Last summer I testified before a Senate subcommittee on the numerous problems with the estimates issued by the Administration’s Working Group on the Social Cost of Carbon. The Working Group’s estimates of the “social cost of carbon” were artificially inflated because of several modeling decisions that it made. Unfortunately, at the time I could only speculate as to the precise quantitative impact of their decisions, because the Working Group didn’t report the intermediate data that would be needed to tweak their findings.
After my testimony, the Heritage Foundation conducted an independent reproduction of (part) of the Working Group’s results, confirming just how significant its decisions were. At that time, Heritage analysts had re-run William Nordhaus’ “DICE” model—one of three computer programs used by the Working Group—to estimate the social cost of carbon, with different parameters fed into the model. When using a discount rate of 7 percent—a scenario that OMB requires federal agencies to include when performing cost/benefit analyses of proposed regulations—Heritage saw the estimates of the social cost of carbon collapse.
Now, Heritage’s analysts have finished a similar exercise with another one of the three Working Group models, this time using Richard Tol’s “FUND” model. The results here are even more striking: As I speculated in my testimony—and now Heritage has confirmed—using the discount rate of 7 percent actually shows a negative social cost of carbon. What this means is that additional tons of carbon dioxide emitted in the near future cause net spillover benefits on humanity. Following the Administration’s own logic, this particular result would imply the need for government subsidies to oil and coal producers.
The Choice of Discount Rate
To remind readers of the context of Heritage’s findings: OMB issues guidelines for federal agencies when they engage in cost/benefit analyses, to ensure uniformity in the reports and (in principle) to provide policymakers with accurate information. OMB clearly requires that cost/benefit analyses be performed using both a 3 percent and a 7 percent discount rate.[i] Therefore, when federal agencies (such as EPA or DOE) propose a new regulation, they must justify it economically using both rates. If they want to include the benefit of reduced carbon dioxide emissions, then they should plug in the “social cost of carbon” at both a 3 percent and a 7 percent rate.
Yet they can’t do so, because the Working Group neglected to generate a 7 percent estimate. This leads to the absurd situation of federal agencies reporting costs and benefits at a “7 percent” discount rate, then having to put in a footnote that actually those aren’t the right numbers because the relevant social cost of carbon estimates “are not available.”
In my Senate testimony, I speculated that this omission of a 7 percent discount rate was no accident. Because the (alleged) harms of carbon dioxide emissions occur in the distant future, using a higher discount rate will reduce the present value of those projected damages. Had the Working Group done the obviously correct thing by reporting a 7 percent estimate of the “social cost of carbon”—so that federal agencies wouldn’t need to fudge with footnotes when reporting their regulatory analyses at a “7 percent” discount rate—then the public would have gained some insight into just how dubious this whole enterprise was.
However, I couldn’t say exactly how much the reported social cost of carbon would fall, had the Working Group used a 7 percent figure, because they didn’t save their intermediate results. In other words, outside analysts would have to run the entire computer simulations from scratch, if they wanted to either double check the Administration’s numbers or tweak the inputs to see how much it affected the result.
Heritage Foundation First Ran DICE Model
The Heritage Foundation—especially its programmer Kevin Dayaratna—began work on reproducing the simulations that the Working Group conducted on its three chosen computer models. First the Heritage team chose William Nordhaus’ DICE model. The interested reader can click through to read Heritage’s full report, but in this post I want to focus on the impact of the discount rate. When they plugged in the value of 7 percent, here is what Heritage found:
The table above from Heritage shows just how significant this decision is. For example, in the year 2020, the estimated social cost of carbon using a 3 percent discount rate is about $38/ton of carbon dioxide. In contrast, the SCC in that same year at the 7 percent discount rate falls to about $6/ton, a drop of almost 85 percent. It’s no wonder that the Working Group entirely neglected to report its SCC estimates at the 7 percent rate, or why federal agencies insist on using the 3 percent figure (when reporting cost/benefit results at the “7 percent” rate) even though a closer 5 percent figure is available to them.
Now Heritage Runs FUND Model
But wait, it gets better. The DICE model and the PAGE model are “pessimistic” when it comes to their projections of the impact of global warming on human welfare. In contrast, the FUND model—which was selected, remember, by the Working Group as being representative of the published literature in the field—projects that moderate warming will confer net social (“spillover”) benefits for the next several decades.
In other words, an additional ton of carbon dioxide emitted in the near future would—according to the FUND model—cause the world to get slightly warmer. This additional warmth would pull the stream of net benefits (through the year 2060 or so) slightly forward in time, but it would also pull the more-distant stream of net harms (from around the year 2060 onward) slightly forward in time as well. At a high enough discount rate, the “present discounted value” of this shift could well be positive, meaning that—from our current vantage point—emitting an additional ton of carbon dioxide was a socially beneficial activity that the government ought to be subsidizing. It was the mirror image of the standard argument for penalizing carbon dioxide emissions.
Heritage’s work has now confirmed the above intuition. In their recent post they outline what the FUND model estimates as the social cost of carbon, using the full range of discount rates as required by existing OMB guidelines:
Notice that in the final column, which shows the estimated SCC using a 7 percent discount rate, the entry is negative at least through the year 2030. In this context, a negative “social cost” is the same thing as a positive “social benefit.” For all the reasons that Americans are told they must accept taxes, subsidies, mandates, and huge public relations campaigns in order to reduce carbon emissions, this result of a negative SCC would flip it all on its head. Following the standard logic, these results would indicate a prima facie argument for increasing carbon emissions, since they generate benefits for third parties that the emitters don’t fully appreciate.
To be clear, the Institute for Energy Research is committed to free-market approaches to energy markets and environmental challenges. I am being quite tongue-in-cheek when raising the possibility of government support for carbon-intensive operations.
My serious point, however, is that the alleged scientific case for cracking down on carbon is quite dubious. Even using one of the three computer models picked by the Obama Administration Working Group, if we run it using one of the discount rates required by OMB guidelines, then oops! Out pops a social benefit of carbon.
Of course, nobody can ever truly know what motivates others, but I am very suspicious that the Working Group consciously chose to ignore the OMB guidelines precisely because they didn’t want the awkwardness of very low SCC estimates floating around. In that embarrassing scenario, suddenly the weakness of the “it’s a consensus” claim would be revealed, and policymakers would see quite clearly how judgments about discount rates—which have nothing directly to do with climate analysis—can literally flip the policy conclusion on carbon from “tax” to “subsidize.”
[i] The interested reader can see the full discussion at OMB Circular A-4, by searching the document for the phrase “discount rate.”