Social Cost of Carbon – Pretzel Logic Cannot Save NetZero Agenda

A new paper by economists Nicolas Stern, Joseph Stiglitz, Kristina Karlson, and Charlotte Taylor calls upon the Biden administration to set a “social cost of carbon consistent with a net-zero climate goal.” Call me old fashioned, but analysis is supposed to inform policy, policy is not supposed to dictate the results of analysis.

The Stern et al paper has the unintended benefit of ripping away whatever remains of the pretense that social cost modeling in the climate policy context is open-minded inquiry rather than computer-enhanced propaganda. It also puts the lie to the claim that carbon tax advocates seek, in the tradition of early 20^th century economist Arthur C. Pigou, to make energy markets more “efficient” by “internalizing” the “externalities” of fossil fuel consumption.

The social cost of carbon (SCC) is an estimate in dollars of the “present value” of the climate change impacts caused by an additional (“marginal”) ton of greenhouse gases—chiefly carbon dioxide (CO₂). The U.S. government’s SCC Interagency Working Group (IWG) uses three integrated assessment models (IAMs) to estimate GHG emissions’ social cost. IAMs “integrate” a climate model, which estimates the physical impacts of GHG emissions, with an economic model, which estimates the dollar value of climate change effects on aggregate GDP.

Critics have long argued that SCC estimates are only as good as the assumptions fed into the IAMs, and many assumptions are speculative or subjective. As MIT economist Robert Pindyck memorably put it:

The modeler has a great deal of freedom in choosing functional forms, parameter values, and other inputs, and different choices can give wildly different estimates of the SCC and the optimal amount of abatement. You might think that some input choices are more reasonable or defensible than others, but no, “reasonable” is very much in the eye of the modeler. Thus these models can be used to obtain almost any result one desires. [Emphasis added]

And what is it that SCC modelers “desire”? In general, they desire the largest possible SCC number, whether plausible or not, because the bigger the number, the easier it is to claim, or insinuate, that fossil fuels are unaffordable no matter how cheap, and climate policies are a bargain at any price.

The IWG exercise is a case in point. The IWG runs its three IAMs with artificially low discount rates, a practice that massively inflates the estimated SCC. The IAMs assume climate sensitivities derived from climate prediction models that repeatedly overshoot observed warming in the tropical bulk atmosphere by more than a factor of two. The IWG uses two IAMs that ignore the agricultural benefits of atmospheric CO₂ fertilization, uses an IAM that assumes human ingenuity is powerless to limit climate damages once warming and sea-level rise exceed low-end projections, and runs the IAMs with baseline emission scenarios that implausibly assume levels of fossil-fuel consumption that on average exceed estimated reserves by factors of 2.5 to 4.7 (see chart below). Those methodological choices increase SCC estimates hugely, supporting an agenda of climate alarm and regulatory ambition.

Source: Electric Power Research Institute, Understanding the Social Cost of Carbon: A Technical Assessment, October 2014, p. 4-15.

For climate campaigners, though, there is one small problem. Despite the aforementioned biases, the IWG’s SCC numbers are not big enough to justify “investing” untold trillions of dollars to create a net-zero economy by 2050. Re-estimating the SCC so that it supports rather than conflicts with the Paris Agreement and President Biden’s climate goals is the chief purpose of Stern et al.’s paper.  

The authors explain that achieving NetZero will require policy makers to use “a sound and strong ‘shadow price’ of carbon—that is, the price the federal government uses internally to carry out cost-benefit analyses and guide climate policy decisions.” Currently, that shadow price is the SCC calculated by the IWG. But the IAMs “cannot be relied upon” to produce SCC estimates “that are in line with international temperature targets or domestic emissions targets.” Stern et al. explain:

The interim values produced by the Interagency Working Group (IAWG) on the SCC range from $62 by 2030 to $85 in 2050 (assuming an average discount rate of 3 percent)—values far lower than those needed to limit warming to well below 2°C or reach net zero by 2050.

Indeed, a carbon tax would have to be set far above those SCC estimates to achieve net zero by 2050. For example, a recent study in Nature Climate Change estimates that even a $1,500 per ton carbon tax would achieve only 80 percent decarbonization by 2050.

Based on that study, analyst Bjorn Lomborg calculates that a carbon tax requisite to achieve 95 percent U.S. decarbonization would cost the economy $4.4 trillion annually by 2050, or $11,279 per person—about 500 times more than most Americans are willing to pay.

