Why the social cost of carbon increases when governments fail: The importance of inequality and institutional constraints for the social cost of carbon as a normative guide for climate policy
Final Report Abstract
Climate Change has become a priority on the political agenda world-wide. The effects of rising global temperatures are increasingly measurable, and public pressure to mitigate greenhouse gas emissions is rising along with climate impacts. However, reducing emissions has also become the subject of heightened public scrutiny, as increasing energy costs put a burden on households. Policy makers face the challenge to strike a balance between the costs of reducing emissions and the benefits from avoided climate change. Social cost benefit analysis provides a flexible tool to guide policy making. The analysis incorporates various normative aspects of distributional justice when valuing cost and benefits. For climate change, applying social cost benefit analysis derives the social cost of carbon. The social cost of carbon measures the additional damage caused by an extra unit of emissions. It is therefore a central measure for climate policy as it provides estimates of optimal carbon prices, such as carbon emission taxes or the price for permits in emission trading schemes. Most estimates of the social cost of carbon however aggregate the effects of climate policy at the national, regional or global level. Previous literature thereby often neglects that the social cost of carbon is critically influenced by normative assumptions about distributional justice below the national level, for example if damages to low-income groups are not compensated or if carbon prices put a large burden of costs on particular parts of the population. This project developed a novel two-level governance model to explicitly account for subnational heterogeneity of households. At the global level, a general social welfare function aggregates the utilities of households that each country consists of. The social cost of carbon is the optimal carbon price derived from maximizing the social welfare function. At the national level, distributional policies determine inequality between households within each country. The model shows that national redistribution significantly influences the level of the social cost of carbon. The analysis considers national distributional policy that is optimal - that is, in accordance with national preferences for inequality. In this case, the social cost of carbon is roughly equivalent to the case of a national representative agent in model settings that are common in the literature on the social cost of carbon. The social cost of carbon remain roughly equivalent even though the initial incidence of a carbon price or damages from climate change may fall over-proportionally on low-income households. In contrast, if national redistribution is suboptimal and low-income households in one country are not compensated for disproportional climate damages, the social cost of carbon increases in all countries. Applying an Integrated Assessment Model, new quantitative estimates show that the social cost of carbon can double in some countries if absolute climate damages fall equally on low- and high-income households and national institutions fail to compensate for these damages.
Publications
- (2019): The social cost of carbon and inequality: when local redistribution shapes global carbon prices, CESifo Working Paper No. 7628
Kornek, U., Klenert, D., Edenhofer, O., Fleurbaey, M.
