Climate change economics

Make carbon pricing a priority

Estimates of the social cost of carbon vary widely as a function of different ethical parameters. Faced with values ranging from US$10 to US$1,000 per tCO2 and above, some perplexed policymakers have adopted 'target-consistent' carbon pricing instead.

Carbon pricing is back in fashion. Global revenues from carbon pricing increased by 60% to US$26 billion in 2015. There are now 40 national and 24 subnational carbon pricing initiatives, and carbon pricing is incorporated in 101 pledges under the Paris Agreement1. In 2017, the world's largest carbon trading system is being planned in China1, the World Bank's High-Level Commission on Carbon Prices is expected to publish their key report mid-year, and the recently launched Climate Leadership Council is advancing a revenue-neutral US$40 per tCO2 carbon tax in the USA2.

But what is the right carbon price? For decades, economists have laboured at pinning down the social cost of carbon — the additional damage caused by the emission of an extra tonne of CO2 — expressed as an equivalent loss of consumption today. Estimates vary widely as a function of model structure and assumptions, including ethical choices. Writing in Nature Climate Change, Matthew Adler and colleagues3 consider some of these ethical aspects, showing that the decision to place more importance on the distribution of well-being leads to carbon prices that are considerably higher than the value currently suggested.

Adler et al. use the RICE integrated assessment model4, with an analysis at the regional level, to compare results between 'utilitarian' and 'prioritarian' ethics. The former sums values that measure the people's well-being (utility) and — since future events include some level of uncertainty — future utilities are reduced (discounted) to be comparable to present values. The latter places more weight on changes in the well-being of worse-off individuals and, in this paper, does not discount the future. The impact of the different ethical positions is analysed through four parameters and their respective central values: the degree of priority for regions with lower utility, γ = 1 (γ = 0 implies conventional utilitarianism); a subsistence level of consumption, czero = US$500 per annum; the pure rate of time preference, ρ = 1% (ρ = 0% implies zero discounting and impartiality between generations); and the elasticity of the marginal utility of consumption, η = 1.

Credit: JAY BRAY / ALAMY STOCK PHOTO

One striking finding is the importance of the choice of base region for converting the utility losses due to climate change back into monetary values. For instance, if all climate damages were converted back to money at (wealthy) US income levels, the social cost of carbon (in 2015 prices) at central parameter values is around US$4,000 per tCO2 for an undiscounted prioritarian, but roughly US$300 per tCO2 for a discounted utilitarian. Equivalent figures normalized to African incomes are approximately US$60 per tCO2 and US$20 per tCO2, respectively. Ignoring regional differences, which is the common approach, leads to global values of approximately US$400 per tCO2 and US$60 per tCO2, respectively. In short, different choices in converting damages into monetary terms can shift the estimated social cost by at least an order of magnitude.

The analysis also shows that the social cost of carbon tends to fall as the priority for the poorest rises. While this finding is not novel, it may appear to contradict the idea that climate change is expected to “hit the poor hardest”. This result can be explained by the assumption that future generations will be considerably richer, compared to the present. Prioritarianism places much greater weight on the interests of the current poor, reducing the social cost of carbon and delaying mitigation into the richer future.

Policy makers are forgiven for wanting simple guidance on the appropriate social cost of carbon, but simple and defensible guidance is not on offer — this paper3 presents wide ranges. For instance, for the utilitarian function (γ = 0) with ρ = 1% and η = 1, the social cost of carbon is around US$60 per tCO2. Values in the range US$10–100 per tCO2 occupy a good part of the ethical parameter space if little weight is placed on the future and a greater weight is placed on the current poor. But values above US$500 per tCO2 are also supported by tenable ethical choices.

The plausible range extends to values well above official US guidance5, which is around US$40 per tCO2 (in 2007 prices). Actual carbon prices tend to be even further below government guidance, at around US$1–10 per tCO2 globally, with the largest carbon trading system, the EU ETS, revealing prices at around €5–10 per tCO2 (ref. 1). This difference between actual prices, official guidance, and the ethical ideal suggests great scope for improvement in carbon pricing. Suggestions to broaden coverage and raise prices include using border carbon adjustments6, the creation of climate clubs with trade sanctions7, or a putative World Climate Assembly8.

The wide range of estimates of the social cost of carbon was a factor in the UK government's decision to instead adopt a target-consistent carbon price9 — that is, a price consistent with achieving politically agreed UK goals10. This has the merit of policy consistency, and it is not as unambitious as it might first appear. Under the Paris Agreement, countries committed to net zero emissions in the second half of the century, and any target-consistent price should therefore achieve this goal. Analyses such as that by Adler and colleagues, in contrast, start from a philosophical and economic ideal. While such ideas may seem politically unrealistic, we have repeatedly seen, not least in 2016, that what is unrealistic one day can become realistic the next.

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Correspondence to Cameron Hepburn.

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Hepburn, C. Make carbon pricing a priority. Nature Clim Change 7, 389–390 (2017). https://doi.org/10.1038/nclimate3302

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