Stanford explainer: Social cost of carbon
In a Q&A, Stanford economists discuss the importance of this number and its role in creating environmental policies.
Carbon emissions not only are causing widespread and potentially irreversible damage to the environment but also may have significant impacts on the economy. Here, Stanford University economists Marshall Burke and Lawrence Goulder explain one tool for understanding those impacts: the social cost of carbon. Burke and Goulder describe what the social cost of carbon is, how it is calculated and used in policymaking, and how it relates to environmental justice.
“The social cost of carbon is the single most important number for thinking about climate change,” said Burke.
Burke is an associate professor of Earth system science in the School of Earth, Energy & Environmental Sciences (Stanford Earth) and a senior fellow at the Freeman Spogli Institute for International Studies. Goulder is the Shuzo Nishihara Professor in Environmental and Resource Economics in the School of Humanities and Sciences and director of the Stanford Environmental and Energy Policy Analysis Center.
Here are the 14 questions Burke and Goulder answered:
[Click on the question to jump to the answer]
- What is the social cost of carbon?
- How is this cost calculated?
- Why is it considered such an important number, and why have I never heard of it?
- What role does the social cost of carbon play in policy evaluation?
- What are the greatest contributors to our carbon emissions?
- What are the greatest costs associated with carbon emissions?
- Why has the social cost of carbon changed between the different presidential administrations?
- What is the Biden administration doing to minimize carbon emissions?
- How does the U.S. estimate of the social cost of carbon compare to estimates from other countries?
- Is it possible to both meet environmental challenges and grow our economy?
- How does the social cost of carbon relate to environmental justice?
- Are there any noteworthy recent advances that will help us lower emissions?
- What research still needs to be done to better understand the true social cost of carbon?
- Are you overall optimistic or pessimistic about our capability to lower our emissions?
1. What is the social cost of carbon?
The short answer: The social cost of carbon is the cost of the damages created by one extra ton of carbon dioxide emissions.
Burke: When we emit a ton of carbon dioxide in the atmosphere, it sticks around for a while and causes warming, affecting human outcomes. The social cost of carbon is the total damage that an additional ton of CO2 has on outcomes, converted into dollars.
2. How is this cost calculated?
The short answer: When calculating the social cost of carbon, the main components are what happens to the climate and how these changes affect economic outcomes, including changes in agricultural productivity, damages caused by sea level rise, and decline in human health and labor productivity.
Goulder: The cost is usually calculated with what are called “integrated assessment models.” These models capture the pathway through which an extra ton of emissions leads to a change in atmospheric concentrations, which in turn leads to changes in average global surface temperature and precipitation. This then leads to biophysical impacts on agriculture and sea level, ultimately leading to damages to our economy and human welfare.
With models, researchers first simulate what the path of climate change would be in the absence of a policy change. Then, they augment the model to record how much damage and climate change increases as a result of an extra ton of emissions. The difference in damage is the social cost of carbon.
Burke: The social cost of carbon is focused on the things that we can measure. These are the sectors of the economy where we have good data on what outcomes look like and where existing research can tell us how that sector of the economy is affected given a specific change in temperature or precipitation. These costs can include changes in agricultural productivity, changes in health outcomes, sea level rise and coastal property damage, changes in energy consumption and declines in labor productivity.
3. Why is it considered such an important number, and why have I never heard of it?
The short answer: The social cost of carbon helps reveal how much society should sacrifice to avoid climate change. It is important to clarify its meaning so that it can be more widely applied.
Goulder: It provides the key information societies need to determine how much to sacrifice to combat climate change. That’s because the social cost of carbon is the benefit – that is, the avoided damage – from reducing emissions of CO2. This makes it a key guide to policymakers: By indicating how much society benefits from reducing CO2 emissions, it shows that climate policies will pay for themselves as long as the economic sacrifices involved don’t exceed the social cost of carbon.
Burke: Many people have never heard of the social cost of carbon because it’s sort of an arcane number. At the very least, we as scientists and academics could do a better job of communicating what this number is, where it comes from and how it’s used, given its importance in policymaking.
The social cost of carbon helps us weigh the benefits of climate mitigation against its costs. I think most people are intuitively on board with a cost-benefit approach. There are just a lot of hard decisions about what counts as costs and what counts as benefits. Excess mortality is a really good example – if a changing climate leads to more mortality, how do we actually value that in dollars? We would do well to be transparent about what these sticky decisions are and get people on board with the process of generating and using these estimates.
4. What role does the social cost of carbon play in policy evaluation?
The short answer: Policymakers use the social cost of carbon to quantify the extra costs associated with carbon emissions that are not automatically reflected in market prices. This helps them better compare the costs and benefits of specific environmental policies.
