The social cost of carbon with intragenerational inequality and economic uncertainty
The ‘social cost of carbon’ (SCC) – or the costs of climate change to the economy and society – is sensitive to the Social Discount Rate (SDR). The SDR contains a wealth effect and so is higher (SCC lower) if there is growth in per capita incomes. Current estimates of the SCC and SDR therefore ignore intra-generational income inequality and the fact that, despite increases in per capita income, many people in society are not getting richer: there is no wealth effect for large sections of society. Inequality and our aversion to it as a society therefore has potentially important implications for the SDR and hence the SCC. This paper investigates just how important intrageneration inequality is for the SCC, compared to intergenerational inequality and macroeconomic uncertainty.
The authors present a tractable formula for the SCC, taking account of intragenerational income inequality, economic uncertainty and economic growth. They adjust the social discount rate so that it takes into account intragenerational fairness and show that if economic growth reduces intragenerational inequality, the SCC is lower than with inequality-neutral growth, especially if there is a significant effort to reduce intra- and intergenerational inequality. The opposite is true if income inequality in increasing.
Calibrated to the observed interest rate and risk premium, the authors calculate the SCC in 2020 at $125 per tonne of carbon dioxide (tCO2) without considering intragenerational inequality, $81/tCO2 if intragenerational inequality decreases over time – as in the Shared Socioeconomic Pathway (SSP) 2, and $213/tCO2 if inequality increases (SSP4). Taking account of changes in intra-generation inequality can be as important for the SCC as the uncertainty associated with rare economic disasters (e.g. major recessions)
Key points for decision-makers
- In the context of climate change policymaking, social discount rates are considered very important for working out how much today’s society should invest in trying to limit the impacts of climate change in the future.
- Because current estimates of the social cost of carbon used in policy circles ignore many factors that are relevant for welfare in the context of climate change, there is a clear need to provide methodological guidance and transparent estimates of the SCC that take into account inequality and inequality aversion (the desire to resist inequality), both within and between generations, and that better reflect the welfare effects of climate change.
- The authors’ aim is to provide the simplest possible framework for evaluating the SDR and the SCC, accounting for inequality both within and across generations, as well as for uncertainty about the future rate of economic growth.
- The formula for the SCC also allows for uncertainty in the growth of mean per-capita consumption over time, and the risk of rare macroeconomic disasters.
- The authors use several Shared Socioeconomic Pathways (SSPs) in their modelling. SSPs have been constructed by climate scientists and economists to predict how society might change over the coming century and how changes might affect greenhouse gas emissions, and they are used as inputs into climate models.
- Progress on estimating the social cost of carbon could inform policy processes like the recent review by the Biden administration of climate policy and the SCC in the United States.