Strategic Behavior and the Environment > Vol 8 > Issue 3

Setting Carbon Taxes using Declining Discount Rates: Implications for Investment-Based Mitigation

Chris J. Kennedy, Environmental Science and Policy, George Mason University, USA, ckenned7@gmu.edu , Shana M. McDermott, Department of Economics, Trinity University, USA, smcdermo@trinity.edu , Matthew E. Oliver, School of Economics, Georgia Institute of Technology, USA, matthew.oliver@econ.gatech.edu
 
Suggested Citation
Chris J. Kennedy, Shana M. McDermott and Matthew E. Oliver (2020), "Setting Carbon Taxes using Declining Discount Rates: Implications for Investment-Based Mitigation", Strategic Behavior and the Environment: Vol. 8: No. 3, pp 311-344. http://dx.doi.org/10.1561/102.00000097

Publication Date: 12 Oct 2020
© 2020 C. J. Kennedy, S. M. McDermott and M. E. Oliver
 
Subjects
Carbon regulation,  Environmental economics,  Climate change
 
Keywords
JEL Codes: H43Q51Q54Q58
Declining discount rateclimate policycarbon taxinvestment-based mitigation
 

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In this article:
Introduction 
Declining Discount Rates: A Brief Review 
Simple Model of Carbon Abatement Investment at t = 0 
Numerical Illustration 
Discussion 
Conclusion 
Acknowledgments 
References 

Abstract

The use of declining discount rates (DDR) to calculate the net present value of damages associated with climate change has important ramifications for climate policy. We examine the behavior of a firm subject to climate-based market interventions, specifically carbon taxes or abatement credits that are indexed to the social cost of carbon (SCC). Recognizing that private abatement investment decisions are financed via capital markets, we show that when the SCC is calculated using a DDR it is impossible for the policymaker to induce a level of investment today that is consistent with the SCC forecast for future periods. This leads to significant under-investment in abatement. We discuss the practical implications of this result for climate policy, with particular focus on climate policies designed to foster investment-based mitigation.

DOI:10.1561/102.00000097