Stern et al. argue that the IAM-calculated SCC does not match the marginal abatement cost of reducing CO₂ emissions because of “key flaws in the IAM approach.” Such flaws supposedly include discount rates that are not low enough, the difficulty of modeling tipping points, the models’ inadequate treatment of the disproportionate burdens climate change imposes on the poor, and the “unknown unknowns of climate change,” which inherently defy estimation. The authors of course ignore the risk of economic tipping points and disproportionate burdens arising from climate policy, and the opportunity costs (both known and unknown) of climate policy “investments.” But it is not my purpose to explore those issues here. 

My point is simpler. SCC analysis pretends to be a policy-neutral inquiry into the magnitude and probability of climate change damages. In fact, it is an agenda-driven enterprise, as is reflected by the biased methodological choices noted above. Even so, Stern et al. are unhappy with the results, and demand that the SCC be revised to justify President Biden’s policy goals. Why not just kick the SCC to the curb and argue that NetZero is “science-based,” hence whatever “shadow price” helps achieve it is also science-based?

One can only speculate. Perhaps the authors are aware that the United Nations Intergovernmental Panel on Climate Change’s (IPCC) Special Report on Global Warming of 1.5°C never calls climate change a “crisis,” “emergency,” or “existential threat, and does not depict 1.5°C as a tipping point beyond which civilization courts its doom. In fact, the IPCC estimates that in “the no-policy baseline scenario, temperature rises by 3.66°C by 2100, resulting in a global gross domestic product (GDP) loss of 2.6 percent” (Chapter 3, p. 256). A 2.6 percent GDP loss in a global economy projected to grow by several hundred percent between now and 2100 is no planetary disaster.

Apparently, the value in calling a NetZero-aligned “shadow price” the “social cost of carbon” is that it makes a politically determined emission-reduction target look more like a science-based target, even though the authors reimagine the SCC to match a price derived from a policy agenda rather than from SCC calculation models.

This will fool only those who want to be fooled. As Stern et al. probably know, the concept of a Pigou-style carbon tax calibrated to the SCC does not assume that fossil fuels should be taxed out of existence. Rather, the ostensible purpose is to make fossil-fuel producers and consumers bear the full (economic + social) cost of GHG-emitting energy. By thus “internalizing” (paying for) the “external” costs of their actions, an SCC-based carbon tax supposedly leads to the “socially efficient” level of consumption, which may be substantially above zero. As noted above, a carbon tax big enough to eliminate fossil fuels would (1) hugely exceed U.S. government SCC estimates and (2) crash the economy, which is no one’s definition of market efficiency.

Unsurprisingly, Stern et al. do not actually call for shadow prices set high enough to squeeze fossil fuels out of the economy. They propose upping the SCC from $62 per ton in 2030—the IWG’s central estimate—to a range of $77 to $124 per ton. A carbon tax based on those numbers would not come close to achieving NetZero by 2050. Accordingly, they state:

Market mechanisms alone, while crucial, are not nearly enough to tackle the challenge at hand. The economic transformation necessary to reach net-zero emissions by 2050 will require regulations, including financial, that wind down the fossil fuel industry and improve the disclosure of climate risk, green procurement, green lending, research and development, and changes in the design of our cities, our energy systems, agriculture, our transportation systems, and much more.

In other words, saving the planet will require centralized economic planning! You may be wondering: Don’t carbon tax advocates claim that pricing emissions is a more efficient—and lower-cost—climate policy than the potpourri of spending and regulatory programs associated with the Green New Deal?  Indeed, they do.

It is hard to shake the suspicion that political calculation leads Stern et al. to propose mixing carbon taxes with central planning, despite the notorious inefficiency of the latter. Their paper is a pitch to policy makers, including those who want to get reelected. New spending programs win more friends and campaign contributions than new taxes. The growth-chilling effects of taxes are more visible than those of regulations. Lawmakers can blame “an out of control bureaucracy” for regulatory burdens but not for tax burdens. 

The bottom line is this. Stern et al. advocate applying the term “social cost of carbon” to a “shadow price” based not on SCC analysis but on President Biden’s emission-reduction targets. That shreds any pretense that SCC estimation is a science-based inquiry rather than political flimflam.

Stern et al. then purport to use the redefined SCC to advance policies less efficient than a $1,500 per ton carbon tax, which no country is rich enough to afford. Does anyone believe the Stern group’s pretzel logic can make Biden’s NetZero fantasy any more sustainable, politically or economically?     

(This post was updated on 1/31/2022.)