Kingdom’s “Green Book” for regulatory analysis (HM Treasury 2020), the declining discount schedule in France (Lebègue 2005) and varying the discount rate based on the time period in Germany (Schwermer 2012, U.S. GAO 2020)). This approach uses a higher discount rate initially, like the current estimate of the consumption interest rate, but applies a graduated scale of lower discount rates further out in time.[1]
Instead of explicitly specifying a declining discount rate schedule, the IWG in 2010 elected to use a constant but lower discount rate to capture the directional effect of the literature on discounting under uncertainty. Specifically, the IWG considered two declining discount rate schedules based on the mean-reverting and random walk models from Newell and Pizer (2003) starting at a discount rate of 3 percent. The 2.5 percent discount rate selected by the IWG in 2010 reflected the midpoint between the average certainty equivalent discount rates of both models. The approach of using a lower, but constant, discount rate to capture the effect of uncertainty has led to inconsistency in regulatory analyses, where impacts occurring in a given year are discounted at different rates depending on whether they are related to climate change (Arrow et al. 2014). The National Academies (2017) and EPA’s Science Advisory Board (2021) have recommended that the U.S. Government establish an explicit declining discount rate schedule that is applied to all regulatory impacts in an analysis to capture the effect of uncertainty on long-term discount rates, while also maintaining consistency across impact categories in the analysis. The IWG will consider the literature on declining discount rates and the recommendations of the National Academies (2017) and EPA’s Science Advisory Board (2021) as it develops future updates to the SC-GHG. In the interim, the IWG is returning to the use of the 2.5, 3, and 5 percent discount rates in calculating the SC-GHG but recommends that agencies describe potential limitations in their analyses to ensure transparency. As noted above, agencies may also consider discount rates below 2.5 percent as part of a sensitivity analysis.
4Interim Estimates of SC-CO2, SC-CH4, SC-N2O
The interim SC-GHG estimates presented in this TSD rely on the same models and harmonized inputs for the socioeconomic emissions scenarios and equilibrium climate sensitivity distribution used for USG SC-GHG estimates since 2013. Specifically, the SC-GHG estimates rely on an ensemble of three IAMs: Dynamic Integrated Climate and Economy (DICE) 2010 (Nordhaus 2010); Climate Framework for Uncertainty, Negotiation, and Distribution (FUND) 3.8 (Anthoff and Tol 2013a, 2013b); and Policy Analysis of the Greenhouse Gas Effect (PAGE) 2009 (Hope 2013). IAMs are useful because they combine climate processes, economic growth, and feedback between the climate and the global economy into a single modeling framework. They gain this advantage at the expense of a more detailed representation of underlying climatic and economic systems. DICE, PAGE, and FUND all take stylized, reduced-form approaches and have been widely used in the economic and scientific literature since the 1990s. They are periodically updated by the model developers, but as discussed further in Section 5, the versions of the three models used in the 2013 and 2016 TSDs do not reflect the tremendous increase in the scientific and economic understanding of climate-related damages that has occurred in the past decade. The three IAMs
- ↑ For instance, the United Kingdom applies a discount rate of 3.5 percent to the first 30 years; 3 percent for years 31 - 75; 2.5 percent for years 76 - 125; 2 percent for years 126 - 200; 1.5 percent for years 201 - 300; and 1 percent after 300 years. As a sensitivity, it recommends a discount rate of 3 percent for the first 30 years, also decreasing over time.
