Discounting for Climate Change

24 Pages Posted: 18 Dec 2010  

David Anthoff

University of California, Berkeley - Energy and Resources Group

Richard S. J. Tol

VU University Amsterdam - Institute for Environmental Studies (IVM); Carnegie Mellon University - Center for Integrated Study of the Human Dimensions of Global Change; University of Hamburg - Centre for Marine and Climate Research (ZMK); Princeton University

Gary Yohe

Wesleyan University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: 2009

Abstract

It is well-known that the discount rate is crucially important for estimating the social cost of carbon, a standard indicator for the seriousness of climate change and desirable level of climate policy. The Ramsey equation for the discount rate has three components: the pure rate of time preference, a measure of relative risk aversion, and the rate of growth of per capita consumption. Much of the attention on the appropriate discount rate for long-term environmental problems has focussed on the role played by the pure rate of time preference in this formulation. We show that the other two elements are numerically just as important in considerations of anthropogenic climate change. The elasticity of the marginal utility with respect to consumption is particularly important because it assumes three roles: consumption smoothing over time, risk aversion, and inequity aversion. Given the large uncertainties about climate change and widely asymmetric impacts, the assumed rates of risk and inequity aversion can be expected to play significant roles. The consumption growth rate plays multiple roles, as well. It is one of the determinants of the discount rate, and one of the drivers of emissions and hence climate change. We also find that the impacts of climate change grow slower than income, so the effective discount rate is higher than the real discount rate. Moreover, the differential growth rate between rich and poor countries determines the time evolution of the size of the equity weights. As there are a number of crucial but uncertain parameters, it is no surprise that one can obtain almost any estimate of the social cost of carbon. We even show that, for a low pure rate of time preference, the estimate of the social cost of carbon is indeed arbitrary - as one can exclude neither large positive nor large negative impacts in the very long run. However, if we probabilistically constrain the parameters to values that are implied by observed behaviour, we find that the expected social cost of carbon, corrected for uncertainty and inequity, is approximate 60 US dollar per metric tonne of carbon (or roughly $17 per tonne of CO2) under the assumption that catastrophic risk is zero. --

Keywords: Social cost of carbon, climate change, pure time preference, risk aversion, inequity aversion, income elasticity, time horizon, uncertainty

JEL Classification: Q54

Suggested Citation

Anthoff, David and Tol, Richard S. J. and Yohe, Gary, Discounting for Climate Change (2009). Economics: The Open-Access, Open-Assessment E-Journal, Vol. 3, 2009-24. Available at SSRN: https://ssrn.com/abstract=1726854 or http://dx.doi.org/10.5018/economics-ejournal.ja.2009-24

David Anthoff (Contact Author)

University of California, Berkeley - Energy and Resources Group ( email )

United States

Richard S. J. Tol

VU University Amsterdam - Institute for Environmental Studies (IVM) ( email )

De Boelelaan 1115
Amsterdam, 1081 HV
Netherlands
+31 20 444 9555 (Phone)
+31 20 444 9553 (Fax)

Carnegie Mellon University - Center for Integrated Study of the Human Dimensions of Global Change

Pittsburgh, PA 15213-3890
United States

University of Hamburg - Centre for Marine and Climate Research (ZMK)

Troplowitzstrasse 7
D-22529 Hamburg
Germany

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544
United States

Gary Yohe

Wesleyan University - Department of Economics ( email )

238 Church Street
Middletown, CT 06459-0007
United States

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