The SCC is an essential mechanism for policy evaluation and is widely viewed as the “gold standard” for cost-benefit analysis for climate policy. The SCC is the present value for the future damages incurred from an additional ton of carbon dioxide emissions released today. The SCC is derived from sophisticated Integrated Assessment Models (IAMs) like dynamic integrated model of climate and economy (DICE), framework for uncertainty, negotiation, and distribution (FUND), and policy analysis of the greenhouse effect (PAGE) that model GDP growth, greenhouse gas concentrations, climate impacts, and eventual damages in order to quantify global damages. One major parameter in all these models that is contested is the discount rate. There is a strong inverse relationship between discount rate and SCC, which is intuitive: a higher discount rate places most value on economic outcomes that are nearer in time to today, and very little or no value on damages that occur progressively into the future, and thus has a low SCC. In a model with a lower discount rate, more value is placed on well-being at a given point in time, and thus you would arrive at a much higher SCC, creating a better economic case for immediate and aggressive climate action.^3,4 The question of what discount rate reflects the appropriate intergenerational equity is as much about ethics as it is about technical specification.

Table 1 demonstrates the considerable variability in SCC estimates, and the considerable sensitivity to model choice, but more importantly to the discount rate. Estimates are significantly higher using lower discount rates, allowing future damages to weigh more heavily on SCC values. The values reported by the Interagency Working Group for calculating SCC are averages across many models.

Aside from theoretical modeling, there have been an increasing number of empirical studies that take advantage of statistical methodologies to estimate climate change’s economic consequences based on historical data. Many of these studies conduct econometric analyses to then determine whether there is a causal influence of temperature anomalies on macroeconomic outcomes.

Researchers have leveraged large panel datasets on multiple countries or regions over several decades and run regressions to disentangle the weather variable from GDP growth, agricultural output, labor productivity, and other metrics from which estimates of long-term climate change influences can be calculated.^5,6

Research indicates that persistent deviations from historical temperature norms have a meaningful, and usually non-linear negative influence on economic growth. Furthermore, lower-income nations, as well as agricultural and manufacturing sectors, are vulnerable to the detrimental long-term economic factors that emerge from climate change.^7,8 For example, Johnston⁸ ran regressions indicating that a 1°C increase of average annual temperature above a historical average measure as a specific percentage decrease in pa GDP per capita, as summarized in Table 2 and Figures 1 and 2.

These policies seek to create pay-for pollution, which make the polluter responsible for the social and environmental costs of their actions, resolving the market failure. A carbon tax is just a charge per ton of carbon in fossil fuels that provides a very clear continuous charge on fossil fuel usage, and allows for a very clear and stable price signal or carbon price that gives the incentive for firms and consumers to reduce their emissions going forward. Carbon taxes are often praised for clarity and simplicity, and also a further benefit of being a revenue generator, to fund green activities or for direct payments to their citizens.^{9,10,11,12,13} However, the political problem often arises that for a domestic government to impose a unilateral carbon tax on firms in their jurisdiction creates legitimacy and fairness complications when the rest of the “world” does not set the same tax, it provides an unlevel playing field for firms seeking to compete in global markets.^14,15,16 This would be specifically referred to as a “carbon leakage” problem. Cap-and-trade systems provide another potential market-based approach, a government-imposed limit or cap defines the upper limit of emissions allowed from a sector of the economy. Firms then receive or can purchase tradable allowances. The allowance market traded price may fluctuate based on their carbon equivalency, in contrast to carbon taxes having fixed rates per ton carbon. The clustered market price of energy provided at lower emissions per unit, creates grants firms a dynamic, flexible and ongoing incentive to reduce lower they can get their emissions into absolute certainty on the total emission reductions being undertaken or achieved dependent of the fluctuating traded price of emissions allowances per carbon equivalency.^17,18 Important examples include the European Union’s Emissions Trading Scheme (EU ETS) and several regional programs in Canada as depicted below (Table 3).^19,20

While carbon pricing is intended to punish emissions, subsidies and direct public investment support low-carbon activities and technologies by creating a reward structure. Green subsidies, such as feed-in tariffs for renewable electricity generation, production tax credits or tax credits for purchasers of electric vehicles, are designed to stimulate the adoption of clean technologies by making them more economically competitive with fossil fuels.^21,22 Government support is also critical when technologies rely on public investment to solve market failure related to innovation. The risk or cost associated with fundamental research and development (R&D) new clean technology very often exceeds what private firms (undoubtedly risk adverse) are prepared to assume. Through R&D, governments can stimulate a green industrial revolution that produces public goods for the benefit of the entire economy.^23,24 Moreover, it tends to be more politically palatable to support programs or subsidies as an investment in the economy and jobs, than it is to raise taxes.