Burke: The social cost of carbon has been used in the evaluation of at least 80 regulations in the U.S., and is used as a way to quantify and compare the costs and benefits of specific policies.
For example, using their estimated social cost of carbon, the Obama administration determined that, although fuel economy standards might be costly to enact, the benefits to society were greater than the costs. When the Trump administration came in, they changed the social cost of carbon to something much lower and decided to roll back the fuel economy standards because the costs of the standards now appeared to exceed the calculated benefits.
Goulder: It also has an important role in the design of climate change policy. Economists tend to embrace introducing a carbon price equal to the social cost of carbon. Such a price would cause businesses and households to take account of the social cost when they decide how to produce or what to consume. As a result, it helps bring about production and consumption decisions that are more consistent with addressing climate change. The social cost of carbon guides policymakers about where to set the carbon price.
5. What are the greatest contributors to our carbon emissions?
The short answer: In the U.S., major contributors to our carbon emissions include the electricity, transportation and refining sectors, as well as agriculture.
Goulder: In the U.S., the electricity, transportation and manufacturing sectors each contribute between 20 and 30 percent of the CO2 emissions. About 10 percent comes from agriculture. Addressing climate change requires a broad-based policy that helps achieve emissions reduction in several different sectors. A broad-based policy can help society pick the “low-hanging fruit,” that is, exploit the lowest-cost opportunities for reducing CO2 emissions.
6. What are the greatest costs associated with carbon emissions?
The short answer: The greatest costs to an economy depend on its structure, but significant costs associated with carbon emissions include impacts on agriculture, human health and labor productivity.
Burke: This is still debated. The costs depend to some degree on how an economy is structured. In many tropical countries, impacts on agriculture are likely the most important. In industrialized countries such as the U.S., where agriculture is a small share of the overall economic output, impacts on health and labor productivity are the most important effects.
For example, many studies now show very clearly that our productivity at work declines quickly as the temperature gets hot. If that happens to every single person in an economy, even if the temperature has gone up only a little bit, economy-wide effects can be quite large.
There’s also very good research showing that hotter temperatures lead to worse health outcomes. Hot temperatures directly affect cardiovascular function and that is linked with heat stroke and heat-related deaths. Homicides, suicides and traffic accidents also all go up in response to high temperatures.
7. Why has the social cost of carbon changed between the different presidential administrations?
The short answer: The Obama administration introduced the first estimated social cost of carbon and it was $43 a ton. The Trump administration estimate was $3–$5 a ton, and the Biden administration estimate is around $51 a ton. Most analysts tend to support the Obama administration’s estimate over the Trump administration’s.
Goulder: There is considerable uncertainty about the magnitude of the social cost of carbon. Under the Obama administration, a task force consisting of 12 U.S. government agencies was put together to employ several climate-economy models and come up with an estimate of the social cost of carbon. They came up with a range – actually, a very wide range. They couldn’t rule out the possibility of a near zero social cost or a cost of around $100 a ton. But these probabilities were very small.
What is especially important is the central or mean estimate. The central estimate from the Obama administration’s task force was about $43 a ton. This would mean that if you avoided one ton of emissions of carbon dioxide, you’re saving $43 in damage that would have otherwise occurred.
The Trump administration was obliged under the Clean Air Act to estimate the social cost of carbon as well. That administration challenged the way the Obama administration came up with the social cost of carbon. Their number was a range of $3–$5 a ton – an order of magnitude lower than the Obama administration’s.
The Obama administration’s estimate was much larger for several reasons:
- First, it was based on the damage that emissions originating in the U.S. would impose on the whole world. The Trump administration argued that only the damage to climate in the U.S. should be counted.
- Second, the Obama administration employed a discount rate centered around 3 percent to translate future damage to values in today’s dollars. The Trump administration argued for a discount rate in the range of 7–10 percent. Because a lot of damages from climate change occur in the distant future, the use of a higher discount rate makes a huge difference and lowers the estimated damage by putting less weight on the future.
- Third, the Trump administration asserted that the models used by the Obama administration to calculate damages from climate change exaggerated the physical damages from climate change. So they based their own estimates on lower physical damages. This implied a lower social cost of carbon, even before applying higher discount rates.
Now, the Biden administration has recently announced its calculated social cost of carbon. The central value is $51 per ton. This estimate mainly applied the assumptions that the Obama administration employed: The estimate includes the damages to other countries, uses a 3 percent discount rate and relies on the same models as the Obama administration had used earlier.
8. What is the Biden administration doing to minimize carbon emissions?
The short answer: The Biden administration plans to focus on tax breaks for renewable energy, increasing fuel economy goals and devoting more government funding for research and development.
