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, , Shana M. McDermott, Department of Economics, Trinity University, USA, , Matthew E. Oliver, School of Economics, Georgia Institute of Technology, USA,
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.

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


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


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.