Why the social cost of carbon increases when governments fail:The importance of inequality and institutional constraints for the social cost of carbon as a normative guide for climate policy

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The social cost of carbon (SCC) has been a central metric for climate policy. The SCC measures the monetary climate damage that is avoided when carbon emissions are reduced by one unit. The level of the SCC critically depends on normative assumptions about justice: global preferences for equity can significantly increase the SCC if climate damages to poor households are not compensated through redistribution from rich households. However, most studies that estimate the SCC assume the availability of efficient instruments for redistribution that balance household inequality in income and climate damages. The SCC may gain importance for regulatory analysis in the future to economically justify ambitious climate policy measures. To increase the robustness of SCC estimates, their derivation needs to take account of real-world constraints to distribution and empirical levels of inequality. This project develops a novel two-level governance model for computing the SCC that allows combining social preferences for equity with inequality at the household level. At the global governance level, the SCC is determined as the optimal carbon tax from maximizing a social welfare function. The national governance level redistributes between households. National transfers lead to a certain level of household inequality that is anticipated at the global level when the SCC is determined. The project will show how household inequality influences the SCC compared to the equality case when national redistribution does not match global preferences for equity. I plan to introduce three specific mechanisms for redistribution at the national level. First, the national level implements emission reductions through command and control instruments without further compensating households for their policy costs or climate damages. Second, the national governance level redistributes between households to maximize a national social welfare function. The level of inequality that results from distribution is efficient from the perspective of the national governance level and reflects its preferences for equity. In the third case, the national level recycles carbon tax revenues through an equal per-capita scheme. The analytical part of the project will reveal how the SCC changes under household inequality and national distributional policies. Additionally, I will estimate the quantitative scope of the analytically identified effects using a numerical Integrated Assessment Model that accounts for empirically calibrated levels of inequality.The goal of my research is to advance the scientific literature on the SCC by including inequality at the household level, combining normative climate change economics with institutional capacity constraints for redistribution at the national governance level. The results are also important for the policy debate about the level of optimal carbon taxes or minimum carbon prices in cap-and-trade systems.