Which Social Cost of Carbon? A Theoretical Perspective

This paper develops a theoretical foundation for the social cost of carbon (SCC). The model highlights the source of debate over whether countries should use the global or domestic SCC for regulatory impact analysis. I identify conditions under which a country’s decision to internalize the global SCC is individually rational. Nevertheless, I show that obtaining international consensus on a particular value will be more challenging than often appreciated. I introduce the notion of a “preferred SCC” to re‡ect each country’s preference for a globally internalized shadow value on emissions conditional on a true value of the global SCC and a distribution of the domestic SCCs among countries. While all countries have a preferred SCC greater than their domestic SCC, a country’s preferred SCC can be greater than or less than the global SCC. How these preferences translate into agreement depends on institutional arrangements for collective decision-making, for which I provide empirical evidence based on various decision rules. Yale University and NBER. I am grateful to Scott Barrett, Arik Levinson, Gernot Wagner and three anonymous referees for helpful comments, in addition to those I received while presenting earlier versions of this paper at Stanford, the University of Illinois, Cornell, Portland State, the NBER Summer Institute, and an AEA session at the 2016 annual meetings in San Francisco. yPlease address correspondence to 195 Prospect Street, Yale University, New Haven, CT 06510. Email: [email protected]. Tel: (203) 432-9533.