Social Cost of Carbon: GAO Report Ignores Pro-Regulation Bias

An eight-month investigation conducted by the Government Accountability Office (GAO) finds no flaws in the Obama administration’s interagency process for developing social cost of carbon (SCC) estimates. Remarkably, GAO has “no recommendations” to improve the process.

GAO did not attempt to evaluate the “quality” of the administration’s SCC estimates. Even so, it’s unusual for GAO to review an agency, program, or policy and find no room for improvement.

Not that anyone should expect GAO to confront the inherent flaws of SCC analysis. As previously argued on this blog, carbon’s social cost is an unknown quantity, discernible in neither meteorological nor economic data. SCC estimates are perforce spun out of non-validated climate parameters and made-up social damage functions. Armed with such sophistry, climate campaigners can make renewable energy look like a bargain at any price and fossil fuels look unaffordable no matter how cheap.

But even taking SCC analysis at face value, the administration’s process is biased, and the evidence is right there in GAO’s report.

Before getting down to particulars, let’s recall why this topic matters. The SCC is an estimate of the dollar value of damages allegedly caused by an incremental ton of carbon dioxide (CO2) emitted in a given year. The higher the SCC estimate, the more plausible the claims of Obama administration officials and their allies that the benefits of CO2-reduction policies justify the costs.

The administration’s SCC interagency working group (IWG) has published two reports called technical support documents. SCC estimates in the 2013 TSD are roughly 50% higher than in the 2010 TSD. In just three years, CO2 reductions became 50% more valuable. Amazing!

EPA, the Department of Energy, and/or the Department of Transportation have used SCC estimates in 68 rulemakings since May 2008, according to GAO (Appendix I). Fossil fuel foes now use SCC analysis to sell everything from carbon taxes to renewable energy mandates to regional cap-and-trade programs to EPA greenhouse gas regulations.

GAO says everything is hunky-dory because the administration “used consensus-based decision making” (several agencies participated), “relied on existing academic literature and models,” and “took steps to disclose limitations and incorporate new information.” Well, of course they did. These folks are professionals; they know how to check the requisite boxes.

Nonetheless, the administration’s process is biased in four ways. In both the 2010 and 2013 TSDs, the IWG:

1. Inflated the perceived benefit of CO2 reductions to the U.S. economy by providing only higher global SCC values, not lower domestic SCC values, as required by OMB Circular A-4.
2. Inflated the estimated benefit of CO2 reductions by using only low discount rates (2.5%, 3%, 5%) to estimate the present value of future CO2-related damages, not a 7% discount rate, as also required by OMB Circular A-4.
3. Inflated the estimated benefit of CO2 reductions by including ‘worse than we thought’ climate impact projections but not ‘better than we feared’ projections.
4. Inflated the estimated benefit of CO2 reductions by uncritically accepting the IPCC’s 2007 Fourth Assessment Report (AR4) climate sensitivity estimates despite growing evidence that IPCC models are tuned ‘too hot.’

Act locally, estimate globally

Under OMB Circular A-4, agencies may estimate the global costs and benefits of regulations but they must estimate domestic costs and benefits:

Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these effects should be reported separately.

The IWG’s 2010 TSD acknowledges as much (p. 11), and concludes that “a range of values from 7 to 23 percent should be used to adjust the global SCC to calculate domestic effects” (p. 12). In other words, if the global SCC is estimated to be $50/ton CO2, the domestic SCC could be as low as $3.50/ton. But when it comes to actually providing dollar estimates, the 2010 TSD provides only the higher, global SCC values.

The 2013 TSD also acknowledges that under Circular A-4, “analysis of economically significant proposed and final regulations from the domestic perspective is required, while analysis from the international perspective is optional” (p. 14). Yet it, too, reports only global SCC values. Unlike its predecessor, however, the 2013 TSD does not explain how global values should be adjusted to estimate domestic values.

Imagine how different the chart above would look if it showed domestic SCC values. All those numbers would be 77%-93% smaller! Because the TSDs do not report domestic SCC values, neither do agency regulatory impact analyses. In regulation after regulation, agencies compare the domestic costs of CO2 reduction to the supposed global benefits of CO2 reduction. This inflates the perceived benefit-cost ratio of CO2-reducing regulations.

Does this bother GAO? Apparently not. GAO concludes everything is peachy because “the working group decided to include a separate discussion in the [2010] Technical Support Document on estimating domestic benefits and costs” (p. 12). Yes, there is a separate discussion — just no actual numbers journalists might quote or agencies might incorporate in regulatory impact analyses.

