, and various artificial chemicals such as chlorofluorocarbons. All but the latter are naturally occurring, but human activity over the last several centuries has significantly increased the amounts of carbon dioxide, methane, and nitrous oxide in Earth's atmosphere, causing global warming and global climate change.
INTEGRATED ASSESSMENT MODEL: A computerized, mathematical model of global climate change that combines results and models from the social, economic, biological, and physical sciences, attempting to capture the interactions of human and environmental factors. The goal is to understand current interactions and predict likely results of various policy choices.
Society as a whole desires a healthy, stable, beautiful, and permanent world, but the existing system of manufacturing and consumption, being both destructive and unsustainable, is not supplying that demand. Economists call any mismatch between supply and demand a market failure. Therefore, according to British government economist and former chief economist of the World Bank Nicholas Stern (1946–), “climate change presents a unique challenge for economists: it is the greatest and widest-ranging market failure ever seen.”
According to Stern and many other economists, the best way to correct the market failure of climate change is to force polluters to feel the social cost of carbon directly, as a private monetary cost. One way to do this is to impose a tax on CO2 emissions: in this case, the polluter experiences the social cost of carbon as a tax bill. The more someone emits, the more they must pay. Such taxes—called Pigovian taxes in honor of Pigou, the economist who first proposed them—motivate polluters to pollute less in order to save money. Norway, for example, imposed a Pigovian carbon tax of about $55 per metric ton of CO2 starting in 1991. Since 1996, the oil company Statoil has been pumping 1.1 million tons (1 million metric tons) of CO2 a year into underground storage at its natural-gas platform in Norwegian waters, rather than emitting it into the atmosphere, to avoid paying the tax.
Other options for internalizing SCC include direct regulation (fines or other penalties for emitting more than a certain amount) and cap-and-trade schemes. In a cap-and-trade scheme, government sets a total limit or cap on emissions of a given pollutant, such as CO2, and allots pollution rights (carbon credits) to individual polluters. Individual polluters can buy and sell carbon credits, but the total amount of emissions stays at or below the cap.
Impacts and Issues
To calculate the social cost of 1 metric ton of carbon emitted today, one must calculate the economic harm it does over the whole period of time that it will remain in the atmosphere (about 100 years). Since the early 1990s, such calculations have been done using mathematical tools called Integrated Assessment Models. These models combine scientific forecasts of climate change with economic models (sets of mathematical equations) that attempt to describe future economic activity.
Many uncertainties afflict such calculations. Scientifically, there are uncertainties in measuring present emissions and predicting future ones; projecting future atmospheric CO2 increases caused by emissions (not all emissions remain in the atmosphere—about half are absorbed by carbon sinks); estimating how much climate change will be caused by a given amount of growth in atmospheric CO2; and, finally, identifying the physical impacts of predicted climate change. Economically, there is the difficulty of guessing at monetary values for non-market impacts (harms for which no monetary price exists, like the extinction of species with no market value), predicting how the values of impacts will change over time, accounting for differences in value between impacts on rich and poor nations, and, probably the most contentious issue of all, determining the rate at which the value of future impacts should be discounted.
The last issue, discounting, requires explanation. The social cost of carbon is a dollar figure, namely, the amount of money that it would be worth spending to prevent the emission of 1 metric ton of carbon. If all harms are valued equally, no matter how far in the future they occur, then SCC can be found by adding up the costs of all the harms that the carbon is likely ever to cause. However, economists always discount future costs: that is, they value a loss in the future less than they value a loss today. The farther in the future a loss is, the less it is valued (i.e., the more it is discounted).
Using discounting, for example, one would not consider it worth $1 today to prevent a $1 loss 50 years from now: the future loss would be discounted to some lower number, say $.50. In this case, one would only be willing to spend $.50 today to prevent a $1 loss 50 years from now. The degree to which a future cost is discounted for each year of futurity is called the discount rate and is expressed as an annual percentage. The larger the discount rate, the less one is willing to spend to prevent future losses.
The type of discounting described here, using a fixed percentage, is termed pure time discounting. Other, more complex types are also possible, but they all discount the value of future losses.
Discount rates are controversial because they involve value judgments. For example, counting $1 of loss to a person in 2035 as worth only $.50 of loss to a person today values the future person's well-being half as much as that of a present-day person. Discounting thus gives less ethical weight to people born at later times. Using 2% discounting, a person born in 2035 has half the value (for present-day economists) of someone born in 2000.
Discounting is important because calculations of SCC depend on how much discounting is applied, and arguments about how much we should spend to prevent global warming depend on SCC. The smaller the discount rate used in calculating the SCC, the larger the SCC will be: that is, the more money we will, theoretically, be willing to spend to prevent the emission of 1 metric ton of carbon. But there is no objective way to choose discount rates. Some economists argue for discount rates of 2% or 3%, while others choose much smaller values.
Just, Richard E. The Welfare Economics of Public Policy. Northampton, MA: E. Elgar, 2004.
Metz, B., et al, eds. Climate Change 2007: Mitigation of Climate Change: Contribution of Working Group IIIto the Fourth Assessment Report of the Intergovernmental Panel on Climate Change. New York: Cambridge University Press, 2007.
Hope, Chris W. “The Social Cost of Carbon: What Does It Actually Depend On?” Climate Policy 6 (2006): 566–572.
Pearce, David. “The Social Cost of Carbon and Its Policy Implications.” Oxford Review of Economic Policy 19 (2003): 362–384.
Stern, Nicholas, and Chris Taylor. “Climate Change: Risk, Ethics, and the Stern Review.” Science 317 (2007): 203–204.
Clarkson, Richard, and Kathryn Deyes. “Estimating the Social Cost of Carbon Emissions” (Government Economic Service Working Paper 140). HM Treasury, January 2002. <http://www.hm-treasury.gov.uk/media/5/F/SCC.pdf> (accessed November 6, 2007).
Stern, Nicholas. “Stern Review on the Economics of Climate Change.” HM Treasury, October 2006. <http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/ stern_review_report.cfm> (accessed November 6, 2007).