The Social Cost of Carbon
How much damage does one ton of CO2 actually cause? This question is at the heart of carbon pricing policy. The social cost of carbon (SCC) attempts to put a dollar value on the harm caused by emissions, from sea level rise to agricultural disruption to health impacts.
What Is the Social Cost of Carbon?
The social cost of carbon is an estimate of the economic damages caused by emitting one additional ton of CO2 into the atmosphere. It includes impacts such as:
- Agricultural changes: Crop yield reductions from heat and drought
- Sea level rise: Coastal flooding, property damage, and displacement
- Health effects: Heat-related deaths, disease spread, air quality impacts
- Extreme weather: More frequent and severe storms, floods, and fires
- Ecosystem damage: Species loss, forest die-offs, ocean acidification
- Economic disruption: Productivity losses, infrastructure damage, migration
Think of the SCC like the cost of a car accident that will happen in the future. We cannot prevent the accident entirely, but we can estimate what it will cost: medical bills, car repairs, lost wages, and pain and suffering. The SCC does the same for climate damage from CO2 emissions.
Why the SCC Matters for Policy
The SCC provides a theoretical foundation for carbon pricing:
If the SCC is $50/ton, then a carbon tax of $50/ton makes emitters pay for the damage they cause. This is economically efficient because it aligns private costs with social costs.
If the carbon price is below the SCC, society is subsidizing pollution. Emitters are not paying for the full damage they cause.
If the carbon price is above the SCC, the policy may be reducing emissions beyond what is economically optimal. (Though some argue we should err on the side of caution given climate risks.)
The SCC is the "right" carbon price in theory. In practice, political and economic constraints mean actual carbon prices are usually lower. But the SCC provides a benchmark for evaluating whether carbon prices are ambitious enough.
How Is the SCC Calculated?
Calculating the SCC involves four steps:
Step 1: Project future emissions
Model how emissions will evolve under different scenarios. This requires assumptions about economic growth, technology development, and policy changes.
Step 2: Translate emissions into climate impacts
Use climate models to convert emissions into temperature changes, sea level rise, and other physical changes.
Step 3: Convert physical changes into economic damages
Estimate how temperature changes affect agriculture, health, productivity, and other economic outcomes. This is the most uncertain step.
Step 4: Discount future damages to present value
Damages occurring decades in the future must be discounted to compare with costs today. The choice of discount rate is extremely important and controversial.
Example calculation (simplified):
Imagine one ton of CO2 emitted today will contribute to:
- $10 in agricultural losses in 2040
- $20 in health costs in 2050
- $30 in coastal flooding damages in 2070
Discounted to present value at 3% per year, these might be worth:
- $6.50 (agriculture, 15 years discounted)
- $9.10 (health, 25 years discounted)
- $8.80 (flooding, 45 years discounted)
Total SCC: about $24/ton
(Actual SCC calculations are far more complex, involving thousands of impact pathways.)
The Discount Rate Debate
The discount rate determines how much we value future damages relative to current costs. This single parameter dramatically affects the SCC.
Higher discount rate (5% or more):
- Future damages are discounted heavily
- Results in lower SCC ($10-30/ton)
- Reflects how financial markets actually discount future returns
Lower discount rate (1-2%):
- Future damages count almost as much as current costs
- Results in higher SCC ($100-200+ per ton)
- Reflects ethical concerns about intergenerational equity
The discount rate question is fundamentally ethical, not just economic.
Consider two scenarios:
- Scenario A: 1,000 people affected by climate damage today
- Scenario B: 1,000 people affected by climate damage in 2100
At a 5% discount rate, Scenario B is worth only about 2% of Scenario A in present value terms. This implies a life in 2100 is worth 50 times less than a life today.
Economist William Nordhaus argues for market-based discount rates (around 4-5%), reflecting how people actually make investment decisions.
Economist Nicholas Stern argues for near-zero discount rates for intergenerational equity. Why should future generations matter less just because they come later?
This debate has no objective answer. It depends on ethical values about obligations to future generations. Most government SCC estimates use rates between 2% and 5%, often presenting a range.
Official SCC Estimates
Several governments have developed official SCC estimates:
| Source | Central estimate | Range | Discount rate |
|---|---|---|---|
| US EPA (2023 interim) | $190/ton | $120-340 | 2% |
| US IWG (2016) | $50/ton | $12-120 | 3% |
| UK Treasury | £70/ton (~$90) | £35-105 | 3.5% |
| Germany (UBA) | €201/ton (~$220) | - | 1% |
| Canada | CAD $65/ton (~$50) | CAD $24-166 | 3% |
Note: Estimates have been rising over time as climate models improve and scientists identify more damage pathways.
The US EPA's 2023 interim value of $190/ton is nearly four times higher than the 2016 estimate. This reflects better science, not just different assumptions. Actual carbon taxes in most countries remain far below even the older estimates.
Limitations of the SCC
The SCC is useful but imperfect:
Hard to measure all damages
Some impacts are difficult to quantify: ecosystem collapse, species extinction, cultural losses from climate migration, potential catastrophic tipping points.
Regional variations
Damages from climate change are not evenly distributed. Tropical and low-income countries face greater impacts. Whose damages should count in a global SCC?
Uncertainty is enormous
Different models produce very different estimates. The range from $10 to $300+ per ton reflects genuine scientific uncertainty, not just different assumptions.
Does not account for abrupt changes
Most SCC models assume gradual climate change. They may underestimate risks from sudden shifts like ice sheet collapse or permafrost thawing.
Using the SCC in Practice
Countries use the SCC in different ways:
Setting carbon tax rates
Some carbon taxes explicitly reference the SCC. However, actual rates are usually lower than SCC estimates due to political and competitiveness concerns.
Cost-benefit analysis
Government agencies use the SCC to evaluate whether climate policies pass a cost-benefit test. A policy that reduces emissions at $40/ton is beneficial if the SCC is $50/ton.
Legal requirements
In the US, courts have required federal agencies to consider the SCC when evaluating regulations. The SCC makes climate costs legally visible.
Corporate decision-making
Some companies use internal carbon prices based on SCC estimates to guide investment decisions.
How Sweden uses the SCC:
Sweden explicitly references the social cost of carbon in policy discussions. The Swedish carbon tax rate (SEK 1,400/ton, about $130) is broadly consistent with SCC estimates, though it varies by sector.
The government argues that pricing carbon at or near the SCC ensures that polluters internalize the true costs of their emissions. This alignment is one reason Sweden's carbon tax has been effective at reducing emissions while maintaining economic growth.
The SCC vs Political Feasibility
In an ideal world, carbon prices would equal the SCC. In practice, politics intervenes:
Gap between theory and practice:
- SCC estimates: $50-200/ton or more
- Average global carbon price: about $14/ton
- Only 5% of emissions priced above $50/ton
Why the gap persists:
- Competitiveness concerns
- Distributional impacts on households
- Political resistance to energy price increases
- Uncertainty about actual SCC values
Closing the gap over time:
The practical strategy is to start with achievable rates and increase over time, gradually approaching the SCC as:
- Acceptance builds
- Complementary policies reduce transition costs
- Revenue recycling protects vulnerable groups
- International coordination addresses competitiveness
Looking Ahead
In the next lesson, we turn from theory to practice: how to actually administer a carbon tax. We will cover registration, reporting, calculation, payment, verification, and enforcement.