Climate change: Assessing the costs of doing nothing

by Bill Chameides | September 27th, 2012
posted by Erica Rowell (Editor)

Pumping that gallon of gasoline may cost you more than you think … eventually.

The debate about what to do about global warming and those pesky carbon dioxide (CO2) emissions almost always eventually comes down to economics. For example, there’s the suggestion of putting “a price on carbon.” All well and good, comes the retort — except that the costs to fill up your gas tank and keep your home lights burning would go up, an already sputtering economy would slow down, jobs would be destroyed, and that, these folks argue, is something we simply can’t afford, end of story.

Of course such arguments miss an important point — climate change will have impacts that will also exact costs that will have to be paid for. In the jargon-speak of the economist, there are the external or social costs to using fossil fuels that emit CO2, costs that are not reflected in the price we pay at the pump for gasoline or in our bill for electricity generated from coal or natural gas but costs that nevertheless we or folks further down the road eventually pay to deal with the environmental impacts of that pollution.

Not including these social costs in the price we pay for CO2-emitting fuels, goes the counter argument, represents a market distortion that is best remedied by internalizing them into their market price. One way to do this would be to impose a carbon tax on fossil fuels. Another indirect way would be through policy changes like mandating emissions reductions from power plants that lower pollution and thereby reduce those external costs. In each case, we would acknowledge and integrate external costs into the actual prices that consumers pay.

So what are those costs anyway?

Calculating external costs is no easy thing. It requires an understanding of what the climate will be like in, say, 2050, and not just the global climate but the climate in different regions of the world where these climate impacts will be occurring. It also requires that we know how and where people live in 2050 and with what types of infrastructure, because those things will largely determine the nature and extent of the impacts of any change in climate on local populations. And lastly we need to know how much a 2012 dollar will be worth in 2050 (i.e., the discount rate). The impacts of climate change will be largely felt decades (and centuries) from now and therefore the costs of any damage from climate change will be paid for then, when some economists assume people will be more affluent and therefore in a better position to pay. Suffice it to say, all these requirements make an estimate of the social costs of carbon problematic.

And so some groups have essentially punted when asked that question (for example, the authors of the National Academy of Sciences report “The Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use”). But others have stepped up to the plate; perhaps most notable of these was Nicholas Stern whose 2006/2007 report titled “Stern Review on the Economics of Climate Change” concluded [pdf] that “the benefits of strong and early action far outweigh the economic costs of not acting.” The report raised quite a stir and was roundly criticized by some economists (see here [pdf] and here) for, among other things, assuming an unrealistically low discount rate.

Traffic safety group enters the fray

Why would a government agency tasked with overseeing traffic safety get involved with estimating the social costs of carbon? Well, remember those fuel economy standards known as CAFE for Corporate Average Fuel Economy? It turns out that the National Highway Traffic Safety Administration (NHTSA) has the responsibility for writing and enforcing those standards and in doing so is required to consider their costs and benefits. In principle, increasing the fuel efficiency of cars will lower CO2 emissions and thus carry a climate benefit. Historically, however, NHTSA had never considered climate impacts and their costs in evaluating the benefits of the fuel economy standards.

In 2007, when the Bush administration proposed new, weaker CAFE standards, a coalition of states, cities and public interest groups led by the Center for Biological Diversity took NHTSA to court demanding that externalities be worked into the rule. NHTSA’s position at the time was that because establishing a monetary value of the standards is so dicey and the range of possible costs so large, as discussed above, it made no sense to do so.

Alas, NHTSA lost in court. Calling the government’s position “arbitrary and capricious” (ouch), the Ninth Circuit Court of Appeals ordered the administration to monetize the social (a k a external) costs of carbon and to include them in its cost-benefit analysis before issuing fuel economy standards.

It took a while (and a change of administrations) for the government to get cracking on the Ninth Circuit’s order and develop a government-wide cost. In 2009, a newly sworn-in President Obama formed the Interagency Working Group on the Social Costs of Carbon. About a year later the group published a report [pdf] with a best estimate of $21 per metric ton of carbon emissions and a possible range from $5 to $65 per ton.

How much is $21 per metric ton of carbon?

Suppose we were to decide to impose a carbon tax on gasoline equivalent to $21 per ton of carbon emissions. How would that affect the price? For simplicity, let’s just consider the carbon in the fuel itself (and not worry about the embedded carbon from the drilling, transport and refining). There are about 20 pounds of carbon dioxide in a gallon of gasoline. At $21 per metric ton of carbon emissions that translates into an additional five cents* for each gallon of gasoline you buy. If the price were $65 per metric ton of carbon, 16 cents* would be added to the price of a gallon of gasoline. Not insignificant but not that much either.

New study raises the stakes

Now a new study published in the Journal of Environmental Science by Laurie Johnson of the Natural Resources Defense Council and Chris Hope of the University of Cambridge challenges the assumptions made by the Interagency Working Group and argues that the social costs of carbon are significantly higher.

Their major points of departure with the working group’s methodology are two-fold:

• Discount Rate:The discount rate attempts to take into account the fact that a dollar today is more valuable than a dollar tomorrow. The larger the discount rate, the lower the cost of a future climate impact will be in terms of today’s dollars. For a discount rate of 5 percent, $100 of climate damage in 2050 would be valued at only $16 today; for a discount rate of 2.5 percent, it would be $39.**The Working Group’s best-estimate discount rate is 3 percent with a range of 2.5 to 5 percent. Johnson and Hope — citing studies by the Office and Management and Budget, the Environmental Protection Agency [pdf], and the Stern Review mentioned above — argue that those rates are too large and that a range of 0.5 to 2.5 percent is more appropriate.
• Equity Weighing: Johnson and Hope, again citing ample literature, claim that the working group’s assumption that a dollar’s worth of climate impact in a poor region is the same as that in a rich region does not recognize the fact that poorer societies are less capable of responding to environmental crises, and in that sense crises there would be more expensive. To compensate for this fact, the authors adopted a so-called “equity weighing” methodology.

Using the lower constant (as well as declining) discounting rates and arguing that the “results are similar when the government’s estimates are equity weighted,” Johnson and Hope arrived at a substantially different social cost for carbon — potentially exceeding $100 per metric ton, with a range from about $50 to $250 per metric ton.

Should you care?

I guess the flip answer would be, Yes, you should care if you plan on being around in 2050 or care about the world your progeny will inherit.

But for those less flippantly inclined, there are nearer term implications. For example, suppose we decide to impose a gasoline tax based on the social costs of carbon. Instead of the ~$0.05* per gallon tax at the pump (from the government’s central estimate of $21), a social cost of $250 per metric ton would add an extra $0.62* or more per gallon. Now we’re beginning to talk about real money. It would add about 16 percent to the cost I paid at the pump here in Durham the other day.

Is that bad? The downside obviously is that you would be paying more to drive. The upside is that you and everyone else will probably end up driving less, using less gasoline, and emitting less carbon and arguably lower the social costs of carbon down the line.

It’s the old pay up now or pay up later conundrum.

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End notes

* The cost added per gallon of gasoline from pricing carbon is a first-order estimate based on the amount of carbon produced from burning a gallon of gasoline. Other estimates (see here and here) differ significantly.

** Over longer periods of time the value in terms of today’s dollars drops even more and this is why some economists argue we should do little now. Others contend that this lens is flawed and doesn’t grasp the finer points of the dilemma of dealing with an event far off into the future. See discussion.

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