This problem is fundamentally about the immediate, concentrated costs of climate policy vs. the long-term, diffuse benefits. In the case of a carbon tax, we see immediate increases in gasoline and electricity prices that bring immediate political pushback and anger from voters. While the benefits an individual might experience from a more stable climate or from avoided future damages may not occur for many decades and are shared by everyone, this gives an elected official a powerful reason to defer or to dilute action on climate in favor of short-term political stability. Economists have analogized this to hyperbolic discounting -our behavioral bias to overvalue immediate rewards and costs, relative to their future alternative.

Climate change is a textbook case of a global public goods dilemma: the benefits of stability of the climate system are non-excludable and non-rivalrous.^25,26 This allows for the “free-rider problem” where, once again, it is rational for each nation to wait for other nations to bear the costs of emissions reductions while finding themselves benefitting for free from a cooler planet.^27,28 International agreements, like the Paris Agreement, aim to partially ameliorate the free-rider problem through voluntary commitments (Nationally Determined Contributions or NDCs), agreed to with transparency and peer pressure as enforcement mechanisms. However, there are no strong enforcement mechanisms, and the political and economic incentives to free-ride are strong, thus weakening the global agreement as a whole.^26,29,30

The status quo is supported by strong and powerful interests who have a vested interest in fossil fuel use. For example, the fossil fuel industry and its proxy businesses lobby for policies that target and seek to influence public opinion, promote laws to stymie climate policy.^31,32 The political effects of this lobbying create a large obstacle to change leading to gridlock or weak measures. In addition, the “incumbency effect” refers to the economies dependent on fossil fuel infrastructure and employment that are as a matter of policy reluctant to change.^33,34 A green economy and climate policies incur costs to existing jobs and business models, and hence it engenders considerable opposition that cannot be dismissed but instead requires a focus on just transition polices and a strategic approach to change (Figure 3).³⁵

The major political obstacle to a carbon tax is its potential for regressivity and the effect of the tax on low-income households. A carbon dividend and revenue recycling approach directly addresses regressivity. In a revenue-neutral carbon tax all of the revenue associated with the carbon tax is returned to the citizens, typically through equal rationing in the form of a check per individual. This approach is more publicly equitable and politically acceptable. By the government putting cash into people’s hands the economic effects of rising energy prices are muted but the price signal allows businesses and consumers to decide to make a change to their carbon footprint.^36,37 This reframes the policy as a fair and market-based approach from a punitive tax.^10,11

Aside from market corrections, government involvement is a necessary step in process of technological innovation that accompanies transition. This is essentially the aim of green industrial policy, a proactive approach to promoting new clean industries and technologies. Instead of waiting for the market’s eventual course of correction, governments can overcome the market failure of innovation by funding fundamental R&D, financing early-stage capital, and generating a predictable policy landscape to demonstrate long-term commitment. This could be direct public investments in these types of projects including smart grid infrastructure, battery manufacturing, and hydrogen production. Ultimately this strategy changes the political frame from focusing on the costs of taking action on climate to focusing on the economic opportunities and employment creation of a new green economy.^{35,38,39,40,41}

The collective action dilemma and carbon leakage, where industries shift to jurisdictions with lower environmental regulations, are significant barriers to global climate agreement. Border Carbon Adjustments (BCAs) would help mitigate carbon leakage by applying a tariff to goods imported from countries that do not have a comparable carbon price. The BCA calculates how much carbon is embedded in a product, and then charges a tariff equivalent to what the domestic producer would have to pay. The major functions of a BCA are two-fold: it insulates domestic industries from foreign competitors which would otherwise have a cost advantage; and it provides a strong economic driver for other countries to develop their own climate policies to avoid the imposition of the BCA. The European Union’s Carbon Border Adjustment Mechanism (CBAM) is one of the most visible world examples of a BCA (Table 4).^40,42,43