Burke: There’s a very long list of investments the Biden administration is proposing to minimize carbon emissions. As an economist, I would like us to be smart about those investments and choose the ones that are the most cost effective. And a key element of understanding whether a given investment is cost effective is having this estimate of the social cost of carbon. Other considerations are certainly important as well, such as the magnitude and location of jobs created through these investments and their related political palatability. So the social cost of carbon is certainly not the only input to climate investment decisions, but it remains a key input.
Goulder: The Biden administration recently announced its American Jobs Plan, which endorses a wide range of new programs to combat climate change. These include tax breaks for solar- and wind-generated electricity, tax credits to businesses that invest in carbon sequestration, government tax breaks for purchases of electric vehicles and increased funding for research and development of new, low-carbon technologies. Notably, the emphasis is on carrots rather than sticks. What’s absent from the plan is a carbon tax. My sense is that the administration recognizes the virtues of a carbon tax, but feels that the political resistance to this policy option might be too great to justify pushing for it.
9. How does the U.S. estimate of the social cost of carbon compare to estimates from other countries?
The short answer: The U.S. plays a major international role in setting the social cost of carbon. Differences in support for applying a social cost of carbon across countries depends on their economies.
Burke: Many countries do not actually have an official social cost of carbon estimate. After the initial Obama administration estimate of the social cost of carbon, some countries either followed the U.S. approach in terms of figuring out the number or they just took the U.S. estimate directly. That’s why it’s so important now that the Biden administration is updating the social cost of carbon by seeking to incorporate a lot of new research on the cost of climate change that has come out since the Obama administration’s initial efforts. How the U.S. prices carbon has huge global implications.
Goulder: Countries will differ, of course, in their support of applying a social cost of carbon. For example, oil-exporting countries, for reasons that are obvious, tend to be less favorably inclined than many other countries toward a carbon tax or other policies that would raise the price of their key product – crude oil.
10. Is it possible to both meet environmental challenges and grow our economy?
The short answer: There is strong evidence that environmental regulations do not prevent economic growth. However, they may slow growth.
Burke: Yes, it’s absolutely possible. We’ve seen pretty strong evidence of this in recent years. Before COVID-19, we saw around the world that economies were growing strongly and emissions were flat or even declining in some industrialized countries. However, we need to be much more ambitious than that. We need to grow our economies while shrinking emissions. This will take a lot of investment in green infrastructure. But yes, I am absolutely optimistic that with those investments, this can happen.
Goulder: Agreed. In California, we’ve seen rather strict climate regulation. Excluding the pandemic, we’ve seen the state economy grow despite significant environmental regulation in both the climate area and elsewhere. That’s also very clear from the evidence in other countries. Most studies indicate that environmental regulations can slow growth but they certainly don’t prevent growth. When you take into account the long-term benefits in terms of a cleaner environment and the avoidance of damages that pollution can cause to growth in the future, the case for environmental regulations in terms of growth is even stronger.
11. How does the social cost of carbon relate to environmental justice?
The short answer: Warming climate as a result of carbon emissions disproportionately impacts lower-income communities. Putting a price on carbon emissions will also disproportionately raise the cost of living in these communities but there are ways to offset this problem.
Burke: There is now very strong evidence that lower-income communities are often more harmed by a changing climate. For example, they might not be able to easily afford protective technologies, like air conditioning for heat waves or air filters for wildfire smoke. From a health outcomes perspective, sometimes lower-income communities have less access to health services or are already more exposed to climate extremes. Therefore, when the climate warms further, they are more at risk.
Climate should be front and center as an environmental justice issue. I think we should be willing to spend extra money to help lower-income populations who will be more harmed. The social cost of carbon can reflect these differences.
Goulder: Anything that raises the price of fossil fuels is going to raise prices of carbon-intensive goods and services, such as home heating or transportation. In low-income households, a greater fraction of their budgets are for home heating, transportation and other goods and services that are highly carbon intensive, so the cost of living is going to go up more for them than for a rich household. This point – that it will impose an unfair burden on low-income households – has been emphasized by opponents of carbon pricing. However, recent studies indicate that low-income households would not be disproportionately affected once you take account of all its impacts.
It’s also important to note that a carbon pricing policy can be designed so that the revenues it brings in are used to benefit low-income households. One such policy, touted by the recently departed George Shultz, is what he called a “revenue-neutral carbon tax,” where the carbon tax is applied to all the fossil fuels and the revenues then go back to the private sector through a dividend check of equal amounts to every U.S. household. I’ve done some work that suggests, with a policy like this, that the overall income of low-income households will actually be higher after a carbon tax.
