The Social Cost of Carbon: Optimal Policy versus Business-As-Usual

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Single authored paper

Abstract: This paper develops a stochastic climate-economy model to study the difference between the social cost of carbon (SCC) in the optimal policy and the business-as-usual (or current policy) scenario. The former is relevant for determining the optimal Pigouvian tax, whereas the latter represents the current benefit of abating a unit of carbon emissions. The business-as-usual scenario should therefore be used in cost-benefit analysis. Using a simplified climate model, an intuitive expression for the SCC is derived which clearly illustrates how the SCC depends on the policy path. Then a more realistic model is studied to quantitatively analyze the SCC in both scenarios. We show that for convex specifications of the damage function in temperature, the social cost of carbon can be up to 35% higher in the business-as-usual scenario compared to the optimal scenario. To solve our high-dimensional model, a novel least-squares solution method is introduced that relies on stochastic grid points.