Updated Estimates of the Social Cost of Greenhouse Gases for Usage in Regulatory Analysis Related to EPA Emissions Guidelines from Existing Fossil Fuel-Fired Generating Units

The supporting regulatory impact analysis for the Environmental Protection Agency’s (EPA) Emissions Guidelines for Greenhouse Gas Emissions from Existing Fossil Fuel-Fired Generating Units includes calculations of costs and benefits of the proposed regulations as required by executive order. The monetization of benefits resulting from the reduction in greenhouse gases from the proposed rule is conducted using the interim values provided for the social cost of greenhouse gases (SC-GHGs). The methodology underpinning the interim values does not represent the best available science for evaluating the social cost of greenhouse gases. EPA has previously proposed an updated methodology and set of values as supplementary material for its November 2022 update to the proposed Standards of Performance for New, Reconstructed, and Modified Sources and Emissions Guidelines for Existing Sources: Oil and Natural Gas Sector Climate Review. We write to state that EPA’s proposed update to the estimates of the social costs of greenhouse gases, as included in the supplementary report entitled EPA External Review Draft of Report on the Social Cost of Greenhouse Gases: Estimates Incorporating Recent Scientific Advances (henceforth, “EPA report”), represents the best available science.

The EPA report comes in response to EO 13990, in which President Biden instructed his administration to update the federal government’s estimates of SC-GHGs to reflect the best available science in consideration of the recommendations of the National Academies of Science, Engineering, and Medicine (NASEM) in a major report, Valuing Climate Damages: Updating Estimation of the Social Cost of Carbon Dioxide (2017) (henceforth, “NASEM report”). The NASEM report included a set of near-term recommendations, including a call to separate the SCC estimation process into four “modules”—a socioeconomic module, climate system module, damage module, and discounting module—each of which would then be improved or developed by domain experts. The NASEM report summarized these recommendations as follows:

• “The socioeconomic module should use statistical methods and expert judgment for projecting distributions of economic activity, population growth, and emissions into the future.
• The climate module should use a simple Earth system model that satisfies well-defined diagnostic tests to confirm that it properly captures the relationships between CO2 emissions, atmospheric CO2 concentrations, and global mean surface temperature change and sea level rise.
• The damages module should improve and update existing formulations of climate change damages, make calibrations transparent, present disaggregated results, and address correlation between different formulations. This update should draw on recent scientific literature relating to both empirical estimation and process-based modeling of damages.
• The discounting module should incorporate the relationship between economic growth and discounting. The committee also recommends that the IWG provide guidance on how the SC-CO2 estimates should be combined in regulatory impact analyses with other calculations.”

In that context, we would like to highlight six specific points regarding the EPA’s updated estimates and their methodology:

1. The EPA report is fully responsive to all of the NASEM’s near-term recommendations.
2. We fully endorse the manner in which EPA used the Greenhouse Gas Impact Value Estimator, or GIVE, model (Rennert et al. 2022), a product of RFF and University of California, Berkeley’s Social Cost of Carbon Initiative, in its analysis.
3. The EPA report’s updated SC-GHG estimates are the best available SC-GHG estimates, consistent with the best available science, and should therefore replace the interim estimates reported by the Interagency Working Group in February 2021 (Interagency Working Group, 2021).
4. We commend EPA’s use of multiple lines of largely independent evidence on the damage functions, and the DSCIM and Howard and Sterner damage functions reflect important research efforts on the SCC that are largely independent of our work.
5. EPA’s updated approach to discounting is supported by peer-reviewed economic evidence and methods. Specifically, two such key justified updates are the change of the central discount rate from 3 percent to 2 percent, reflecting changes in market interest rates since the 3 percent rate was originally calculated in 2003, and also reflecting the consensus from the economic literature (see, e.g., Giglio, Maggiori, and Stroebel 2015; Del Negro et al. 2017, Council of Economic Advisers 2017, Drupp et al. 2018, Bauer and Rudebusch 2020, Bauer and Rudebusch 2021) and the use of “dynamic discounting,” which links the discount rate to the rate of consumption growth using the parameters from Rennert et al. (2021). This is particularly important to accurately capture risk, in line with standard asset pricing theory (see, e.g. Gollier 2013).
6. The shadow price of capital (SPC) approach discussed in section A.2 of the appendix of the EPA report is the correct method to account for concerns that regulatory costs may displace investment rather than consumption. Indeed, Office of Management and Budget guidance document Circular A-4 calls the SPC approach “the analytically preferred method.” While it remains common to proxy for capital displacement by using a higher 7 percent discount rate based on investment returns, Li and Pizer (2021) and Pizer (2021) demonstrate this approach is generally deeply flawed, especially when impacts are long-lived, such as in the case of climate change. Newell, Pizer, and Prest (2022b) provide an example of how flawed the use of an investment rate can be in such a context and demonstrate a practical example of how to implement the SPC approach in the context of a particular Regulatory Impact Analysis. We encourage analysts undertaking benefit-cost analysis at EPA and elsewhere to use the SPC approach to account for potential concerns around capital displacement, as detailed in Newell, Pizer, and Prest (2022b).