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The Social Cost of Carbon

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In 2021, Alberta farmers’ average crop yields were significantly reduced by drought. A summer of wildfire smoke, blown into our province from fires here and elsewhere, impacted our health and that of our children. And flooding in B.C choked supply lines across Canada, causing $450 million in insured damages alone.

It cannot be denied that costs arise from our changing climate. These costs come at the expense of our food, our health, our economy, and more. Quantifying these costs (both at present and in future) is a task that policy makers and economists have struggled with since at least 1977, when Nobel Prize winner William Nordhaus first began estimatingPDF icon what came to be known as the social cost of carbon.

What Is the Social Cost of Carbon?

This figure, though elusive to calculate, is quite simple at its core: It is the estimated damage to us, in dollars, of emitting a single additional ton of greenhouse gases into our atmospherePDF icon

Take, for example, a fictional proposal for a new coal mine. Ideally, the social cost of carbon would offer policymakers, in plain economic terms, a yardstick with which to measure the future costs of this action against the present day benefits. In this case, it would weigh the straightforward economic benefits of a new mine against the more nebulous costs of the mine’s future damages to our health, our water supply, our planet, and so on. 

Alternatively, the SCC could also be used to measure the future benefits of an action against its present day costs. This would occur for policies meant to decrease emissions, such as the construction of a bicycle lane on a city street. If the future benefits of the action outweighed the present costs, then it would be a sound investment.

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A Brief History of the Social Cost of Carbon

The idea of a social cost of carbon has deep roots in economic theory. Pigouvian taxes — which price the unaccounted externalities in marketplaces — described social costs as early as 1920. And many economic textbooks today use carbon emissions (and the resulting impacts of climate change from them) as a canonical example of an externality that must be addressed through Pigouvian taxation. 

In 1981, due in part to President Reagan’s Executive Order 12291, which required executive agencies to perform a cost-benefit analysis for all major government policies, the social cost of carbon moved from a theoretical concept into the practical world. Today, it informs government policy throughout the United States and Canada, including vehicle fuel standards, power plant regulations, and rules that reduce emissions from oil and gas infrastructure.

Here in Alberta, there are two forms of carbon pricing, both based on the concept of the social cost of carbon. As consumers, we pay a carbon fee for the carbon content of the products we buy; this fee is returned to us in the form of Climate Action Incentive Payments, which we receive quarterly under the Greenhouse Gas Pollution Pricing Act (aka the federal backstop). I advocate for this policy as a volunteer with Citizens’ Climate Lobby Canada.

The other form of carbon pricing in Alberta is the fee on industrial carbon dioxide emissions, which large emitters pay under the provincial Technology Innovation and Emissions Reduction (TIER) program. Industrial emitters currently pay a fee of $50 per tonne, but this fee will rise yearly in $15 increments until it reaches $170 per tonne in 2030.

So What Is the Price?

Modelling the social cost of carbon is not easy. Estimates rely on a number of uncertain factorsPDF icon, including our understanding of Earth’s changing climate, the effect of climate change on our economies, future socioeconomic conditions, and more. Furthermore, determining the cost relies on research into a number of differing fields of study, within which the scientific consensus constantly shifts as more and better data becomes available. Finally, attempts at calculating the SCC depend upon a number of value judgements made by economists and politicians alike, including what is known as the discount ratePDF icon — how much weight we should give to future damages compared to today’s benefits.

Because of these challenges, a number of differing SCC ranges have been put forward over the years.

In the United States, under the Biden administration, the interim social cost of carbon is priced at $51 per ton. This price has been challenged by a number of critics, including the National Academies of Science, Engineering, and Medicine, which noted that the price was based on outdated, simplistic modelling, and a poorly designed discount rate. A higher price is rumoured to be in the works, but has yet to materialize. 

Canada, following the United States’ lead and using United States research, has a carbon price of $50 per tonne, with this important note:

Recent research indicates that this value underestimates the damages of climate change to society and the social benefits of reducing carbon pollution.

Government of Canada, Annex: Pricing carbon pollution

If this value is too low, then what value is the right price? 

Studies from Nature, Resources for the Future, and elsewhere pin that number at around $185 per ton, with some estimates going higher than $300 per ton. These studies differ from the United States’ SCC generally because they:

  • Use more comprehensive coverage of recent, peer-reviewed scientific literature.
  • Reflect the uncertainty of our knowledge into their valuations by drawing an average social cost of carbon from the results of many thousands of estimates made using different inputs.
  • Lower the discount rate.

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The Discount Rate

That last point of lowering the discount rate, as described by Resources for the Future, has driven the majority of the increase in the SCC’s price. 

The reason for this adjustment is that higher discount rates (such as the 3% rate used in the United States’ SCC calculations) devalue the costs of future damages compared to the economic benefits of present-day investments. In general, it is accepted that the present-value of a dollar is worth more than the future-value of a dollar because a dollar today can be invested and return dividends. But, if our valuation of the present-day dollar’s worth is too high, it dangerously limits efforts to reduce future hardships in favour of economic investments we can make today.

Alternatively, a lower discount rate places more importance on safeguarding a future liveable planet by putting present costs and future costs on more equal footing. Consistently, more recent analysis of market interest rates have concluded that lower discount rates are appropriate.

What About Canada?

As I mentioned previously, Canada’s $50 per tonne figure for the social cost of carbon price relies heavily on legwork from the United States. As some critics have pointed out, waiting for research and policy updates from the U.S. can leave Canadian decision makers with incomplete information while deciding critical long-term climate objectives. 

To address this issue, Canada could implement a stop-gap measure with lower or declining discount ratesPDF icon in order to err on the side of caution in addressing the global, intergenerational, and long-term nature of climate change. Another possibility, carbon pricingPDF icon, has already been implemented and can work alongside the social cost of carbon to explicitly price emissions in the marketplace of goods. In either case, a continued commitment to adhering to the latest science and most accurate models should be at the forefront of our continued understanding of our country’s social cost of carbon.

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