12. Are there any noteworthy recent advances that will help us lower emissions?
The short answer: One of the most notable recent advances is the dramatic drop in cost of renewable solar and wind energy.
Burke: The trends that have been most important have been the remarkable decline in the cost of solar and wind energy and the cost of energy storage. The costs of renewables have come down way faster than anyone could have imagined. There’s no excuse to build dirty electricity power generation anymore. In most places, we should use renewables – a sentiment now echoed by the International Energy Agency, an organization set up decades ago to ensure that we never ran out of oil!
We need to be able to store that energy produced by renewables. Battery costs have also come down pretty dramatically and need to keep coming down. If these current trends continue, there’s a lot of optimism that, at least for electricity power generation, we should be able to make these much more carbon friendly, and really carbon free, within a decade or two.
Goulder: We’ve also seen some progress in terms of the cost of terrestrial sequestration of carbon, though perhaps not quite as dramatic as the progress in the cost of renewables. By and large, what’s most exciting to me is what Marshall mentioned: the significant reduction in the cost of wind and solar energy. We’ve also seen progress in fuel efficiency of automobiles, stimulated by fuel economy standards. The costs of reducing emissions have come down, but there is still a long way to go.
13. What research still needs to be done to better understand the true social cost of carbon?
The short answer: Calculating better estimates for how climate change will affect various sectors of the economy and reducing the uncertainty of our estimate of the social cost of carbon.
Burke: There are still sectors of the economy where we do not have good estimates of how they will be affected by changes in climate. For instance, in the U.S., the largest sector of the economy is one we call “services.” This is everything from selling hot dogs on the street to hedge funds. Although it is the largest sector of the U.S. economy, it’s still very hard in many service sectors to understand how changes in climate might affect productivity of workers in that sector. That’s a big, glaring hole in our understanding of what the damages might be from changes in climate.
Goulder: To understand the true social cost of carbon, we really need to understand impacts along a path involving a lot of uncertainties. We need to understand, in particular for emissions of greenhouse gases, how much of those emissions stay in the atmosphere and add to concentrations. The next step is to understand the impact of higher atmospheric concentrations on temperature. Then you need to understand the changes in average global surface temperature on climate.
Scientists from many different walks of life – atmospheric physicists, ecologists, economists – are all working on those connected paths. What needs to be done is to reduce the uncertainties at each link on the chain. In effect, this would reduce the uncertainty about the social cost of carbon, which is now quite wide. There is a lot of work being done on this by think tanks, universities and government agencies. Progress is being made.
However, I don’t think we should wait until we have no uncertainty before applying the important tool of social cost of carbon. To ignore the concept entirely is to make the unwarranted assumption that the social cost of carbon is zero, and I think we can do better than that.
14. Are you overall optimistic or pessimistic about our capability to lower our emissions?
The short answer: Optimistic. There is growing support and promising technological progress for significantly lowering carbon emissions, although political challenges still remain.
Burke: I’m optimistic. The last five to 10 years suggest that there is global appetite for doing something about this problem and that we can have economies that continue to grow while emissions come down. We can look to other sectors where we’ve made remarkable scientific progress in the face of enormous challenges.
COVID-19 is a great example of this. With concerted investment and a lot of smart people working together simultaneously, we showed that we as a society can make dramatic technological progress – i.e., quickly invent new vaccines – to combat a global challenge. Seeing how well we can do against COVID on the technological side makes me really hopeful about what we might do on the climate side. Somewhat surprisingly, within a few decades mortality from climate change could approach the mortality from COVID that we saw over the past year. So we need progress on dealing with climate change that’s at a similar scale to our COVID response.
Goulder: I, too, am optimistic in terms of our technical capability to lower emissions. We already know of a lot of promising technologies that would achieve very significant reductions in emissions. We also know that households are capable of shifting their consumption away from carbon-intensive goods and services toward others.
I’m less optimistic about the likelihood of clearing the political hurdles. There remain a significant number of legislators who refuse to endorse vigorous climate policy publicly or, worse, are climate deniers. Moreover, in the general public, although it has increased its support for government policy to deal with climate change, there remains some real resistance, especially to policies like carbon taxes, for which the costs to businesses or consumers are most salient. I am pretty confident that progress will be made on the climate policy front, but I am less optimistic that there will be speedy progress. Many of the scientists indicate we have 10 to 15 years to take very significant action if extremely serious and irreversible climate-related damages are to be avoided.
Burke is also deputy director at the Center on Food Security and the Environment, a senior fellow at the Stanford Woods Institute for the Environment and the Stanford Institute for Economic Policy Research, and a member of Bio-X. Goulder is also a senior fellow at the Stanford Institute for Economic Policy Research and at Stanford’s Precourt Institute for Energy.
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