GAO also sees no problem in the IWG’s non-reporting of domestic SCC values because such estimates are “approximate, provisional, and highly speculative due to limited evidence” (p. 13) — as if that weren’t the case with all SCC values!

Skew the discount rates

Circular A-4 directs agencies to use a discount rate of 7% as the “base case” in regulatory analysis. Why? Regulations affect how capital is allocated, and 7% is approximately the “average before-tax rate of return to private capital in the U.S. economy.” Some regulations primarily affect consumption, so agencies should also use a lower, 3% discount rate, reflecting the time-value of money. Thus, OMB states that agencies “should provide estimates of net benefits using both 3 percent and 7 percent.”

To be sure, if a rule would “have important intergenerational benefits or costs” — as any climate change policy presumably would — then, according to Circular A-4, agencies “might consider a further sensitivity analysis using a lower but positive discount rate in addition to calculating net benefits using discount rates of 3 and 7 percent.” Or as GAO puts it, in such cases agencies “may, in addition” use a lower discount rate than 3% (p. 4, fn. 9). They still have to crunch the numbers using a 7% rate.

Ignoring this requirement, the IWG in both the 2010 and 2013 TSDs calculated global SCC values using only 2.5%, 3%, and 5% discount rates. To determine what impact this selection had on SCC values, Heritage Foundation analysts David Kreutzer and Kevin Dayaratna ran two of the IWG’s three main “integrated assessment models” with OMB’s “base-case” rate. Here’s what they found: “The simple substitution of the [7%] discount rate drops the SCC estimate by more than 80 percent in the DICE model and pushes it to zero or even negative for the FUND model.”

The GAO, which used to be called the General Accounting Office, professes to see nothing amiss in the IWG’s accounting gimmickry:

The Technical Support Document states that the working group decided to calculate estimates for several discount rates (2.5, 3, and 5 percent) because the academic literature shows that the social cost of carbon is highly sensitive to the discount rate chosen, and because no consensus exists on the appropriate rate. It further states that, in light of such uncertainties, the working group determined that these three discount rates reflect reasonable judgments about the appropriate rate to use [pp. 14-15].

SCC estimates are “highly sensitive” to the discount rate chosen, there is “no consensus” about the appropriate rate due to “uncertainties,” so it’s “reasonable” to exclude OMB’s base-case rate when estimating SCC values. How’s that for a non-sequitur?

Err on the side of alarm

For each half decade from 2010 to 2050, the TSDs provide four different SCC estimates. As GAO observes:

The working group selected four values of the social cost of carbon for regulatory analysis. The first three values are based on the average of estimates calculated at discount rates of 2.5 percent, 3 percent, and 5 percent, and the fourth value was included to represent higher-than-expected economic impacts at the 3 percent discount rate [p. 7].

The 2010 TSD (p. 4) explains that values in the fourth column are “included to represent the higher than-expected impacts from temperature change further out in the tails of the SCC distribution.” Why isn’t there a fifth column to represent lower than-expected impacts from temperature change?

In both TSDs, the IWG calculated ‘worse-than-we-thought’ but not ‘better-than-we-feared’ CO2-related damages. A rather clear case of bias, yet GAO raises no objection.

Cherry pick your science

As mentioned, the IWG used three models to calculate SCC values. GAO states that “the developers updated the academic models to reflect new scientific information, such as in sea level rise and associated damages, resulting in higher [SCC] estimates” in the 2013 TSD (p. 16). However, the developers — and thus the IWG — took no notice of other new scientific information that cuts the other way. I’m referring to the pause, the growing divergence between IPCC warming predictions and observations, and a pile of papers indicating that IPCC climate models are tuned too hot.

The key issue of climate sensitivity is less ‘settled’ today than it appeared to be in 2007. Yet GAO reports that, like the 2010 TSD, the 2013 TSD uses IPCC AR4 climate sensitivity estimates. The IWG claims it revised SCC values to reflect new scientific information. But it conveniently ignored new information that conflicts with the administration’s political narrative.

To sum up, GAO had all the information it needed to identify bias in the IWG’s “process” for developing SCC estimates. The appropriate corrective actions are obvious. Future IWG reports (if we have to put up with them) should:

1. Include domestic as well as global SCC estimates.
2. Include estimates using a 7% discount rate.
3. Include estimates based on lower-than-expected impacts from potential temperature changes.
4. Include estimates based on new information regarding the key scientific variable: climate sensitivity.

What accounts for the vapidity of GAO’s report? A colleague replied as follows:

The real question should be why we need a GAO – an “attaboy, more government” institution, anyway. If it lives here, it eats the same food, drinks the same water, and breathes the same air as the rest of the town. Oh, and cashes the same check.